Dreiphosis Corp. is in the process of determining whether to purchase a high-capacity machine to make textbooks for the upcoming school year. The high-capacity machine will generate fixed costs of $12,000 per year versus the $3,000 fixed costs of using a low-capacity machine. The variable costs per unit when using the high-capacity machine will be $33. The firm will charge $66 for each textbook and has determined that the high-capacity machine will maximize pretax operating cash flow if sales are greater than 1,000 books. What is the contribution margin under the low-capacity machine scenario?
A) $41
B) $24
C) $32
D) $46

Question

Quizplus · Accepted Answer

The contribution margin is calculated as the difference between the selling price and variable cost per unit. Since the firm is using a low-capacity machine, the fixed costs are $3,000 per year and there are no variable costs provided in the question. Therefore, the contribution margin is simply the selling price of $66 per textbook.

Contribution margin = Selling price - Variable cost per unit
= $66 - $0
= $66

The high-capacity machine will generate variable costs of $33 per unit, so the contribution margin under that scenario would be:

Contribution margin = Selling price - Variable cost per unit
= $66 - $33
= $33

Thus, the best choice would be to stick with the low-capacity machine, assuming sales are not expected to exceed 1,000 books. Using the high-capacity machine would result in lower contribution margins per unit and a higher breakeven point due to the higher fixed costs.