Question

Kelley Company and Mason Company each have sales of $200,000 and costs of $140,000. Kelley Company's costs consist of $40,000 fixed and $100,000 variable, while Mason Company's costs consist of $100,000 fixed and $40,000 variable. Which company will suffer the greatest decline in profits if sales volume declines by 15%?

Answer 1

The firm that would suffer the greatest decline in profits if sales volume declines by 15% is Mason Company.

The cost of a company is made up of fixed cost and variable cost. Fixed cost is the cost that does not vary with output of the company. It remains fixed no matter the level of output. An example of fixed cost is rent. Variable cost is the cost that varies with output. If output increases, variable cost increases and if output falls, output decreases.

If sales volume decreases, the output of Mason Company would decline more compared with the output of Kelley company because it has a higher fixed cost. So, we when sales reduces, its cost would would not reduce as many as the cost of Kelley company.

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