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COST-VOLUME-PROFIT ANALYSIS:
A MANAGERIAL PLANNING TOOL
DISCUSSION QUESTIONS
1. CVP analysis allows managers to focus on 8. Packages of products, based on the
selling prices, volume, costs, profits, and expected sales mix, are defined as a single
sales mix. Many different what-if questions product. Selling price and cost information
can be asked to assess the effect of for this package can then be used to carry
changes in key variables on profits. out CVP analysis.
2. The units sold approach defines sales 9. This statement is wrong; break-even
volume in terms of units of product and analysis can be easily adjusted to focus on
gives answers in these same terms. The unit target profit.
contribution margin is needed to solve for
10. The basic break-even equation is adjusted
the break-even units. The sales revenue
for target profit by adding the desired target
approach defines sales volume in terms of
revenues and provides answers in these profit to the total fixed costs in the
same terms. The overall contribution margin numerator. The denominator remains the
ratio can be used to solve for the break-even contribution margin per unit.
sales dollars. 11. A change in sales mix will change the
3. Break-even point is the level of sales activity contribution margin of the package (defined
where total revenues equal total costs, or by the sales mix), and thus will change the
where zero profits are earned. units needed to break even.
4. At the break-even point, all fixed costs are 12. Margin of safety is the sales activity in excess
covered. Above the break-even point, only of that needed to break even. The higher the
variable costs need to be covered. Thus, margin of safety, the lower the risk.
contribution margin per unit is profit per unit,
provided that the unit selling price is greater 13. Operating leverage is the use of fixed costs
than the unit variable cost (which it must be to extract higher percentage changes in
for break even to be achieved). profits as sales activity changes. It is
achieved by increasing fixed costs while
5. Variable cost ratio = Variable costs/Sales lowering variable costs. Therefore, increased
Contribution margin ratio leverage implies increased risk, and vice
= Contribution margin/Sales versa.
Contribution margin ratio 14. Sensitivity analysis is a what-if technique
= 1 Variable cost ratio that examines the impact of changes in
underlying assumptions on an answer. A
6. No. The increase in contribution is $9,000 company can input data on selling prices,
(0.3 $30,000), and the increase in variable costs, fixed costs, and sales mix
advertising is $10,000. If the contribution
and set up formulas to calculate break-even
margin ratio is 0.40, then the increased
points and expected profits. Then, the data
contribution is $12,000 (0.4 $30,000). This
is $2,000 above the increased advertising can be varied as desired to see what impact
expense, so the increased advertising would changes have on the expected profit.
be a good decision. 15. A declining margin of safety means that
7. Sales mix is the relative proportion sold of sales are moving closer to the break-even
each product. For example, a sales mix of point. Profit is going down, and the
3:2 means that three units of one product possibility of loss is greater. Managers
are sold for every two of the second product. should analyze the reasons for the
decreasing margin of safety and look for
Cornerstone Exercise 41
3. Head-First Company
Contribution Margin Income Statement
For the Coming Year
Total Per Unit
Sales ($70 5,000 helmets).................................. $350,000 $70
Total variable expense ($49 5,000).................... 245,000 49
Total contribution margin...................................... 105,000 $21
Total fixed expense................................................ 29,400
Operating income ................................................. $ 75,600
Cornerstone Exercise 42
$29,400
= ($70 - $49)
= 1,400 helmets
2. Head-First Company
Contribution Margin Income Statement
At Break-Even
Total
Sales ($70 1,400 helmets)................................................... $98,000
Total variable expense ($49 1,400).................................... 68,600
Total contribution margin...................................................... 29,400
Total fixed expense................................................................ 29,400
Operating income................................................................... $ 0
($70 - $49)
= $70
= 0.30, or 30%
3. Head-First Company
Contribution Margin Income Statement
For the Coming Year
Percent
of Sales
Sales ($70 5,000 helmets).................................. $350,000 100%
Total variable expense ($49 5,000).................... 245,000 70
Total contribution margin...................................... 105,000 30
Total fixed expense................................................ 29,400
Operating income ................................................. $ 75,600
Cornerstone Exercise 44
$29,400
= 0.30
= $98,000
2. Head-First Company
Contribution Margin Income Statement
At Break-Even
Total
Sales........................................................................................ $98,000
Total variable expense ($98,000 0.70)............................... 68,600
Total contribution margin...................................................... 29,400
Total fixed expense................................................................ 29,400
Operating income................................................................... $ 0
Cornerstone Exercise 45
($29,400 + $81,900)
= ($70 - $49)
= 5,300 helmets
2. Head-First Company
Contribution Margin Income Statement
At 5,300 Helmets Sold
Total
Sales ($70 5,300 helmets)................................................... $371,000
Total variable expense ($49 5,300).................................... 259,700
Total contribution margin...................................................... 111,300
Total fixed expense................................................................ 29,400
Operating income................................................................... $ 81,900
Cornerstone Exercise 46
($29,400 + $81,900)
= 0.30
= $371,000
2. Head-First Company
Contribution Margin Income Statement
At Sales Revenue of $371,000
Total
Sales........................................................................................ $371,000
Total variable expense ($371,000 0.70)............................. 259,700
Total contribution margin...................................................... 111,300
Total fixed expense................................................................ 29,400
Operating income................................................................... $ 81,900
Cornerstone Exercise 47
1. Any package with 5 bicycle helmets for every 1 motorcycle helmet is fine; for
example, 5:1, or 10:2, or 30:6. Throughout the rest of this exercise, we will use
5:1.
Fixed cost
2. Break-even packages = Package contributi on margin
$54,600
= $182
= 300 packages
3. Head-First Company
Contribution Margin Income Statement
At Break-Even
Total
Sales [($70 1,500) + ($220 300)]...................................... $171,000
Total variable expense [($49 1,500) + ($143 300)]......... 116,400
Total contribution margin...................................................... 54,600
Total fixed expense................................................................ 54,600
Operating income................................................................... $ 0
Cornerstone Exercise 48
($570,000 - $388,000)
1. Contribution margin ratio = $570,000
= 0.3193
2. Head-First Company
Contribution Margin Income Statement
At Break-Even Sales Dollars
Total
Sales........................................................................................ $170,999
Total variable expense ($170,999 0.6807)......................... 116,399
Total contribution margin...................................................... 54,600
Total fixed expense................................................................ 54,600
Operating income................................................................... $ 0
Cornerstone Exercise 49
$105,000 *
= $75,600
= 1.4
* 5,000 ($70 - $49)
Exercise 412
$10.50
2. Contribution margin ratio = $24 = 0.4375, or 43.75%
$13.50
Variable cost ratio = $24 = 0.5625, or 56.25%
Exercise 413
$874,000
2. Break-even units = $7.60 = 115,000
4. Sales........................................................................................ $2,185,000
Less: Variable costs (0.6 x $2,185,000)................................ 1,311,000
Contribution margin............................................................... 874,000
Less: Fixed costs................................................................... 874,000
Operating income................................................................... $ 0
Exercise 414
Contribution margin
1. Contribution margin ratio = Sales
$63,000
= $315,000 = 0.20, or 20%
Fixed cost
3. Break-even sales revenue = Contribution margin ratio
$24,150
= 0.20 = $120,750
Exercise 416
($131,650 + $18,350)
1. Break-even units = ($2.45 - $1.65)
$150,000
= $0.80
= 187,500
= 203,250
Exercise 417
A B C D
Sales $15,000 $15,600* $16,250* $10,600
Total variable costs 5,000 11,700 9,750 5,300*
Total contribution margin 10,000 3,900 6,500* 5,300*
Total fixed costs 9,500* 4,000 6,136* 4,452
Operating income (loss) $ 500 $ (100)* $ 364 $ 848
(Note: Calculated break-even units that include a fractional amount have been
rounded to the nearest whole unit.)
Exercise 419
$141,750
1. Variable cost ratio = $315,000 = 0.45, or 45%
$173,250
Contribution margin ratio = $315,000 = 0.55, or 55%
2. Because all fixed costs are covered by break even, any revenue above break
even contributes directly to operating income.
Sales Contribution margin ratio = Increased operating income
$30,000 0.55 = $16,500
Therefore, operating income will be $16,500 higher.
$63,000
3. Break-even sales revenue = 0.55 = $114,545 (rounded to the nearest
dollar)
Sales........................................................................................ $114,545
Less: Variable cost ($114,545 0.45)................................... 51,545
...............................................................Contribution margin
63,000
Less: Fixed cost..................................................................... 63,000
...................................................................Operating income $
0
Exercise 420
1. Sales mix is 2:1 (twice as many DVDs are sold as equipment sets).
1. Sales mix is 2:1:4 (twice as many DVDs will be sold as equipment sets, and
four times as many yoga mats will be sold as equipment sets).
3. Switzer Company
Income Statement
For the Coming Year
Sales........................................................................................ $555,000
Less: Total variable costs..................................................... 330,000
...............................................................Contribution margin
225,000
Less: Total fixed costs........................................................... 118,350
...................................................................Operating income
$106,650
$225,000
Contribution margin ratio = $555,000 = 0.405, or 40.5%
$118,350
Break-even revenue = 0.405 = $292,222
1. Sales mix is 3:5:1 (three times as many small basics will be sold as carved
models, and five times as many large basics will be sold as carved models).
3. Sonora Company
Income Statement
For the Coming Year
Sales........................................................................................ $25,650,000
Less: Total variable costs..................................................... 18,520,000
...............................................................Contribution margin
7,130,000
Less: Total fixed costs........................................................... 669,750
...................................................................Operating income $
6,460,250
$7,130,000
Contribution margin ratio = $25,650,00 0 = 0.2780, or 27.80%
$669,750
Break-even revenue = 0.2780 = $2,409,173
Break-even point = 2,500 units; + line is total revenue, and X line is total cost.
Exercise 424
$486,000
1. Unit contribution margin = 18,000 = $27
$540,000
Break-even units = $27 = 20,000 units
$27
3. Contribution margin ratio = $60 = 0.45, or 45%
$540,000
Break-even sales revenue = 0.45 = $1,200,000
$1,833,300
1. Break-even sales dollars = 0.58 * = $3,160,862
$2,610,000
*Contribution margin ratio = $4,500,000 = 0.58, or 58%
Contribution margin
3. Degree of operating leverage = Operating income
$2,610,000
= $776,700
= 3.36
Exercise 426
$75,000
Break-even packages = $120 = 625
Break-even vases = 2 625 = 1,250
Break-even figurines = 1 625 = 625
$88,150
Break-even packages = $215 = 410
Break-even vases = 3 410 = 1,230
Break-even figurines = 2 410 = 820
Exercise 427
$6,720,000
1. a. Variable cost per unit = 350,000 = $19.20
$1,680,000
b. Contribution margin per unit = 350,000 = $4.80
$4.80
c. Contribution margin ratio = $24.00 = 0.20, or 20%
$1,512,000
d. Break-even units = $4.80 = 315,000
$1,512,000
e. Break-even sales dollars = 0.20 = $7,560,000
OR
Break-even sales dollars = 315,000 $24 = $7,560,000
($1,512,000 + $300,000)
2. Units for target income = $4.80 = 377,500
$1,680,000
5. Degree of operating leverage = $168,000 = 10.0
Problem 428
Fixed cost
1. Break-even units = (Price - Unit variable cost)
$1,792,000
= $20
= 89,600 units
$3,392,000
= $20
= 169,600 units
$20
3. Contribution margin ratio = $50 = 0.40
$6,200,000
4. Current units = = 124,000 units
$50
Margin of safety in units = 124,000 89,600 = 34,400 units
Fixed cost
1. Break-even units = (Price - Unit variable cost)
$96,000
= ($10 - $5)
= 19,200 units
($96,000 - $13,500)
2. Break-even units = ($10 - $5)
= 16,500 units
3. The reduction in fixed costs reduces the break-even point because less
contribution margin is needed to cover the new, lower fixed costs. Operating
income goes up, and the margin of safety also goes up.
Problem 430
$5,760,000
1. Unit contribution margin = 384,000 = $15
$3,000,000
Break-even point = $15 = 200,000 units
$15
Contribution margin ratio = $50 = 0.3
$3,000,000
Break-even sales = 0.3 = $10,000,000
OR
= $50 200,000 = $10,000,000
$5,760,000
6. $2,760,000 = 2.09 (operating leverage)
20% 2.09 = 41.8% (profit increase)
Problem 431
1. Sales mix:
$300,000
Squares: $30 = 10,000 units
$2,500,000
Circles: $50 = 50,000 units
$100,000
* 10,000 = $10
$500,000
50,000 = $10
$1,628,000
Break-even packages = $220 = 7,400 packages
Break-even squares = 7,400 1 = 7,400
2. New mix:
Variable Contribution Sales Total
Product Price Cost = Margin Mix = CM
Squares $30 $10 $20 3 $ 60
Circles 50 10 40 5 200
Package $260
$1,628,000
Break-even packages = $260 = 6,262 packages
Break-even squares = 6,262 3 = 18,786
Break-even circles = 6,262 5 = 31,310
Kenno would gain $55,000 by increasing advertising for the squares. This
is a good strategy.
Problem 432
$58,500
1. Break-even units = ($0.36 - $0.27) = 650,000
Margin of safety in units = 830,000 650,000 = 180,000
($58,500 + $36,000)
3. Units for target profit = ($0.36 - $0.27)
Problem 433
$302,616
1. Contribution margin ratio = $560,400 = 0.54, or 54%
$150,000
2. Break-even revenue = 0.54 = $277,778
$332,878
Contribution margin ratio = $616,440 = 0.54
$285,804
New contribution margin ratio = $560,400 = 0.51
$150,000
Break-even revenue = 0.51 = $294,118
The effect is to increase the break-even revenue.
Problem 434
Fixed cost
1. Revenue = (1 - Variable rate)
$150,000
= (1/3)
= $450,000
$360,000
$30 = 12,000 units
$240,000
$20 = 12,000 units
Thus, the sales mix is 1:1.
$150,000
= $16.67
= 8,998 packages
Contribution margin
3. Operating leverage = Operating income
$200,000
= $50,000
= 4.0
Problem 435
2. Contribution margin:
($3 20,000) + ($3 40,000) $180,000
Less: Fixed costs 146,000
Operating income $ 34,000
$300,000
1. Break-even units = $14* = 21,429
$406,000
* 29,000 = $14
$1,218,000
** 29,000 = $42
2. Margin of safety = $1,218,000 $900,000 = $318,000
3. Sales........................................................................................ $1,218,000
Variable cost (0.45 $1,218,000).......................................... 548,100
...............................................................Contribution margin
669,900
Fixed costs.............................................................................. 550,000
...................................................................Operating income $
119,900
$550,000
Break-even in units = $23.10* = 23,810
$550,000
Break-even in sales dollars = 0.55** = $1,000,000
$669,900
* 29,000 = $23.10
$669,900
** $1,218,000 = 55%
Variable costs
1. Variable cost ratio = Sales
$353,400
= $930,000 = 0.38, or 38%
(Sales - Variable costs)
Contribution margin ratio = Sales
($930,000 - $353,400)
= $930,000
= 0.62, or 62%
$310,000
2. Break-even sales revenue = 0.62 = $500,000
Problem 438
$160,000
2. ($3.50 - Unit variable cost) = 128,000
Unit variable cost = $2.25
($32,300 + $12,500)
2. Break-even in units = $1.40 = 32,000 boxes
Break-even in sales = 32,000 $5.60 = $179,200
OR
($32,300 + $12,500)
= 0.25 = $179,200
$44,800
5. Break-even in units = ($6.20 - $4.20) = 22,400 boxes
New operating income = $6.20(31,500) $4.20(31,500) $44,800
= $195,300 $132,300 $44,800 = $18,200
Yes, operating income will increase by $14,000 ($18,200 $4,200).
Problem 440
$100,000
1. Company A: $50,000 = 2
2. Company A Company B
$50,000 $250,000
X = (1 - 0.8) X = (1 - 0.4)
$50,000 $250,000
X= 0.2 X= 0.6
X = $250,000 X = $416,667
Company B must sell more than Company A to break even because it must
cover $200,000 more in fixed costs (it is more highly leveraged).
Problem 4-41
Variable
Target units are calculated by taking the fixed costs plus the target pre-tax
profit divided by the contribution margin per package and then calculating the
number of each unit in a package.
Revenue $7,940,000
Less: Variable costs 5,558,000
Contribution $2,382,000
Per product: A: 133 x 10 = 1,330; B: 133 x 6 =798; C: 133 x 3 =399; D: 133 x 1 = 133.
Revised contribution
$23,910
May of current year = $43,560 = 0.549, or 54.9%
$23,400
May of prior year = $41,700 = 0.561, or 56.1%
$20,330
May of current year = 0.549 = $37,031
$13,800
May of prior year = 0.561 = $24,599
4. Clearly, the sharp rise in fixed costs from the prior year to the current year has
had a strong impact on the break-even point and the margin of safety.
Bissonette will need to ensure that tight cost control is exercised since the
margin of safety is much slimmer. Still, the decision to go with the OEM
investment program could pay large dividends in the future. Note that the
margin of safety and break-even point give the company important information
on the potential risk of the venture but do not tell it the upside potential.
b. $440,000 / $1.60
= 275,000 boxes
d. CM = $4 - $2.70 = $1.30
CM ratio = $1.30 / $4 = 32.5%
Desired operating income = $110,400 / .6 = $184,000
Case 445
1.Let X be a package of 3 Grade I cabinets and 7 Grade II cabinets.
0.3X($3,400) + 0.7X($1,600) = $1,600,000
X = 748 packages
Grade I: 0.3 748 = 224 units
Grade II: 0.7 748 = 524 units
$225,000
$4,046 = 56 packages
Grade I: 3 56 = 168
Grade II: 7 56 = 392
Effect on profits:
Change in contribution margin:
$714(260 141) $272(329 260) $66,198
Increase in fixed costs:
$70,000(7/12) 40,833
Increase in operating income $25,365
Fixed cost
X = (Price - Variable cost)
$295,000
= $986
= 299 packages (or 299 of each cabinet)
The break-even point is computed as follows:
($295,000 - $118,102)
X = $986
$176,898
= $986
= 179 packages (179 of each)
To this, add the units already sold, yielding the revised break-even point:
I: 83 + 179 = 262
II: 195 + 179 = 374
Jackets
Revenue to achieve target = profit fixed costs plus pre-tax target / Contribution
margin %
Units: 54,905 t-shirts (10,981 x 5); 32,943 sweatshirts (10,981 x 3); 21,962 fleece
(10,981 x 2).
Units: 73,105 t-shirts (14,641 x 5); 43,863 sweatshirts (14,641 x 3); 29,242 fleece
(14,641 x 2).
Case 447
Fixed expense
1. Break-even point =
(Price-Variable cost)
$100,000
First process: ($30 - $10) = 5,000 cases
$200,000
Second process: ($30 - $6) = 8,333 cases
The manual process is more profitable if sales are less than 25,000 cases; the
automated process is more profitable at a level greater than 25,000 cases. It is
important for the manager to have a sales forecast to help in deciding which
process should be chosen.
3. The right to decide which process should be chosen belongs to the divisional
manager. Donna has an ethical obligation to report the correct information to
her superior. By altering the sales forecast, Donna unfairly and unethically
influenced the decision-making process. Managers certainly have a moral
obligation to assess the impact of their decisions on employees, and every
effort should be taken to be fair and honest with employees. Donnas
behaviour, however, is not justified by the fact that it helped a number of
employees retain their employment. First, Donna had no right to make that
decision. Donna certainly has the right to voice her concerns about the impact
of automation on the employees well-being. In so doing, perhaps the
divisional manager would come to the same conclusion, even though the
automated system appears to be more profitable. Second, the choice to select
the manual system may not be the best for the employees anyway. The
divisional manager may possess more information, making the selection of
the automated system the best alternative for all concerned, provided the
sales volume justifies its selection. For example, if the automated system is
viable, the divisional manager may have plans to retrain and relocate the
displaced workers in better jobs within the company. Third, her motivation for
altering the forecast seems more driven by her friendship with Hussan Khalil
than any legitimate concerns for the layoff of other employees. Donna should
examine her reasoning carefully to assess the real reasons for her behaviour.
Perhaps in so doing, the conflict of interest that underlies her decision will
become apparent.