Question

Outback Outfitters sells recreational equipment. One of the company's products, a small camp stove, sells for $50 per unit. The contribution margin per camp stove is 36% while the fixed expenses associated with the stove total $108,000 per month. At present, the company is selling 8,000 stoves per month. The sales manager is convinced that a 10% reduction in the selling price would result in a 25% increase in monthly sales of stoves. Should Outback Outfitters reduce the selling price? Show all computations.

Answer 1

Sale price per unit = $50

Contribution margin per unit = $50 x 36% = $18

Fixed expenses per month = $108000

Total Contribution margin =

$18 x 8000 = $144000

Net operating profit for 8000 stoves =

Total Contribution margin - Fixed expenses per month

= $144000 - $108000 = $36000

Reduced selling price = $50 - $50 x 10%

= $50 - $5 = $45

Monthly increased quantity in sales =

8000 + 8000 x 25% = 8000 + 2000 = 10000

Contribution margin per unit = $45 x 36% = $16.2

Total Contribution margin =

$16.2 x 10000 = $162000

Fixed expenses per month = $108000

Net operating profit for 10000 stoves =

$162000 - $108000 = $54000

Change in net operating profit =

$54000 - $36000 = $18000

Outback Outfitters should reduce selling price because net operating profit has been increased from $36000 to $54000 after reduction in selling price by 10%.