Bill

French, Accountant CASE STUDY

Below you can see the initial calculations of Bill French, as well as the break-even calculation
conducted by him.

Exhibit 1 Bill French initial calculation
Plant capacity
Past year's level of operations
Average unit selling price
Total fixed costs
Average variable unit cost

2,000,000 units
1,500,000 units
$1.20
$520,000.00
$0.75

CVP analysis: Mathematical approach

!"#$%& = ()*+, "+.+/0+ 2)"%)3*+ 4#,&, 5%6+7 4#,&,

!"#$%& = 89: 0/%&, ,#*7 5%6+7 4#,&,

5%6+7 4#,&,
()*+, .#*0<+ =

At break-even
89:
(profit = 0)

()*+, "+.+/0+, = 8/%& ,+ *%/= >"%4+ 0/%&, ,#*7 )& 3"+)?+.+/


Exhibit 2 CVP Income Statement (Initial situation)
Unit selling price
$1.20
Unit variable cost
$0.75
Unit contribution margin
$0.45
Sales Volume
1,155,556



$
Sales revenues
$1,386,666.67
Variable costs
$866,666.67
Contribution margin
$520,000.00
Fixed costs
$520,000.00
Profit
$-

%
100.0%
62.5%
37.5%
37.5%
0%

As already suggested in the case, Bill French calculated the break-even point of the company
at 1,155,556 units or at $ 1,386,666.67.

What are the assumptions implicit in Bill Frenchs determination of the companys breakeven point? (Question 1)

For his analysis Bill French assumed that there is only one break-even point, even though there
are several different product lines. Furthermore, he presumed that there will not be a change
in the sales mix, nor the variable or fix costs in the following year. Total revenue and total
costs would, according to him, behave in a linear manner over the relevant range.

In summary, the following assumptions are being made and need to be considered for the
revised version:

Total sales boost of 20%
Hit capacity of 90%
Fixed costs will increase by $10,000.00 monthly (yearly: $120,000.00)
Product line A will be scaled down by 1/3
The 200,000 lost from Product A, plus an additional 250,000 units should be picked up
by Product C
Product B will stay solid
Product C will double its price
50% extra on the regular dividend of $50,000.00
Would like to hit $100,000.00 before taxes
Variable costs are likely to increase by 10% due to union demands, this will most likely
raise break-even point (hence the companies profit should be considered a fixed cost)

On the basis of Frenchs revised information, what does the next year look like?
(Question 2)


Table 1 Product Class Cost Analysis (Normal year)

In order to achieve a better understanding of the case. We will first analyse the initial situation.
Break-even points can be calculated using the following formula:

5%6+7 4#,&,
()*+, .#*0<+ =

89:

89: = (+**%/= >"%4+ 2)"%)3*+ 4#,& >+" 0/%&

First of all, Table 1 is used to calculate the CVP Income Statements for product A, B and C (refer
to exhibits 3-5):

Exhibit 3 CVP Income Statement Product A
Unit selling price
Unit variable cost
Unit contribution margin
Sales Volume


Sales revenues
Variable costs
Contribution margin
Fixed costs
Profit

$1.67
$1.25
$0.42
404,761.90

$
$675,952.38
$505,952.38
$170,000.00
$170,000.00
0

%
100.0%
74.9%

25.1%
0%

Exhibit 4 CVP Income Statement Product B
Unit selling price
Unit variable cost
Unit contribution margin
Sales Volume


Sales revenues
Variable costs
Contribution margin
Fixed costs
Profit

$1.50
$0.63
$0.88
314,285.71

$
$471,428.57
$196,428.57
$275,000.00
$275,000.00
0

%
100.0%
41.7%

58.3%
0%

Exhibit 5 CVP Income Statement Product B
Unit selling price
Unit variable cost
Unit contribution margin
Sales Volume


Sales revenues
Variable costs
Contribution margin
Fixed costs
Profit

$0.40
$0.25
$0.15
500,000.00

$
$200,000.00
$125,000.00
$75,000.00
$75,000.00
0

%
100.0%
62.5%

37.5%
0%


The sales volume marked yellow, shows the reader the split up break-even points of
the normal year. Looking back at Table 1 shows, that Product A and B break even,
Product C is just break-even selling 500,000 units during a normal year.

a) What is the break-even point, ignoring dividends and union demands?

Product Lines

A
B
Sales at full capacity (units)
2,000,000

Sales volume (units)
1,750,000
400,000
400,000
Volume %

22.86%
22.86%
Unit sales price

$1.67
$1.50





Total sales revenue

$668,000.00 $600,000.00
Variable cost per unit

$1.25
$0.625
Contribution margin per unit

$0.42
$0.88
Unit contribution margin average
$0.59






Total variable cost

$500,000.00 $250,000.00
Fixed costs
$640,000.00 $170,000.00 $275,000.00





Net Profit

$(2,000.00)
$75,000.00
Ratios



87.5%
20.0%
20.0%
Utilization of capacity (%)





Break-even point (units)

1,076,405.57
404,761.90
314,285.71
Break-even point (units)*Volume %

246,035.56
246,035.56

Assumptions:
Capacity will reach 87.5% in the next year, instead of the suggested 90%

Additional
Fixed costs

950,000
54.29%
$0.80

$760,000.00
$0.25
$0.55

$237,500.00

$75,000.00 $120,000.00


$447,500.00

47.5%

136,363.64
584,334.45

b) What level of operations must be achieved to pay the extra dividend, ignoring union
demands?

Last year the company made a net profit of $150,000.00 and then paid half of that in
taxes, leaving $75,000.00. Then they paid out dividends of $50,000.00 to their
stockholders leaving them with a cash reserve of $25,000.00. This year, as it is their
anniversary they are planning to put out a special dividend of about 50% extra.
Therefore, their stockholders would receive $75,000.00 in dividends, adding on the
yearly reserve of $25,000.00 the company would need to hit $100,000.00 after being
governed. The total profits before tax deduction should be equal to $200,000.00.

Assumptions: 50% extra dividend on the initial dividend of $50,000.00.

Operating income after taxes

($75,000.00 dividend +
$25,000.00 reserve)
Selling price per unit
Variable cost per unit
Contribution margin per unit

$100,000.00
$1.16
$0.56
$0.59

Operating income before tax

(assuming 50% of the profit are
being governed)
Total fixed costs

$200,000.00
$640,000.00

Number of units required to be

produced = (FC + Operating
income)/Contribution

1,412,782.32

!"#$%&'($&"# *+%,&# -.% (#&$ 0 2! = 4%"5&$

0=

4%"5&$ + 2!

!"#$%&'($&"# *+%,&# -.% (#&$

c) What level of operations must be achieved to meet the union demands, ignoring
bonus-dividends?

Operating income after
taxes ($50,000.00 dividend
+ $25,000.00 reserve)
Selling price per unit
Variable cost per unit
Contribution margin per
unit

$75,000.00
$1.16
$0.62
$0.54

Operating income before

tax (assuming 50% of the
profit are being governed)
Total fixed costs

$150,000.00
$640,000.00

Number of units required

to be produced = (FC +
Operating
income)/Contribution

1,468,011.68

d) What level of operations must be achieved to meet both dividend and expected union
requirements?

Operating income after
taxes ($75,000.00 dividend
+ $25,000.00 reserve)
Selling price per unit
Variable cost per unit
Contribution margin per
unit

$100,000.00
$1.16
$0.62
$0.54

Operating income before

tax (assuming 50% of the
profit are being governed)
Total fixed costs

$200,000.00
$640,000.00

Number of units required

to be produced = (FC +
Operating
income)/Contribution

1,560,923.81

Can the break-even analysis help the company decide whether to alter the existing product
emphasis? What can the company afford to invest for additional C capacity? (Question 3)

Break-even analysis can be used to decide whether to alter the existing product emphasis or
not. For example, in this case, if we refer to last years data, we can see that it is not
economically feasible to manufacture product C at $0.40 / unit. The following table shows an
analysis checking whether the company can afford to invest in the additional capacity needed
for C.

Assumption: For this exercise we assume that the increase in fixed costs of $120,000.00 will
be allocated completely to Product C, as B stays stable and A is decreasing.

Total number of units produced
950,000
Sale price
$0.80
Sales revenues
$760,000.00
Variable cost
$0.28
Total variable cost
$261,250.00
Contribution margin
$498,750.00
Fixed costs
$195,000.00
Investment the company can
afford
$303,750.00


Is this type of analysis of any value? How can it be used? (Question 4)

The following are the benefits of the break-even analysis:
The break-even analysis helps understand and formulate the relationship
between costs (fixed and variable), output and profit.
It can be used to set sales targets and/ or prices to generate target profits.
In a wide product range, the analysis helps to consider which products are
performing well and which are leading to losses.
It is also possible to include items like dividends, change in variable costs, tax
increase, bonuses etc. that directly or indirectly affect costs.