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Dear Sir, could you please explain to the answers for the above questions:
Q 22.4 with the change in production method, variables costs will fall from 40% of sales to 36%?
Q 22.5 …….variable cost would add £2 to profit for each kg of material bought and used, how do I get the £2?
Currently, because the CS ratio is 60%, the variable costs must be 40% of sales.
If variable costs fall by 10% then they fall by 10% x 40% = 4% and fall to 40 – 4 = 36% of sales.
The shadow price is the most extra they would be prepared to pay over the normal price.
So they would be prepared to pay up to 16 (10 + 6) per kg. They can buy for 14 per kg and therefore they will buy extra (and make extra profit of 16 – 14 = 2 per kg).
The free lectures on both of the these topics will help you.