Dude Skis wants to create an entirely new line of skis that can be used separately to ski uphill, and then lock together into a single monoski for downhill use. It is called the Chump Ski. The company projects incremental revenues from the new line of skis of $1,000,000, as well as incremental labor costs of $200,000, incremental material costs of $400,000, overhead that is directly traceable to the new product of $120,000, and a general manufacturing overhead allocation of $80,000. The existing production equipment can accommodate the new product with no changes. The calculation of the margin on the Chump Ski line is:
|
Contribution Margin Calculation |
Gross Margin Calculation |
|
|
Revenue |
$800,000 |
$800,000 |
|
Expenses Materials |
400,000 |
400,000 |
|
Labor |
200,000 |
200,000 |
|
Traceable overhead |
120,000 |
120,000 |
|
General overhead |
80,000 |
|
|
Total expenses |
720,000 |
800,000 |
|
Margin |
$80,000 |
$0 |
|
Margin percentage |
10% |
0% |
The contribution margin reveals a positive outcome of $80,000, while the gross margin calculation (which includes the general overhead allocation) shows no profit at all. If management only saw the gross margin calculation, it might elect to avoid rolling out the Chump Ski line, whereas the contribution margin might be sufficiently positive to encourage an alternative course of action.