Capital One produces a single product, which it sells for $8.00 per unit. Variable costs per unit equal $3.20. The company expects short-term fixed costs to be $7,200 for the coming month, at the projected sales level of 20,000 units. Management is considering several alternative actions designed to improve operating results. In conjunction with this, they have created a profit-planning (that is, a CVP) model, which can be used to evaluate different scenarios.

Capital One's management believes that a 10% reduction in the selling price will increase sales volume by 10%. If this plan is implemented, then operating profit should:

Question

Capital One's management believes that a 10% reduction in the selling price will increase sales volume by 10%. If this plan is implemented, then operating profit should:

Quizplus · Accepted Answer

With a 10% reduction in selling price, the new selling price becomes $8.00 - $0.80 = $7.20 per unit. The sales volume is expected to increase by 10%, making it 22,000 units. The contribution margin per unit becomes $7.20 - $3.20 = $4.00. The total contribution margin is $4.00 * 22,000 = $88,000. Subtracting the fixed costs of $7,200, the new profit is $80,800. Originally, the profit was $8.00 - $3.20 = $4.80 per unit contribution margin, times 20,000 units = $96,000, minus fixed costs of $7,200, resulting in an original profit of $88,800. The difference is $88,800 - $80,800 = $8,000, indicating a decrease in profit.

Capital One Produces a Single Product, Which It Sells for $8.00