Dodge Industries incurs the following costs during the current year:Depreciation of machinery…………$15,000Direct labor………………………6,000Direct materials……………………4,000Executive salaries…………………20,000Insurance…………………………2,000Rent on building…………………8,000Factory supplies……………………10,000Vehicle lease cost…………………5,000Sales for the year were $80,000 and Dodge determined that only the direct production costs and factory supplies are to be classified as variable costs; all other costs are classified as fixed costs. Dodge sold 400 units.(a) Calculate the unit contribution margin and the contribution margin ratio for DodgeIndustries.(b) Dodge Industries is considering plans that would
increase the contribution margin ratio for next year. Should it pursue these plans? Explain.
What will be an ideal response?
(a)
| Total variable costs are: | ? |
| Direct materials | $ 4,000 |
| Direct labor | 6,000 |
| Factory supplies | 10,000 |
| Total variable costs | $20,000 |
Sales price per unit = $80,000/400 = $200 per unit
Unit contribution margin:
| Sales price per unit | $200 |
| Variable costs per unit | 50 |
| Contribution margin per unit | $150 |
(b) Perhaps. Based on the current cost structure, for every dollar of sales, contribution margin increases by $0.75. The contribution margin is used to cover fixed cost and contribute toward net income. As long as fixed costs do not change, net income will increase if the contribution margin is increased. The risk is that if sales decrease, then contribution margin will fall by $0.75. If the contribution margin ratio increases, the decline in income will be larger.
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