Define product contribution margin ratio and how it is used
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1. What is meant by a product's contribution margin ratio? How is this ratio useful in planning business operations? Give an example of a company and specific items that might go into the calculation of the contribution margin. Can break-even sales be calculated by using contribution ratio?
2. What arguments can be advanced in favor of treating fixed manufacturing overhead costs as product costs? What arguments can be advanced in favor of treating fixed manufacturing overhead costs as period costs? Which arguments do you find to be the most valid? Explain.
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1. What is meant by a product's contribution margin ratio?
The contribution margin ratio is the amount of gross profit on sales after subtracting variable costs. For example, if you make and sell bicycles for $300 each and your variable costs are $180, your contribution margin is $120. $120 / 300 = .40 or 40%, which is your contribution margin ratio.
How is this ratio useful in planning business operations?
This ratio is vital to any company to understand the effects of increased or decreased sale of product. Using the bicycle example again, let's say your company has fixed costs of $80,000. Normally the company sells 1000 bicycles a year at $300 for a contribution margin ratio of 40%. The profit that is available to pay fixed costs is 1000 x 300 x 40% = 120,000. In this example, after paying the fixed costs, the company will have a profit of 40,000.
Can break-even sales be calculated by using contribution ratio?
When times are hard, fewer bicycles will be sold. A ...
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