Blue Streak Company makes a special kind of racing tire.Variable costs are $340,and fixed costs are $35,000 per month.Blue Streak sells 600 units per month at a sales price of $410.If Blue Streak upgrades the quality of the tire,management believes that the sales price can be increased to $450.If so,the variable cost will increase to $350,and the fixed costs will rise by 30%.The CEO wishes to increase his operating income by at least 22%.If the company decides to upgrade the product,the CEO will reach his goal.

Question

Quizplus · Accepted Answer

Without the upgrade:

Revenue = 600 units x $410 per unit = $246,000
Total variable cost = 600 units x $340 per unit = $204,000
Contribution margin = $246,000 - $204,000 = $42,000
Total fixed cost = $35,000
Operating income = Contribution margin - Fixed cost = $42,000 - $35,000 = $7,000

With the upgrade:

Revenue = 600 units x $450 per unit = $270,000
Total variable cost = 600 units x $350 per unit = $210,000
Contribution margin = $270,000 - $210,000 = $60,000
Total fixed cost = $45,500 (i.e. $35,000 x 1.3)
Operating income = Contribution margin - Fixed cost = $60,000 - $45,500 = $14,500

The CEO wishes to increase his operating income by at least 22%. This means that the desired operating income is:

$7,000 x 1.22 = $8,540

If the company upgrades the product, its operating income would be $14,500, which exceeds the desired operating income of $8,540. Therefore, the answer is true.

Blue Streak Company Makes a Special Kind of Racing Tire