Juan Martinez played classical guitar professionally until his motorcycle accident left him disabled. After long months of therapy, he hired an experienced luthier (maker of stringed instruments)and opened a small shop that makes and sells Spanish guitars. The guitars sell for $600, and the fixed monthly operating costs are as follows: Juan got confused when his accountant told him about contribution margin ratios, but he understood clearly that for every dollar of sales, $0.70 went to cover his fixed costs, and that anything past that point was pure profit.
Juan knows his breakeven point is now 8 units per month, but he is considering raising his price to $660. If he does so, how will that affect the contribution margin ratio?

Question

Juan Martinez played classical guitar professionally until his motorcycle accident left him disabled. After long months of therapy, he hired an experienced luthier (maker of stringed instruments)and opened a small shop that makes and sells Spanish guitars. The guitars sell for $600, and the fixed monthly operating costs are as follows:  Juan got confused when his accountant told him about contribution margin ratios, but he understood clearly that for every dollar of sales, $0.70 went to cover his fixed costs, and that anything past that point was pure profit.
Juan knows his breakeven point is now 8 units per month, but he is considering raising his price to $660. If he does so, how will that affect the contribution margin ratio?

Quizplus · Accepted Answer

The contribution margin ratio is the percentage of each sale that contributes to covering the fixed costs and generating profit. 
Currently, Juan's contribution margin ratio is (600 - 420)/600 = 0.3 or 30%. 
If he raises his price to $660, his new contribution margin will be (660 - 420)/660 = 0.3636 or approximately 36.36%. This means that for every dollar of sales, $0.6364 would go to cover his fixed costs and generate profit, an increase from the current 30%. Therefore, the contribution margin ratio will go up from 70% to approximately 73%.

Juan Martinez Played Classical Guitar Professionally Until His Motorcycle Accident