Gwyneth Inc. currently has a contribution margin of $12 on its only product and sells 40,000 units. Gwyneth Inc. is considering cutting its sales price by $2 to generate an increase in sales of 10,000 units. How will this change affect its operating income?

Question

Quizplus · Accepted Answer

The current contribution margin is $12 per unit. Reducing the sales price by $2 decreases the contribution margin to $10 per unit. The increase in sales volume is 10,000 units, so the additional contribution to operating income is 10,000 units * $10 = $100,000. However, the reduction in contribution margin for the original 40,000 units is 40,000 units * $2 = $80,000. Therefore, the net increase in operating income is $100,000 - $80,000 = $20,000.