This question really got me off-guard

CFA Level I
#1

McQueen Corporation prepared the following common-size income statement for the year ended December 31, 20X7:

Sales 100% Cost of goods sold 60% Gross profit 40%

For 20X7, McQueen sold 250 million units at a sales price of $1 each. For 20X8, McQueen has decided to reduce its sales price by 10%. McQueen believes the price cut will double unit sales. The cost of each unit sold is expected to remain the same. Calculate the change in McQueen’s expected gross profit for 20X8 assuming the price cut doubles sales.

A) $50 million increase. B) $150 million increase. C) $80 million increase.

#2

Not sure if you mean the question is too tough or too easy, but here goes:

For 20X7: Sales = $250 m Cost = $250 m * 60% = $150 m or $0.60 per unit. Profit = $100 m For 20X8: Sales = (250 m * 2) * ($1 * 0.9) = $450 m Cost = 0.60 \* (250 m \* 2) = 300 m Profit = $ 150 m Change in profit = $50 m increase --> (A)

#3

b?

#4

Your calculations are a little contradictory because in 20X7, you calculate Cost based on Sales (dollar value of $250) then in 20X8 instead of calculating cost of sales (dollar value of $450) in the same manner as 20X7 you multiply it by the total UNITS sold (500).

I don’t get it, please elaborate if you get a chance. I’d appreciate to read your feedback.

#5

broken heart

#6

Well, IMO, it’s because of the language of the problem.

While the data for 20X7 is given on percentage basis, for 20X8, the question says “the cost of EACH unit sold is expected to remain the same”.

Hence, you have to calculate the cost of EACH UNIT for 20X7 and then use the same per unit cost to find out total Cost of Goods Sold for 20X8.

Hope this clears it up. Again, this is IMO. What is the answer as per the book?

#7

What’s IMO?

Your answer 50Mill was right, but you calculated it different. The solution they provided is also contradictory to the question because they changed the COGS to 67%.

Ugghh…

The correct answer was A) $50 million increase.

20X7 gross profit is equal to $100 million ($1 × 250 million units sold × 40% gross profit margin). The 10% price cut to $0.90 will increase cost of goods sold to 67% of sales [COGS=0.6($1) = $0.60; $0.60 / $0.90 = 67%.]. As a result, gross profit will decrease to 33% of sales. If unit sales double in 20X8, gross profit will equal $150 million ($0.90 × 500 million units × 33% gross profit margin). Therefore, gross profit will increase $50 million ($150 million 20X8 gross profit – $100 million 20X7 gross profit).

#8

IMO means In My Opinion

The calculations are shown differently but are fundamentally the same. I think the issue here is that the COGS will always be $0.60/unit under both years as it does not change. So for the first year, the COGS as a % of sale price would be $0.60 / $1 = 60%. However, in the second year, sales price drops down to $0.90, so the COGS as a percentage would be $0.60 / $0.90 = 67%

I hope that clears it up for you