A firm has revenues of $120,000, a contribution margin ratio of 30%, and fixed expenses that total $56,000. If revenues increase $20,000, then:

Question

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First, we need to calculate the current contribution margin:

Contribution Margin = Revenue x Contribution Margin Ratio 
Contribution Margin = $120,000 x 0.30 
Contribution Margin = $36,000

Next, we can calculate the current operating income:

Operating Income = Contribution Margin - Fixed Expenses 
Operating Income = $36,000 - $56,000 
Operating Income = -$20,000

This means that the firm is currently operating at a loss.

If revenues increase by $20,000, then the new contribution margin will be:

New Contribution Margin = ($120,000 + $20,000) x 0.30 
New Contribution Margin = $36,000 + $6,000 
New Contribution Margin = $42,000

We can now calculate the new operating income:

New Operating Income = New Contribution Margin - Fixed Expenses 
New Operating Income = $42,000 - $56,000 
New Operating Income = -$14,000

Even though the firm's operating income has improved, it is still operating at a loss. The increase in revenue was not enough to cover the fixed expenses.

Therefore, the correct answer is A) operating income will increase by $6000.

A Firm Has Revenues of $120,000, a Contribution Margin Ratio