Mossfeet Shoe Corporation is a single product firm. The company is predicting that a price increase next year will not cause unit sales to decrease. What effect would this price increase have on the following items for next year? A) B) C) D) Contribution Margin Ratio Increase Decrease Increase Decrease O Choice A O Choice B O Choice C O Choice D Break-even Point Decrease Decrease No effect No effec
The correct answer and explanation is:
Correct Answer: Choice A
- Contribution Margin Ratio: Increase
- Break-even Point: Decrease
Explanation:
Mossfeet Shoe Corporation is a single-product firm planning a price increase while assuming that unit sales will remain unchanged. This price adjustment will directly affect two critical financial metrics: the Contribution Margin Ratio and the Break-even Point.
Contribution Margin Ratio (CMR) – Increase
The Contribution Margin Ratio (CMR) is calculated as: CMR=Sales Price per Unit−Variable Cost per UnitSales Price per UnitCMR = \frac{\text{Sales Price per Unit} – \text{Variable Cost per Unit}}{\text{Sales Price per Unit}}
When the sales price increases while variable costs remain unchanged, the numerator (Sales Price per Unit – Variable Cost per Unit) increases. As a result, the contribution margin ratio rises. A higher contribution margin ratio means that a greater proportion of each sales dollar contributes to covering fixed costs and generating profit.
Break-even Point – Decrease
The Break-even Point (in units) is given by: Break-even Point=Total Fixed CostsContribution Margin per Unit\text{Break-even Point} = \frac{\text{Total Fixed Costs}}{\text{Contribution Margin per Unit}}
Since the contribution margin per unit is increasing due to the higher selling price, the denominator in this equation increases. A higher denominator results in a lower break-even point. This means that the company needs to sell fewer units to cover its fixed costs and start generating a profit.
Conclusion
By increasing the product price, the company enhances its profitability per unit sold and lowers the break-even point. This strategic move is beneficial as long as the assumption holds that demand remains steady despite the price increase. However, in reality, price hikes often lead to some level of demand reduction, which the company should monitor closely.
Now, I will generate an image representing these financial effects.
I’ve generated an infographic that visually represents the impact of a price increase on the contribution margin ratio and break-even point. Let me know if you need any modifications or further explanations!
