PEV Exam June 2008 - Section 2.1

Beware the examiner's answers.

Beware the examiner's answers.

Look at the question
(b) Draft a report for the Finance Director covering the following:

(i) an explanation of why the gross profit margin is different in each scenario
Your answer should refer to the following:
• sales price per unit
• materials, labour and fixed cost per unit

............................Scenario 1.. Scenario 2
Gross profit margin...... 36.00%..... 28.57%

So first thing first, the examiner's comment

The net effect is an increase in the profit per unit of £164.29

Is not answering the question, and if you had put it in your answer there wouldn't be any marks for saying it.

The marks are there for saying

1. Scenario 1 is to set the price at £1,250 per unit whereas Scenario 2 is to set the price at £1,000 per unit
2. So where one price is 25% more than the other, then you would expect the gross profit margin to be higher.
3. The variable costs (Materials and Labour) are no different between the two alternatives, so they have had no effect on the different gross profit %
4. But fixed costs are significant, they are identical under each scenario (genuinely FIXED)
5. As scenario 1 has sales of 10,000 units each year then the fixed cost per unit is £300
6. Whereas Scenario 2 has sales of 14,000 units each year so the fixed costs are spread more thinly at £214.29
7. So lower fixed costs per unit would increase the gross profit margin
8. Overall Scenario 1 has a £250 per unit selling price but a £85.71 per unit higher cost per unit. This means the gross profit is higher in scenario 1.

Does this help?