Question

The Greenback Store’s cost structure is dominated by variable costs with a contribution margin ratio of 0.25 and fixed costs of $40,000. Every dollar of sales contributes 25 cents toward fixed costs and profit. The cost structure of a competitor, One-Mart, is dominated by fixed costs with a higher contribution margin ratio of 0.75 and fixed costs of $440,000. Every dollar of sales contributes 75 cents toward fixed costs and profit. Both companies have sales of $800,000 for the month. Required: a. Compare the two companies’ cost structures. b. Suppose that both companies experience a 15 percent increase in sales volume. By how much would each company’s profits increase?

Answer 1

Greenback Store One-Mart

Amount % Amount %

a. Sales $800,000 100% $800,000 100%

Variable cost $600,000 75% $200,000 25%

Contribution margin $200,000 25% $600,000 75%

Fixed cost $40,000 5% $440,000 55%

Operating profit $160,000 20% $160,000 20%

Break even point $160,000 $586,666.67

Workings

Greenback Store Break even point = Fixed cost / Contribution margin ratio = 40,000 / 0.25 = 160,000

One-Mart Break even point = Fixed cost / Contribution margin ratio = 440,000 / 0.75 = 586,666.67

b. Greenback Store

Increase in sales = $800,000*15% = $120,000

Company profit Increase by + (Increase in sales * Contribution margin ratio = 120,000 * 25% = $30,000

Thus, with the increase in 15% of sales of Greenback Store, the profit of the company increase by $30,000

One-Mart

Increase in sales = $800,000*15% = $120,000

Company profit Increase by + (Increase in sales * Contribution margin ratio = 120,000 * 75% = $90,000

Thus, with the increase in 15% of sales of One-Mart , the profit of the company increase by $90,000.