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Hello Sir,
Can you please explain me how did they calculated the contribution/sales ratio in the below question of BPP Study kit:
Grabbit Quick Co achieves current annual sales of $1,800,000. The cost of sales is 80% of this amount,
but bad debts average 1% of total sales, and the annual profit is as follows.
$
Sales 1,800,000
Less cost of sales 1,440,000
360,000
Less bad debts 18,000
Profit 342,000
The current debt collection period is one month, and the management consider that, if credit terms were
eased (Option A), the effects would be as follows.
Present policy Option A
Additional sales (%) – 25%
Average collection period 1 month 2 months
Bad debts (% of sales) 1% 3%
The company requires a 20% return on its investments. The costs of sales are 75% variable and 25%
fixed. Assume there would be no increase in fixed costs from the extra revenue and that there would be no
increase in average inventories or accounts payable. Which is the preferable policy, Option A or the
present one?For every $100 sales, the cost of sales is $80.
Of this $80, the variable cost is 75% x 80 = $60.
Therefore the contribution is $40 for every $100 of sales.
Therefore the CS ratio is 40/100 = 40%
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