Answer the following questions using the information below:
Bush Manufacturing produces a single product that sells for $100. Variable costs per unit equal $25. The company expects total fixed costs to be $60,000 for the next month at the projected sales level of 1,000 units. In an attempt to improve performance, management is considering a number of alternative actions. Each situation is to be evaluated separately.
-Suppose that management believes that a 20% reduction in the selling price will result in a 20% increase in sales. If this proposed reduction in selling price is implemented:
A)operating income will decrease by $9,000
B)operating income will increase by $9,000
C)operating income will decrease by $20,000
D)operating income will increase by $15,000

Question

Quizplus · Accepted Answer

If the selling price is reduced by 20%, the new selling price would be $80 ($100 - 20%). Given that the company sells 1,000 units, the revenue would be $80,000. However, the variable costs ($25 per unit) would still be the same, resulting in total variable costs of $25,000 (1,000 units x $25 per unit).

Fixed costs are still expected to be $60,000.

Therefore, the operating income can be calculated as follows:

Operating Income = Total Revenue - Total Variable Costs - Total Fixed Costs

Operating Income = ($80 x 1,200 units) - $25,000 - $60,000

Operating Income = $96,000 - $25,000 - $60,000

Operating Income = $11,000

This is a decrease in operating income by $9,000 ($20,000 decrease in revenue minus $11,000 increase in operating income). Therefore, the best choice would be A – operating income will decrease by $9,000.

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