Victory Tire Company makes a special kind of racing tire.Variable costs are $220 per unit,and fixed costs are $10,000 per month.Victory sells 600 units per month at a sales price of $300.If the quality of the tire is upgraded,the company believes it can increase the sales price to $350.If so,the variable cost will increase to $240 per unit,and the fixed costs will remain the same.If Victory decides to upgrade,how will it affect operating income?

Question

Quizplus · Accepted Answer

Currently, Victory Tire Company's monthly revenue is 600 x $300 = $180,000, and its monthly variable costs are 600 x $220 = $132,000. Its monthly contribution margin is therefore $48,000, and its monthly operating income is $38,000 ($48,000 - $10,000 in fixed costs).

If Victory Tire Company upgrades the quality of its tires, it can increase its sales price to $350 per unit. The new monthly revenue will be 600 x $350 = $210,000, and the new monthly variable costs will be 600 x $240 = $144,000. The new monthly contribution margin will be $66,000, and the new monthly operating income will be $56,000 ($66,000 - $10,000 in fixed costs).

The increase in monthly operating income will be $56,000 - $38,000 = $18,000. Therefore, the correct answer is D.

Victory Tire Company Makes a Special Kind of Racing Tire