Question

Warner Clothing is considering the introduction of a new baseball cap for sales by local vendors. The company has collected the following price and cost characteristics.

Sales price	$	17	per unit
Variable costs		3	per unit
Fixed costs		756,000	per year

Assume that the company plans to sell 7,000 units per month. Consider requirements (b), (c), and (d) independently of each other.

Required:

d. Suppose that fixed costs for the year are 10 percent lower than projected, and variable costs per unit are 10 percent higher than projected. What impact will these cost changes have on operating profit for the year? Will profit go up? Down? By how much?

Answer 1

Present Scenario:

Contribution margin per unit = Sales price per unit - Variable costs per unit
Contribution margin per unit = $17.00 - $3.00
Contribution margin per unit = $14.00

Annual units sold = 12 * Monthly units sold
Annual units sold = 12 * 7,000
Annual units sold = 84,000

Operating profit = Contribution margin per unit * Annual units sold - Fixed costs
Operating profit = $14.00 * 84,000 - $756,000
Operating profit = $1,176,000 - $756,000
Operating profit = $420,000

Proposed Scenario:

Variable costs per unit = $3.00 + 10% * $3.00
Variable costs per unit = $3.30

Contribution margin per unit = Sales price per unit - Variable costs per unit
Contribution margin per unit = $17.00 - $3.30
Contribution margin per unit = $13.70

Fixed costs = $756,000 - 10% * $756,000
Fixed costs = $680,400

Operating profit = Contribution margin per unit * Annual units sold - Fixed costs
Operating profit = $13.70 * 84,000 - $680,400
Operating profit = $1,150,800 - $680,400
Operating profit = $470,400

Therefore, these cost changes will increase operating profit by $50,400 ($470,400 - $420,000).