A small business produces a single product and reports the following data: $$\begin{array} { l c }
\text { Price } & \$ 8.00 \text { per unit } \
\text { Variable cost } & \$ 5.00 \text { per unit } \
\text { Fixed cost } & \$ 21,000 \text { per month } \
\text { Volume } & 10,000 \text { per month }
\end{array}$$ If the company reduces its price to $7.50, it believes that the volume will go up to 11,000 units. How would this change affect operating income?

Question

A small business produces a single product and reports the following data: $$\begin{array} { l c } 
\text { Price } & \$ 8.00 \text { per unit } \
\text { Variable cost } & \$ 5.00 \text { per unit } \
\text { Fixed cost } & \$ 21,000 \text { per month } \
\text { Volume } & 10,000 \text { per month }
\end{array}$$ If the company reduces its price to $7.50, it believes that the volume will go up to 11,000 units. How would this change affect operating income?

Quizplus · Accepted Answer

The operating income will decrease by $2,500. The initial operating income is $9,000 (10,000 units * ($8 - $5) - $21,000). After the price reduction, the operating income is $6,500 (11,000 units * ($7.50 - $5) - $21,000). The change is $6,500 - $9,000 = -$2,500.

A Small Business Produces a Single Product and Reports the Following