How would you answer this technical?
If a company has $100 in revenue and $20 in EBITDA, what happens if management decides to decrease prices by 10%?
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Prob revenue drops by 10% if everything else held constant (no increase in volume), so maybe rev now 90 and that 10 million decrease in rev is pure “negative margin” so EBITDA may go down by 10 mil, too to be 10 million of EBITDA. Just an initial thought….
Wouldn't that be assuming that 100% of the company's costs are variable? If you assume fixed costs, EBITDA wouldn't drop that much
Edit: I'm wrong nevermind
I’m not sure I’m understanding you here. I think if the company did everything the same, produced the same amount of volume and all that but just demanded 10% less money from their customers for the product they were providing, then the company would have 10% less revenue which would flow directly to the bottom line. Maybe I’m not understanding you though and/or the question
I originally took the weird approach of assuming earnings would always be 20% of revenue and so EBITDA would drop to $18 (which is probably incorrect).
I think the correct approach (which is the way you went about it) was to assume that $80 are necessary to break even; anything past that is EBITDA. If revenue was to drop 10%, you would only get $10 (90-80).
Correct me if I'm wrong. Thanks.
You may be right, idk. I’m just not sure why you would assume that EBITDA is always going to be 20% of revenue. Maybe I’m just not seeing/understanding why you thought that
The only right answer here is $90mm in revenue and $10mm in EBITDA. You must hold all else equal e.g. volume. Since volume is the exact same, the total cost $ spent is still $80mm. Doesn’t matter if it is fixed or variable costs since volume is the same. So $90-$80=$10mm of EBITDA.
This all still relies on a lot of assumptions. Like no reduction in payment / revenue processing fees even with the revenue reduction
Sure it relies on a lot of assumptions but this question only has like 3 parameters. You can make up a million scenarios where xyz thing happens and ultimately say that the question is unanswerable due to lack of sufficient information.
In my opinion, however, considering that this is presumably supposed to be a technical question and not a consulting case study, you can make the assumption that you should be holding all other variables constant (a reasonable assumption given the scope of given info) and reach the conclusion that, given all underlying figures remain the same (same volume of sales, COGS, fixed costs, etc.) that you lost $10m in revenue, and from a Operating Profit = Sales - Costs, if you reduce sales by $10m, you reduce EBITDA by $10m, i.e. $90m in sales and $10m EBITDA.
There are other potential factors, e.g. lower cost of product = higher volume sales, and EBITDA doesn't suffer as much due to mitigated reduction in revenue and constant fixed costs, but once again, all that really accomplishes is throwing a bunch of confounding variables into a simple question for no reason other than to try and point out how smart you are, considering that asking those questions will likely not yield a differentiated or meaningful answer.
I suppose the only caveat is that it is worth stating your assumptions when you give your response.
Answer it 'math first' i.e., decreasing price by 10% would be essentially reducing top-line by 10% and directly flows down to bottom-line and reducing it by 10M. Then, be sure to jump into the business intuition answer as well e.g., 'however, reducing prices would have other implications, such as increasing our market share or causing brand dilution.. etc, which makes me think it's a good/bad idea'
Consider whether the demand for the company's products is price elastic (e.g. availability of close substitutes on the market) or price inelastic (e.g. necessities or a product with strong pricing power or brand loyalty).
Case 1: If demand is price elastic, a 10% decrease in prices will lead to a more than proportionate increase in the number of units sold. The total revenue increases. EBITDA margin likely increases due to greater economies of scale leading to fall in both average variable and fixed costs.
Case 2: If demand is price inelastic, a 10% decrease in prices will lead to a smaller than proportionate increase in the number of units sold. The total revenue decreases. Same reasoning that EBITDA margin likely increases due to greater economies of scale, but the difference here is that the increase in absolute percentage points is not as big (due to smaller increase in number of units sold). So applying this EBITDA margin to a smaller revenue base will cause the EBITDA to be much smaller than Case 1, but still greater than $20
Assumption here is that the company has excess capacity (no increase in fixed costs by expanding production) and the demand is there. You can then lead the discussion into the factors that can make the demand for the company's goods/services price elastic or inelastic, and whether it fits into the company's strategy and positioning by lowering prices.
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this is how I'd answer as well - all thats changing is price, not costs, according to the question. its testing your understanding of margins.
technically the answer depends on the variability/fixed nature of the costs. can't really answer it without more info so I'd just say 18m if i was asked this q.
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