Question

If a product’s variable cost increases, the number of units needed to be sold to earn a target profit will:

		Increase
		Decrease
		Not change
		Cannot be determined since predicting the effect requires more information

Answer 1

Solution :

The Answer is (a) Increases.

Explanation :

If product's variable cost increases then the contribution margin will be reduced resuting in increase in number of units sold to earn target profit. This can be understand with the following example :

	Situation 1	Situation 2 (When Variable Cost Increases)
Units	1	1
(a) Sale Price	$ 200	$ 200
(b) Variable Cost	$ 50	$ 75
(c) Contribution Margin (a - b)	$ 150	$ 125
(d) Fixed Cost	$ 80	$ 80
(e) Profit	$ 70	$ 45

Now in Situation 2 if we want to earn same profit $ 70 then Units to be Sold :

Units to be Sold to earn target profit = (Fixed Cost + Target Profit) / CM per Unit

= ($ 80 + $ 70) / $ 125

= $ 150 / $ 125

= 1.20 Units

Units has been increased from 1 to 1.20.

This is because the base is CM per Unit and when we increases variable cost the base value decreases resulting in higher units to be sold to earn target profit.