Question

A jeans maker is designing a new line of jeans called Slims. The jeans will sell for \(205 per pair and cost \)164 per pair in variable costs to make.

1. Compute the contribution margin per pair.

2. Compute the contribution margin ratio.

3. Describe what the contribution margin ratio reveals about this new jeans line.

Short answer

Answer

1. Contribution margin per pair:$41

2. Contribution margin ratio:0.20

3. Only 20% of the sales price is available to cover fixed costs.

Step-by-step solution

Definition of Fixed Cost

The cost that does not get affected by the level of activity achieved by the business entity is known as a fixed cost. Such cost remains fixed until the capacity is increased by capital expenditure.

 Contribution margin per pair

Particular	Amount $
Sales price per pair	$205
Less: Variable cost per pair	(164)
Contribution margin per pair	$41

Contribution margin ratio

$$\begin{gathered} \mathit{C}\mathit{o}\mathit{n}\mathit{t}\mathit{r}\mathit{i}\mathit{b}\mathit{u}\mathit{t}\mathit{i}\mathit{o}\mathit{n}\mathbf{}\mathit{m}\mathit{a}\mathit{r}\mathit{g}\mathit{i}\mathit{n}\mathbf{}\mathit{r}\mathit{a}\mathit{t}\mathit{i}\mathit{o}\mathit{n}\mathbf{}\mathbf{=}\frac{\mathbf{C}\mathbf{o}\mathbf{n}\mathbf{t}\mathbf{r}\mathbf{i}\mathbf{b}\mathbf{u}\mathbf{t}\mathbf{i}\mathbf{o}\mathbf{n}\mathbf{}\mathbf{m}\mathbf{a}\mathbf{r}\mathbf{g}\mathbf{i}\mathbf{n}\mathbf{}\mathbf{p}\mathbf{e}\mathbf{r}\mathbf{}\mathbf{p}\mathbf{a}\mathbf{i}\mathbf{r}}{\mathbf{S}\mathbf{a}\mathbf{l}\mathbf{e}\mathbf{s}\mathbf{}\mathbf{p}\mathbf{r}\mathbf{i}\mathbf{c}\mathbf{e}\mathbf{}\mathbf{p}\mathbf{e}\mathbf{r}\mathbf{}\mathbf{p}\mathbf{a}\mathbf{i}\mathbf{r}} \\ \mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{=}\frac{\mathbf{\$}\mathbf{41}}{\mathbf{\$}\mathbf{205}} \\ \mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{=}\mathbf{0}\mathbf{.}\mathbf{2} \end{gathered}$$

Information revealed by contribution margin ratio

The contribution margin ratio reflects that only 20% remains with the business entity to cover the fixed cost after deducting the variable cost from the sales price. The business entity must try to reduce the variable cost or increase the sales price so that a higher portion is available to cover fixed costs. In such a situation, the business entity might incur a loss.