As a result of cost increases imposed by its primary supplier, Fast-Fly Fishing Supplies Inc. has experienced an increase in its direct or variable costs per unit that will result in a decrease of 2% in the contribution margin ratio. Operating income last month, before the cost increase, was $2,500 based on sales revenues of $32,000 and fixed costs of $15,500. If sales revenues increase next month by 5%, and the new variable costs come into effect, what can Fast-Fly anticipate in terms of operating profit?
A) $3,288
B) $2,728
C) $4,108
D) $3,109

Question

Quizplus · Accepted Answer

Last month, before the variable cost increase, total variable costs were equal to sales revenues of $32,000 minus total fixed costs of $15,500 minus operating profit of $2,500, amounting to $14,000. This means that the contribution margin ratio last month was equal to $18,000 ($32,000 F1F1F1S1?F1F1F10 $14,000) ÷ $32,000, for a total contribution margin ratio of 56.25%. The increase in variable costs will reduce the contribution margin ratio by 2%; therefore, it will drop to 54.25%. If sales revenues increase next month by 5%, this will result in total sales revenues of $32,000 × 1.05 = $33,600. If the contribution margin on this sales revenue is 54.25%, the contribution margin in dollars will be 0.5425 × $33,600 = $18,228. Subtracting fixed costs of $15,500 from this amount will result in operating income of $2,728.

As a Result of Cost Increases Imposed by Its Primary