US CMA Part 2 · Chapter 6
Business decision analysis: marginal analysis and pricing MCQs with Answers
22 multiple-choice questions on Business decision analysis: marginal analysis and pricing for US CMA Part 2 Strategic Financial Management. Try each one before revealing the answer and explanation.
Practise this chapter interactivelyQuestion 1
Which market structure is characterized by a few large, interdependent sellers whose pricing decisions provoke reactions from competitors, often illustrated by a kinked demand curve?
- A) Perfect competition
- B) Pure monopoly
- C) Oligopoly
- D) Monopolistic competition
Show answer & explanation
Answer: C) Oligopoly
In an oligopoly a few firms dominate and each firm's pricing affects its rivals. The kinked demand curve model suggests rivals match price cuts but not price increases, which makes prices relatively rigid. Perfect competition has many price-takers, monopolistic competition has many sellers of differentiated products, and a monopoly has a single seller.
Question 2
Ashby Printing paid $45,000 last year for a feasibility study on a new product line. In deciding now whether to launch the line, how should the $45,000 be treated?
- A) Ignored, because it is a sunk cost that cannot be changed by the decision
- B) Treated as an opportunity cost of launching the product
- C) Added to the initial investment because it relates to the product line
- D) Spread over the expected life of the product line as a relevant cost
Show answer & explanation
Answer: A) Ignored, because it is a sunk cost that cannot be changed by the decision
A sunk cost has already been incurred and will not differ between alternatives, so it is irrelevant to the decision. Only future costs and revenues that differ between alternatives (relevant or incremental amounts) should be considered.
Question 3
A company could rent an empty warehouse to another business for $8,000 per month. Instead it plans to use the warehouse to store a new product line. In evaluating the product line, the $8,000 per month is best described as:
- A) An allocated cost that should be excluded
- B) A fixed cost that is irrelevant because it does not change with volume
- C) A sunk cost that should be ignored
- D) An opportunity cost that is relevant to the decision
Show answer & explanation
Answer: D) An opportunity cost that is relevant to the decision
An opportunity cost is the benefit forgone by choosing one alternative over the next best one. By using the warehouse for the new line, the company gives up $8,000 of monthly rental income, so this amount is a relevant cost of the new product line even though no cash is paid.
Question 4
Bristow Valves normally sells a component for $40. Unit costs are: variable $24 and allocated fixed overhead $8. A customer offers to buy 5,000 units at $28 each as a one-time order. Bristow has enough idle capacity and fixed costs will not change. What is the effect of accepting the order on operating income?
- A) Increase of $20,000
- B) Decrease of $20,000
- C) No change in operating income
- D) Decrease of $60,000
Show answer & explanation
Answer: A) Increase of $20,000
With idle capacity, only variable costs are incremental. Incremental profit = ($28 - $24) x 5,000 = $4 x 5,000 = $20,000. The allocated fixed overhead of $8 will be incurred regardless, so comparing the price with full cost ($32) wrongly suggests a loss.
Question 5
Assume instead that Bristow Valves (regular price $40, variable cost $24) is near full capacity. Accepting the 5,000-unit special order at $28 would require $1 per unit of extra shipping cost and would force Bristow to give up 2,000 units of regular sales. What is the effect on operating income?
- A) Increase of $20,000
- B) Decrease of $32,000
- C) Decrease of $17,000
- D) Increase of $15,000
Show answer & explanation
Answer: C) Decrease of $17,000
Contribution from the special order = 5,000 x ($28 - $24 - $1) = 5,000 x $3 = $15,000. Lost contribution on regular sales (opportunity cost) = 2,000 x ($40 - $24) = $32,000. Net effect = $15,000 - $32,000 = -$17,000, a decrease of $17,000.
Question 6
Cromwell Engines makes 10,000 valves a year. Unit costs are: direct materials $8, direct labor $6, variable overhead $4 and fixed overhead $7. If the valves are bought outside, 40% of the fixed overhead would be avoided. An outside supplier offers the valves at $21 each. Which option is cheaper and by how much in total?
- A) Make; saves $30,000
- B) Buy; saves $8,000
- C) Make; saves $2,000
- D) Buy; saves $40,000
Show answer & explanation
Answer: C) Make; saves $2,000
Relevant cost to make = $8 + $6 + $4 + (40% x $7) = $18 + $2.80 = $20.80. Buying costs $21, so making is cheaper by $0.20 x 10,000 = $2,000. Using full cost of $25 wrongly includes unavoidable fixed overhead and suggests buying.
Question 7
Using the Cromwell Engines data (relevant cost to make $20.80 per unit, purchase price $21, 10,000 units), assume that if the valves are bought, the freed production space can be rented out for $30,000 per year. What should Cromwell do?
- A) Buy, because total relevant cost is $180,000 versus $250,000 to make
- B) Make, because total relevant cost is $178,000 versus $210,000 to buy
- C) Make, because total relevant cost is $208,000 versus $210,000 to buy
- D) Buy, because total relevant cost is $180,000 versus $208,000 to make
Show answer & explanation
Answer: D) Buy, because total relevant cost is $180,000 versus $208,000 to make
Relevant cost to make = $20.80 x 10,000 = $208,000. Relevant cost to buy = ($21 x 10,000) - rental income forgone if making $30,000 = $210,000 - $30,000 = $180,000. Buying is cheaper by $28,000. Equivalently, the $30,000 rent is an opportunity cost of making.
Question 8
Dorset Chemicals produces 8,000 gallons of Product K from a joint process costing $96,000. K can be sold at split-off for $12 per gallon or processed further at a cost of $5 per gallon and sold for $18 per gallon. What is the effect on profit of processing further?
- A) Decrease of $8,000
- B) Decrease of $88,000
- C) Increase of $8,000
- D) Increase of $104,000
Show answer & explanation
Answer: C) Increase of $8,000
Incremental revenue from further processing = ($18 - $12) x 8,000 = $48,000. Incremental cost = $5 x 8,000 = $40,000. Net increase = $8,000, so K should be processed further. The $96,000 joint cost is incurred whichever choice is made and is irrelevant.
Question 9
Eldon Stores' garden segment reports sales of $600,000, variable costs of $390,000 and fixed costs of $260,000, of which $150,000 would be eliminated if the segment were closed (the rest is allocated corporate overhead). What would be the effect on company operating income of closing the segment?
- A) Decrease of $60,000
- B) Increase of $50,000
- C) Decrease of $210,000
- D) Increase of $110,000
Show answer & explanation
Answer: A) Decrease of $60,000
Closing the segment loses its contribution margin of $600,000 - $390,000 = $210,000 but saves avoidable fixed costs of $150,000. Net effect = -$210,000 + $150,000 = -$60,000. The reported segment loss of $50,000 is misleading because $110,000 of allocated overhead would continue.
Question 10
Felton Machining has a shortage of machine hours. Data per unit: Product P: contribution margin $30, 2 machine hours Product Q: contribution margin $36, 3 machine hours Product R: contribution margin $20, 1 machine hour Demand exceeds capacity for all three. In what order should production be prioritized to maximize total contribution?
- A) Q, then P, then R
- B) R, then Q, then P
- C) P, then Q, then R
- D) R, then P, then Q
Show answer & explanation
Answer: D) R, then P, then Q
When one resource is binding, rank products by contribution margin per unit of the scarce resource. P: $30 / 2 = $15 per hour. Q: $36 / 3 = $12 per hour. R: $20 / 1 = $20 per hour. Priority is R ($20), then P ($15), then Q ($12). Ranking by contribution per unit (Q first) ignores the constraint.
Question 11
Under marginal analysis, a profit-maximizing firm should increase output up to the point at which:
- A) Total revenue is at its maximum
- B) Marginal revenue equals marginal cost
- C) Average total cost is at its minimum
- D) Price equals average variable cost
Show answer & explanation
Answer: B) Marginal revenue equals marginal cost
Profit increases as long as each extra unit adds more to revenue than to cost (marginal revenue > marginal cost). Profit is maximized where marginal revenue equals marginal cost. Total revenue is maximized where marginal revenue is zero, which is generally beyond the profit-maximizing output.
Question 12
Gilford Instruments' total cost is $50,000 at 1,000 units and $53,800 at 1,100 units. What is the marginal (incremental) cost per unit over this range?
- A) $48.91
- B) $3.45
- C) $50.00
- D) $38.00
Show answer & explanation
Answer: D) $38.00
Marginal cost per unit = change in total cost / change in output = ($53,800 - $50,000) / (1,100 - 1,000) = $3,800 / 100 = $38.00. $48.91 and $50.00 are average costs, which include fixed costs that do not change with the extra units.
Question 13
Hanover Clocks prices products at full cost plus a 25% markup. If the full cost per unit is $80, what is the selling price?
- A) $20
- B) $106.67
- C) $100
- D) $105
Show answer & explanation
Answer: C) $100
Cost-plus price = full cost x (1 + markup) = $80 x 1.25 = $100. Dividing by (1 - 25%) gives $106.67, which would be a 25% margin on selling price rather than a 25% markup on cost.
Question 14
Inglewood Shoes sets prices as a markup on variable cost. A product with a variable cost of $48 sells for $72. What markup percentage on variable cost is being used?
- A) 33.3%
- B) 150%
- C) 50%
- D) 66.7%
Show answer & explanation
Answer: C) 50%
Markup on variable cost = (price - variable cost) / variable cost = ($72 - $48) / $48 = $24 / $48 = 50%. 33.3% is the contribution margin ratio (a margin on price), not the markup on cost.
Question 15
Market research shows customers will pay $150 for a new kitchen appliance. Jesmond Home requires a profit margin of 20% of the selling price. Under target costing, what is the maximum allowable cost per unit?
- A) $120
- B) $30
- C) $125
- D) $180
Show answer & explanation
Answer: A) $120
Target cost = target price - required profit = $150 - (20% x $150) = $150 - $30 = $120. Target costing starts with the market price and works back to the cost that must be achieved, often through value engineering. $125 would apply a 20% markup on cost instead of a 20% margin on price.
Question 16
Kirkby Coffee raised the price of a product from $20 to $22, and monthly unit sales fell from 5,000 to 4,400. Using simple percentage changes based on the original values, what is the price elasticity of demand (absolute value) and how is demand described?
- A) 1.2; elastic
- B) 1.2; inelastic
- C) 0.83; inelastic
- D) 0.83; elastic
Show answer & explanation
Answer: A) 1.2; elastic
Percentage change in quantity = (4,400 - 5,000) / 5,000 = -12%. Percentage change in price = ($22 - $20) / $20 = 10%. Elasticity = -12% / 10% = -1.2, or 1.2 in absolute value. Because it exceeds 1, demand is elastic, and total revenue fell from $100,000 to $96,800.
Question 17
If demand for a product is price elastic, what is the effect of a price increase on total revenue?
- A) Total revenue increases, because each unit is sold at a higher price
- B) Total revenue decreases, because the percentage fall in quantity exceeds the percentage rise in price
- C) Total revenue is unchanged, because price and quantity changes offset exactly
- D) Total revenue increases, because the percentage fall in quantity is smaller than the price rise
Show answer & explanation
Answer: B) Total revenue decreases, because the percentage fall in quantity exceeds the percentage rise in price
With elastic demand (elasticity greater than 1 in absolute value), quantity demanded is highly responsive to price, so a price increase reduces quantity proportionately more and total revenue falls. Revenue rises after a price increase only when demand is inelastic, and is unchanged when elasticity equals exactly 1 (unit elastic).
Question 18
Lyndon Tech is launching an innovative product protected by patents, and early adopters are willing to pay a high price. Which pricing strategy is most appropriate at launch?
- A) Predatory pricing below cost to eliminate existing competitors
- B) Penetration pricing: set a low initial price to gain market share quickly
- C) Cost-plus pricing at variable cost to discourage competitors
- D) Price skimming: set a high initial price and lower it as competition and volume increase
Show answer & explanation
Answer: D) Price skimming: set a high initial price and lower it as competition and volume increase
Price skimming suits innovative, differentiated products with inelastic early demand and barriers to entry such as patents; it recovers development costs quickly before prices fall. Penetration pricing suits products with elastic demand where economies of scale or network effects reward rapid market share. Predatory pricing is generally illegal under antitrust laws.
Question 19
During product design, a cross-functional team examines each component of a product to find ways to reduce cost without reducing the functions that customers value. This technique is known as:
- A) Peak-load pricing
- B) Life-cycle costing
- C) Value engineering
- D) Cost-plus pricing
Show answer & explanation
Answer: C) Value engineering
Value engineering systematically evaluates the design, materials and processes of a product to reduce cost while preserving the features customers value. It is a key tool for closing the gap between current cost and target cost under target costing. Life-cycle costing tracks costs over a product's whole life, and peak-load pricing charges more when demand is highest.
Question 20
Marston Boats has invested $2,000,000 in assets for a new product line and requires a 15% return on investment. Annual fixed costs are $600,000, variable cost is $25 per unit and expected sales are 40,000 units. What selling price will achieve the target return?
- A) $46.00
- B) $90.00
- C) $47.50
- D) $40.00
Show answer & explanation
Answer: C) $47.50
Required profit = $2,000,000 x 15% = $300,000. Total revenue needed = variable costs (40,000 x $25 = $1,000,000) + fixed costs $600,000 + target profit $300,000 = $1,900,000. Price = $1,900,000 / 40,000 = $47.50. $40.00 only breaks even, and adding a 15% markup on full cost ($46.00) does not tie the profit to the investment.
Question 21
A company has substantial idle capacity and receives a one-time special order that will not affect regular sales or prices. In the short run, what is the minimum price per unit it should accept?
- A) The full absorption cost per unit, including allocated fixed overhead
- B) The normal selling price less the normal profit margin
- C) The average total cost per unit at current volume
- D) The incremental (variable) cost per unit of filling the order
Show answer & explanation
Answer: D) The incremental (variable) cost per unit of filling the order
With idle capacity and no effect on regular business, any price above the incremental cost of the order increases short-run profit, because fixed costs are unchanged. The minimum acceptable price is therefore the incremental (usually variable) cost, plus any opportunity costs if they exist. Long-run pricing, by contrast, must cover all costs.
Question 22
Norcross Foods incurs joint costs of $120,000, of which $60,000 is allocated to Product B. B yields 20,000 kg, which can be sold at split-off for $9.00 per kg or processed further at a total cost of $70,000 and sold for $12.20 per kg. What should Norcross do?
- A) Sell at split-off, because processing further reduces profit by $66,000
- B) Process further, because it increases revenue by $64,000
- C) Sell at split-off, because processing further reduces profit by $6,000
- D) Process further, because final revenue of $244,000 exceeds the further processing cost plus allocated joint cost
Show answer & explanation
Answer: C) Sell at split-off, because processing further reduces profit by $6,000
Incremental revenue = ($12.20 - $9.00) x 20,000 = $64,000. Incremental cost = $70,000. Net effect of further processing = $64,000 - $70,000 = -$6,000, so B should be sold at split-off. Allocated joint cost is irrelevant to the decision because it is incurred either way.