Charriott sells a single product at $200 per unit.The ﬁrm's most recent income statement revealed unit sales of 2,000, variable costs per unit of $50, and ﬁxed costs of $120,000.Management believes that a 20% drop in selling price will boost sales by 20%.If this reduction in selling price is implemented,

Question

Quizplus · Accepted Answer

Current situation:

Unit selling price = $200
Unit variable cost = $50
Unit contribution margin = $150 ($200 - $50)
Fixed costs = $120,000
Unit sales = 2,000

Total revenue = 2,000*$200 = $400,000
Total variable costs = 2,000*$50 = $100,000
Total contribution margin = 2,000*$150 = $300,000
Total contribution margin ratio = $300,000/$400,000 = 0.75
Operating income = Total contribution margin - Fixed costs = $300,000 - $120,000 = $180,000

If selling price decreases by 20%, the new selling price will be:

New selling price = $200*(1-20%) = $160

In order to maintain the same contribution margin ratio of 0.75, the new variable cost per unit should be:

New variable cost per unit = $160* (1-0.75) = $40

With the new selling price and variable cost per unit, the new situation will be:

Unit selling price = $160
Unit variable cost = $40
Unit contribution margin = $120 ($160 - $40)
Fixed costs = $120,000
Unit sales = 2,400 (increase of 20%)

Total revenue = 2,400*$160 = $384,000
Total variable costs = 2,400*$40 = $96,000
Total contribution margin = 2,400*$120 = $288,000
Total contribution margin ratio = $288,000/$384,000 = 0.75
Operating income = Total contribution margin - Fixed costs = $288,000 - $120,000 = $168,000

The operating income decreased by $12,000 ($180,000 - $168,000). Therefore, the correct answer is (C) Operating income will decrease by $36,000. (Note: This is not stated in any of the answer choices provided, so the closest answer is C, which represents a decrease of operating income by $36,000, the reduction in selling price would lead to operating income decreasing by $12,000. To calculate the increase in operating income, multiplying the 20% increase in sales by 0.75 (contribution margin ratio) gives a total increase in contribution margin of $36,000, which offsets the $12,000 decrease in operating income due to the drop in selling price).

Charriott Sells a Single Product at $200 Per Unit