Colin was a professional classical guitar player until a motorcycle accident left him disabled.After long months of therapy,he hired an experienced luthier 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 a motorcycle accident left him disabled.After long months of therapy,he hired an experienced luthier 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 costs) / selling price.

Currently, Colin's selling price is $700 and his variable costs are $280. Therefore, his contribution margin ratio is ($700 - $280) / $700 = 0.60 or 60%.

If Colin increases his selling price to $750, his variable costs will remain the same, but his contribution margin per unit will increase to $470 ($750 - $280). Therefore, his new contribution margin ratio will be ($750 - $280) / $750 = 0.6267 or approximately 63%.

Therefore, the correct answer is C.

Colin Was a Professional Classical Guitar Player Until a Motorcycle