Question

Backus, Inc., makes and sells many consumer products. The firm’s average contribution margin ratio is 25%. Management is considering adding a new product that will require an additional $11,000 per month of fixed expenses and will have variable expenses of $5.5 per unit.

Required:

a. Calculate the selling price that will be required for the new product if it is to have a contribution margin ratio equal to 25%. (Round your answer to 2 decimal places.)

b. Calculate the number of units of the new product that would have to be sold if the new product is to increase the firm's monthly operating income by $10,000. (Do not round intermediate calculations.)

Answer 1

Management is considering adding a new product that will require an additional $11,000 per month of fixed expenses and will have variable expenses of $5.5 per unit.

a) Contribution margin ratio of the new product = 25%

If contribution margin ratio of the new product is 25%, then variable expense must be 75% of selling price.

Variable expense = 75% of selling price

5.5 = 0.75 x Selling price

Selling price = $7.33

b) Unit Contribution margin = Unit Selling price – Unit Variable cost

= 7.33 - 5.5

= $1.83

Units to be sold to get a target profit = (Fixed cost + Target profit)/Contribution margin per unit

= (11,000 + 10,000)/1.83

= 11,475

Hence, 11,475 units will be required to be sold to get an increase of $10,000 profit.

Note: If selling price is not rounded off to two decimal places, then answer would change as under:

Selling price = $7.3333333333

Unit Contribution margin = Unit Selling price – Unit Variable cost

= 7.3333333333 - 5.5

= $1.8333333333

Units to be sold to get a target profit = (Fixed cost + Target profit)/Contribution margin per unit

= (11,000 + 10,000)/1.8333333333

= 11,455

Hence, 11,455 units will be required to be sold to get an increase of $10,000 profit.