Colin was a professional classical guitar player until his motorcycle accident that left him disabled. After long months of therapy, he hired an experienced luthier (maker of stringed instruments)and started a small shop to make and sell Spanish guitars. The guitars sell for $700 and the fixed monthly operating costs are as follows: Colin's accountant told him about contribution margin ratios and he understood clearly that for every dollar of sales, $0.60 went to cover his fixed costs, and that anything past that point was pure profit. Colin is planning to increase the selling price to $750. What impact will the increase in selling price have on the contribution margin ratio?

Question

Colin was a professional classical guitar player until his motorcycle accident that left him disabled. After long months of therapy, he hired an experienced luthier (maker of stringed instruments)and started a small shop to make and sell Spanish guitars. The guitars sell for $700 and the fixed monthly operating costs are as follows:  Colin's accountant told him about contribution margin ratios and he understood clearly that for every dollar of sales, $0.60 went to cover his fixed costs, and that anything past that point was pure profit. Colin is planning to increase the selling price to $750. What impact will the increase in selling price have on the contribution margin ratio?

Quizplus · Accepted Answer

The contribution margin ratio is calculated as (selling price - variable cost) / selling price. Since the variable cost is not given in the problem, we can assume that it remains constant. With an increase in selling price from $700 to $750, the contribution per unit will increase (assuming the variable cost per unit remains the same), resulting in an increase in the contribution margin ratio. The new contribution margin ratio can be calculated as (750 - variable cost) / 750. Therefore, the contribution margin ratio will go up from 60% to approximately 63%.

Colin Was a Professional Classical Guitar Player Until His Motorcycle