Question

Flower Company manufactures and sells a single product that has a positive contribution margin. If the selling price and variable costs both decrease by 5% and fixed costs do not change, then what would be the effect on the contribution margin per unit and the contribution margin ratio?

Answer 1

Answer:

a. Contribution margin per unit will fall

b. Contribution margin ratio will remain the same.

Explanation:

To show this let us assume that we have:

Selling price per unit = $100

Variable cost per unit = $60

Therefore,

Contribution margin per unit = $40

Contribution margin ratio = $40 / $100 = 0.40, or 40%

If the selling price and variable costs both decrease by 5% and fixed costs do not change, we have:

Selling price per unit = $100 * 95% = $95

Variable cost per unit = $60 * 95% = $57

Contribution margin per unit = $95 - $57 = $38

Contribution margin ratio = $38 / $95 = 0.40, or 40%

From the above, contribution margin per unit fall from $40 to $38, while contribution margin ratio will remain the same at 40%.