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Variable cost rises from $10 to $15 per unit on 1,000 units while the price holds at $25 and fixed costs hold at $8,000. What are the new contribution margin ratio and operating income?
A60% and operating income of $2,000
B40% and operating income of $7,000
C40% and operating income of $2,000
D20% and operating income of $5,000
Answer & Solution
Correct answer: C. 40% and operating income of $2,000
1. Sales are unchanged at 1,000 units times $25, which is $25,000.
2. Variable costs are now 1,000 units times $15, which is $15,000.
3. Contribution margin is $25,000 minus $15,000, which is $10,000.
4. The ratio is $10,000 divided by $25,000, which is 40%.
5. Operating income is $10,000 minus fixed costs of $8,000, which is $2,000.
6. The extra $5 of variable cost costs 20 points of ratio, moving it from 60% down to 40%.
7. Pairing 40% with income of $7,000 keeps the old income, which the higher variable cost has already destroyed.
_Source: Jonick, Principles of Managerial Accounting (UNG Press, CC BY-SA 4.0), section 5.2.1 Contribution Margin_
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