Question

Fixed vs Variable cost preference. Bates operates a kiosk at a local mall, selling duck calls for $30 each. The variable cost to make a duck call is $18. A new mall is opening where Bates wants to locate a new kiosk. The mall operator offers the following two options for Bates: 1. paying a fixed rent of $15,000 a month, or: 2. paying a fixed rent of $9,000 per month plus 10% of revenue earned from each duck call. The amount of monthly sales (in units) at which Bates would be indifferent as to which plan to select is:

Answer 1

Answer:

Option 2 should be selected

Explanation:

Using a rational approach which option most benefit and have a minimum cost. We will use the break-even level here to decide which option should be selected.

Option 1

Price per call = $30

Variable cost per call = $18

Contribution = Sales  - Variable cost = $30 - $18 = $12

Fixed Cost = $15,000

Break-even point = Fixed cost / Contribution per call = $15,000 / $12 = 1,250 calls

Option 2

Price per call = $30

Variable cost per call = $18 + ( $30 x 10% ) = $18 + $3 = $21

Contribution = Sales  - Variable cost = $30 - $21 = $9

Fixed Cost = $9,000

Break-even point = Fixed cost / Contribution per call = $9,000 / $9 = 1,000 calls

Difference  = 1,250 calls - 1,000 calls = 250 calls

Option 2  is better option because it take 250 less calls to reach at break-even in the month. It should be selected.