Luca 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: $$\begin{array} { | l | r | }
\hline \text { Rent and utilities } & \$ 810 \
\hline \text { Wages and benefits to luthier } & 2,500 \
\hline \text { Other expenses } & 480 \
\hline
\end{array}$$ Luca's accountant told him about contribution margin ratios,and Luca understood clearly that for every dollar of sales,$0.60 went to cover his fixed costs,and anything above that point was profit.
Luca is planning to increase the sales price to $750.What impact will the increase in sales price have on the contribution margin ratio?

Question

Luca 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: $$\begin{array} { | l | r | } 
\hline \text { Rent and utilities } & \$ 810 \
\hline \text { Wages and benefits to luthier } & 2,500 \
\hline \text { Other expenses } & 480 \
\hline
\end{array}$$ Luca's accountant told him about contribution margin ratios,and Luca understood clearly that for every dollar of sales,$0.60 went to cover his fixed costs,and anything above that point was profit.
Luca is planning to increase the sales price to $750.What impact will the increase in sales price have on the contribution margin ratio?

Quizplus · Accepted Answer

The contribution margin ratio is calculated as (Sales Price - Variable Costs) / Sales Price. With the increase in sales price to $750, assuming variable costs remain constant, the contribution margin ratio will increase because the numerator (Sales Price - Variable Costs) increases while the denominator (Sales Price) also increases, but at a slower rate.

Luca Was a Professional Classical Guitar Player Until a Motorcycle