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CMA Final · Strategic Cost Management · Decisions involving Alternative Choices

Narmada Tools Ltd. makes a product with selling price Rs 100, variable cost Rs 64. Fixed costs are Rs 5,40,000 per year. Management is considering a price cut to Rs 90, which is expected to raise volume from 20,000 units to 28,000 units, with fixed costs unchanged. What is the change in annual profit if the price cut is adopted?

Profit increases by Rs 8,000. Contribution before the cut is Rs 36 x 20,000 = Rs 7,20,000, and after the cut it is Rs 26 x 28,000 = Rs 7,28,000. Fixed costs stay the same, so the entire Rs 8,000 rise in contribution is the rise in profit.

  1. ADecrease of Rs 8,000
  2. BIncrease of Rs 8,000Correct
  3. CIncrease of Rs 88,000
  4. DIncrease of Rs 28,000

Explanation

Current contribution = (100-64) x 20,000 = Rs 7,20,000. New contribution = (90-64) x 28,000 = 26 x 28,000 = Rs 7,28,000. Fixed costs are unchanged, so profit rises by Rs 8,000. Option Rs 88,000 wrongly ignores the lower margin on existing units.

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