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A company with sales of $60,000 and variable expenses of $30,000 should spend $40,000 on increased...

A company with sales of $60,000 and variable expenses of $30,000 should spend $40,000 on increased advertising if the increased advertising will increase sales by $60,000.

True

False

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Homework Answers

Answer #1
  • The statement is FALSE.
  • Conceptually, company should increase its Fixed Cost (advertisement cost in this question) to increase its sales IF Additional Contribution margin earned from those increased sales is MORE than the amount of additional fixed cost.
  • In the given question, additional fixed cost (advertisement) = $ 40,000
  • CM Ratio = (60000 – 30000)/60000 = 50%
  • If after advertisement, sales increased by $ 60,000 (as mentioned), the contribution margin generated on those sales would be= 60000 x 50% = $ 30,000 ONLY.
  • Since additional contribution margin earned ($30,000) is less than additional fixed cost of $ 40,000, Advertisement cost of $ 40,000 SHOULD NOT BE INCURRED to increase sales.
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