Question

The cost structure of Dennis's Retail Mart is dominated by variable costs with a contribution margin ratio of 0.33 and fixed costs of $74,520. Every dollar of sales contributes 33 cents toward fixed costs and profit. The cost structure of a competitor, Oakfield Convenience Store, is dominated by fixed costs with a higher contribution margin ratio of 0.67 and fixed costs of $596,160. Every dollar of sales contributes 67 cents toward fixed costs and profit. Both companies have sales of $1,242,000 for the year.

Required:
a. Compare the two companies' cost structures.
b. Suppose that both companies experience a 10 percent increase in sales volume. By how much would each company's profits Increase?

Answer 1

Dennis's Retail Mart's cost structure is variable cost-heavy with a lower contribution margin, while Oakfield Convenience Store has a higher fixed-cost structure and contribution margin. With a 10% sales increase, Oakfield would see a larger profit increment due to its higher contribution margin ratio.

Step-by-step explanation:

To compare Dennis's Retail Mart and Oakfield Convenience Store's cost structures, we look at their variable and fixed costs and the contribution margin ratio. Dennis's Retail Mart has a structure dominated by variable costs and a contribution margin ratio of 0.33. In contrast, Oakfield Convenience Store's structure is primarily fixed costs with a higher contribution margin ratio of 0.67. Dennis incurs fixed costs of $74,520, while Oakfield has significantly higher fixed costs at $596,160.

With a 10 percent increase in sales volume, both companies would increase their profits, but the extent would vary due to their different cost structures and contribution margin ratios. For Dennis, each additional dollar of sales contributes 33 cents to profit after covering fixed costs. For Oakfield, 67 cents of each dollar go towards profit after fixed costs. Therefore, with the same percentage increase in sales, Oakfield's profits would increase by a greater amount due to the higher contribution margin ratio.