Question

Suppose you're considering making an investment in one of two firms. Firm A has fixed costs that account for 50 percent of total costs, and variable costs account for 50 percent of total costs. Firm B has fixed costs that account for 80 percent of total costs, and variable costs account for 20 percent of total costs. Assuming everything else is equal and that you're risk adverse, which firm would you invest in and why?

A. Firm B because it's less risky

B. Firm A because it's less risky

C It doesn't matter because both firms have a similar amount of risk.

D. There isn't enough information

Answer 1

Assume Total Cost=$100

Units sold=100

Sales price per unit=$1.50

Firm A:

Fixed cost=$50

Total Variable cost=$50

Variable cost per unit=(50/100)=$0.50

Contribution Margin per unit=(1.50-0.50)=$1

Breakeven in units=(50/1)=50 units

Firm B:

Fixed cost=$80

Total Variable cost=$20

Variable cost per unit=(20/100)=$0.20

Contribution Margin per unit=(1.5-0.20)=$1.3

Breakeven in units=(80/1.3)= 61.53846 units

Breakeven quantity (rounded off)=62 units

Firm b will have Break even point at higher (62 units) compared to Firm A which has break even point at 50 units.

If the number of units sold gets reduced , from B will be at risk of loss earlier than Firm A.

Hence Firm A is less risky.

B. Firm A because it's less risky