Blue Streak Company makes a special kind of racing tire.Variable costs are $340,and fixed costs are $35,500 per month.Blue Streak sells 610 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 20%.If the company decides to upgrade the product,the CEO will reach his goal.

Question

Quizplus · Accepted Answer

First, let's calculate the current operating income:

Current revenue = 610 x $410 = $250,100 
Current total variable costs = 610 x $340 = $207,400 
Current contribution margin = revenue - total variable costs 
= $250,100 - $207,400 = $42,700 
Current operating income = contribution margin - fixed costs 
= $42,700 - $35,500 = $7,200

Now, let's calculate the potential operating income if the product is upgraded:

New revenue = 610 x $450 = $274,500 
New total variable costs = 610 x $350 = $213,500 
New contribution margin = revenue - total variable costs 
= $274,500 - $213,500 = $61,000

New fixed costs = $35,500 x 1.3 = $46,150

New operating income = contribution margin - fixed costs 
= $61,000 - $46,150 = $14,850

The CEO wants to increase his operating income by at least 20% from the current level of $7,200.

20% of $7,200 = $1,440

Therefore, the CEO's new target operating income is $7,200 + $1,440 = $8,640

Since the potential operating income with the upgraded product is $14,850, which is higher than the target operating income of $8,640, it is true that if the company decides to upgrade the product, the CEO will reach his goal.

Blue Streak Company Makes a Special Kind of Racing Tire