Which of the following would most likely result in a higher gross profit margin assuming no fixed costs?

Solution

A 5% decrease in production cost will increase gross profit by lowering the cost of goods sold. Assuming no fixed costs, the gross profit margin will remain the same if the number of quantities sold increases. Administrative expenses are not deducted while calculating gross profit so this statement is irrelevant. For example: If A Ltd has sold 200 units @ 5 each and the cost of production is @ 3/ unit. As no fixed costs are involved, gross profit will be (200*5 – 200*3) = 400 Gross profit margin = Gross profit/sales = 400/1000 = 40% If the number of units sold increase to 250, keeping everything else constant New gross profit becomes = (250*5 – 250*3) = 500 New gross profit margin = 500/1250 = 40% So, with the increase in the number of units sold, the gross profit margin remains the same. But if the cost of production decreases to 2/unit Then, new gross profit = (200*5 – 200*2) = 600 New gross profit margin = 600/1000 = 60% Therefore, with the decrease in production cost per unit, the numerator increases but the denominator remains the same, therefore the overall gross profit margin increases.