Professional Documents
Culture Documents
18.1 (a) The break-even point in sales units is calculated using the following formula:
fixed costs
=
unit contribution margin
(b) The break-even point is calculated in sales dollars using the following formula:
fixed costs
=
contribution margin ratio
(c) In the graphical approach, sales revenue and total costs are graphed. The break-even point occurs
at the intersection of the total revenue and total cost lines.
18.2 A CVP graph plots the total cost line and the revenue line. The profit is the difference between the
values on these two lines for any volume of sales. The break-even point is at the sales volume where the
two lines intersect (i.e. revenue equals total costs). A profit volume graph shows the profit to be earned
at each level of sales volumethere is only one line plotted, which depicts the profit at each level of
sales volume. The break-even point on this graph is at the sales volume where the graph crosses the
horizontal axis.
18.3 The formula to estimate break-even sales revenue can be adjusted to estimate the sales revenue required
to achieve a target net profit by adding the profit required to the fixed costs in the formula. The amount
used in the numerator of the formula must always represent the total contribution margin required.
Break-even point calculations consider the sales level at which fixed costs will just be covered; the total
contribution margin required is the same as fixed costs. Target profit calculations calculate the sales
level at which the total contribution margin equals fixed costs plus the required profit. The same
approach can be used for profit before or after taxthe profit margin can be converted to an after tax
profit and added to fixed costs.
18.4 An increase in variable costs per unit can result in decreased fixed costs if the behaviour of a cost has
changed such that it requires a change in classification. An example is the increasing opportunity to hire
equipment as and when required rather than purchase the equipment and record fixed depreciation costs.
This means that the variable cost per unit has increased but the fixed costs have decreased.
At Malaka Oyster Company it is possible that crew members were previously rewarded on the basis of a
fixed payment per trip but this has changed to the size of the catch. The unit contribution margin, which
is the denominator of the break-even (sales volume) equation, decreases when the unit variable cost
increases. This increases the break-even point. However, the fixed cost (the numerator) has decreased,
and this will decrease the break-even point.
So, the firms break-even sales volume increases with the decrease in unit contribution margin but
would decrease when there is a decrease in fixed costs. Whether the final break-even sales volume has
increased or decreased will depend on the relationship between the decreases in (a) the numerator and
(b) the denominator. If both increase by the same percentage the break-even sales volume will remain
the same. If the fixed costs decrease by a greater percentage than the unit contribution margin the break-
even volume will reduce, and vice versa.
18.6 The fixed costs of a travel agency may include the salaries of travel consultants, line rentals included in
the phone bills, and rent of the agency premises or depreciation of office equipment. The increases in
these fixed costs would mean a higher break-even point in the number of sales to clients, because more
sales are required to cover the higher fixed costs.
18.7 The safety margin is the amount by which budgeted sales revenue exceeds break-even sales revenue. It
is the amount by which actual sales can fall below budgeted sales before losses are incurred. Managers
may use this information to highlight how close a project or enterprise is to the break-even point and
hence focus on maintaining activities so that revenue does not fall below the break-even point. In this
way managers can focus on keeping operations profitable, which adds to shareholder value.
18.8 The annual donation will partially offset the art gallerys fixed costs. The reduction in net fixed costs
will reduce the gallerys break-even point.
18.9 The low selling-price company may have a higher sales volume than the high selling-price company. By
spreading its fixed costs across a larger sales volume, the low-price firm can afford to charge a lower
price and still earn the same profit as the high-price company.
In the following example, Companies A and B have the identical variable cost per unit, fixed cost and
total profits. However, the higher sales volume of 350 units allows Company A to charge customers
only $10 per unit, whereas Company B charges $20 per unit.
Company A Company B
Sales revenue:
Variable costs:
18.10 Cost-volume-profit analysis can be used in budgeting by projecting the profit that will be achieved at the
budgeted sales volume. Budgeting in a cafe business begins with a sales forecast of number of coffees
and cake to be sold. A CVP analysis also shows how pricing would contribute to the profitability, as
changes in coffee and cake prices would change the contribution margin and affect the break-even sales
volume. However, it is important to understand that CVP analysis ignores the effect that sales price has
on sales volume because it is not designed to predict sales.
18.11 The sales mix of a multi-product business such as Tassal is the relative proportion of the different types
of products provided by the salmon producer. The weighted-average unit contribution margin is the
average of the unit contribution margins for Tassals products (e.g. fresh salmon, frozen salmon, smoked
salmon, canned salmon and roasted canned salmon) with each products contribution margin weighted
by its relative proportion of the total quantity of output.
18.13 When a company is liable for income taxes, then this may be taken into account when determining the
target sales volume. When a target profit is stated as an after-tax amount, then the break-even formula
must be modified to account for the amount of taxation payable. However, income taxes make no
difference to determining the break-even point, as there is no tax payable on zero profit.
18.14 CVP analysis enables us to estimate how many units need to be sold to break even or to achieve a target
profit. However, it does not take account of how a products price influences the demand for that
product and, therefore the number of units sold. It ignores the effect that sales price has on sales volume
because it is not designed to predict sales.
18.15 Conventional CVP analysis assumes that product costs are driven by the volume of production and selling
costs are driven by the volume of sales (and that production volume equals sales volume). Whereas,
activity-based costing recognises a range of cost drivers, including non-volume based drivers such as the
number of batches. The classification of costs as fixed or variable with respect to production/sales volume
is no longer considered relevant under an ABC system, therefore, under ABC we cannot satisfy some of
the conventional assumptions of CVP analysis. Instead, we need to consider how to calculate the break-
even point, or target sales volume, by considering complex relationships between a range of cost drivers
and costs which can be considered as unit, batch or product-level costs for production, and order, customer,
and market-level costs for customer-related matters, as well as facility level costs.
18.16 CVP analysis is based on estimates of a number of variables, and whenever estimates are used, a degree
of uncertainty exists. Sensitivity analysis is an approach that examines how a result or outcome may
change if there are variations in the predicted data or underlying assumptions. Using simple spreadsheet
models, the sensitivity to changes in certain variables can be determined, such as the sensitivity of profit
to changes in fixed or variable costs.
18.17 CVP analysis assumes that costs are fixed or vary with the sales/production volume. Computer
modelling can be used to move from conventional CVP analysis to an activity-based costing model
which recognises a much broader range of cost drivers, such as the number of batches, products,
customers, orders and markets. Also a business can use computer modelling to perform sensitivity
analysis to assess the effects of changes in the variables underlying the CVP model. The sensitivity
analysis, therefore, can identify the effect on profits of varying assumptions about the cost structure and
cost drivers underlying CVP analysis.
18.19 East Ltd, which is highly automated, will have a cost structure dominated by fixed costs. West Ltds
cost structure will include a larger proportion of variable costs than East Ltds cost structure.
A firms operating leverage factor, at a particular sales volume, is defined as its total contribution margin
divided by its net profit. Since East Ltd has proportionately higher fixed costs, it will have a
proportionately higher total contribution margin. Therefore, East Ltds operating leverage factor will be
higher.
18.20 False. The statement is only partly true. A company with capital intensive processes is likely to have
higher fixed costs and higher operating leverage (which is equal to contribution margin/net profit). The
higher fixed costs often result in a higher break-even point and therefore a smaller safety margin.
Total
Sales Variable contribution Fixed Net Break-even
revenue costs margin costs profit sales revenue
2 $240 000b $ 60 000 $180 000 $60 000 $120 000 $ 80 000
4 $360 000 $120 000 $240 000 $90 000 $150 000 $135 000d
(c) $80 000 is the break-even sales revenue, which is identical to total sales revenue, so fixed costs must be
equal to the contribution margin of $15 000 and profit must be zero.
(d) $135 000 = $90 000 0.667, where 0.666667 is the contribution margin ratio
(240 000 / 360 000).
$54 000
= = 13 500 pizzas
$10 - $6
unit contribution margin
2 Contribution margin ratio =
unit sales price
$10 - $6
= = 0.4
$10
Break - even point fixed costs
3 =
(in sales dollars) contribution margin ratio
$54 000
= = $135 000
0.4
EXERCISE 18.23 (25 minutes) Cost volume profit graph: sports team
1 Cost-volume-profit graph:
900 000
Total revenue
Break-even point:
20 000 tickets
Total costs line
Profit
area
Loss area
Tickets
sold per
year
5 000 10 000 15 000 20 000 25 000 30 000
EXERCISE 18.24 (25 minutes) Profit volume graph; safety margin: sports team
1 Profit-volume graph:
Dollars per
year
600 000
Break-even point:
20 000 tickets
Profit area
Tickets
sold per
year
5000 10 000 15 000 20 000 25 000
Loss area
Loss Total
(300 000) profit/loss
(10 games 6000 seats 0.45 full $40) ...................................................................... $1 080 000
3 Let P denote the break-even ticket price, assuming a 10-game season and 40 per cent attendance:
EXERCISE 18.25 (25 minutes) Cost volume profit analysis and decisions:
manufacturer
fixed costs
1 Break-even point (in units) =
unit contribution margin
= 8000 TVs
Price
$3 000 $2 500
The price cut should not be made, since instead of $1 000 000 profit, a loss of $900 000 will incur.
2 Sales mix:
= $1125
4 fixed expenses
Break - even point (in units) =
weighted - average unit contribution margin
$390 000
= = 347 bicycles
$1125
Break-even
Bicycle type sales volume Sales price Sales revenue
3 Service revenue required to earn target target after - tax net profit
fixed expenses +
after-tax profit of $260 000 (1 - t )
=
contribution margin ratio
$260 000
$400 000 +
= 1 - 0.40 = $3 333 333
0.25
4 A change in the tax rate will have no effect on the firms break-even point. At the break-even point, the
firm has no profit and does not have to pay any income taxes.
contribution margin
Operating leverage factor (at $2 000 000 sales level)
net profit
2
$870 000
4.35
$200 000
3 percentage increase
Percentage increase in net profit = operating
in sales revenue leverage factor
= 10% 4.35
= 43.5%
4 Most operating managers prefer the contribution income statement for answering this type of question.
The contribution format highlights the contribution margin and separates fixed and variable expenses.
1 The following income statement, often called a common-size income statement, provides a convenient
way to show the cost structure.
Amount Percent
The key to understanding this answer is to realise that the change in net profit will be the same as the
change in contribution margin, since fixed costs will not change.
3 contribution margin
Operating leverage factor (at revenue of $1 500 000) =
net profit
$600 000
= =4
$150 000
Requirement 1 Requirement 2
fixed expenses
Break - even point =
contribution margin ratio
$540 000 + $216 000 $756 000
= =
$30 - $12 - $6 .4
$30
= $1 890 000
= $14.40
fixed expenses
Break - even point =
contribution margin ratio
$756 000
= = $2 362 500
0.32
4 Let P denote the selling price that will yield the same contribution-margin ratio:
PROBLEM 18.32 (30 minutes) Cost volume profit relationships; indifference point:
manufacturer
Model A Model B
Sales revenue (184 000 units $32.00) $5 888 000 $5 888 000
Sales commissions ($5 888 000 5%) 294 400 294 400
3 Annual fixed costs will increase by $180 000 ($900 000 5 years) because of straight-line depreciation
associated with the new equipment, to $2 407 200 ($2 227 200 + $180 000). The unit contribution
margin is ($4 416 000 184 000 units) i.e. $24. Thus:
Required sales = (fixed costs + target net profit) unit contribution margin
= ($2 407 200 + $1 912 800) $24
= 180 000 units
2 fixed cost
Break - even point (in sales dollars) =
contribution - margin ratio
$702 000
= = $3 375 000
$25.00 - $19.80
$25.00
= $4.80
Let P denote sales price required to maintain a contribution-margin ratio of .208. Then P is determined as
follows:
2 fixed cost
Break - even point (in sales dollars) =
contribution - margin ratio
$702 000
= = $3 375 000
$25.00 - $19.80
$25.00
3 Number of sales units required fixed costs + (target net after profit/(1 - t))
to earn target net profit after tax =
unit contribution margin
$702, 000 + ($400 000/.7)
= = 244 890 units
$25.00 - $19.80
= $4.80
Sales 140 000 110 000 120 000 130 000 140 000 150 000 160 000 170 000
Selling price 25 33 31 28 25 22 19 16
Sales revenue 3 500 000 3 630 000 3 720 000 3 640 000 3 500 000 3 300 000 3 040 000 2 720 000
Direct material 1 148 000 902 000 984 000 1 066 000 1 148 000 1 230 000 1 312 000 1 394 000
Direct labour 560 000 440 000 480 000 520 000 560 000 600 000 640 000 680 000
Manufacturing overhead 840 000 660 000 720 000 780 000 840 000 900 000 960 000 1 020 000
Selling expenses 224 000 176 000 192 000 208 000 224 000 240 000 256 000 272 000
Total variable costs 2 772 000 2 178 000 2 376 000 2 574 000 2 772 000 2 970 000 3 168 000 3 366 000
Manufacturing fixed costs 288 000 288 000 288 000 288 000 288 000 288 000 288 000 288 000
Selling and admin fixed costs 414 000 414 000 414 000 414 000 414 000 414 000 414 000 414 000
Total fixed costs 702 000 702 000 702 000 702 000 702 000 702 000 702 000 702 000
Total costs 3 474 000 2 880 000 3 078 000 3 276 000 3 474 000 3 672 000 3 870 000 4 068 000
Profit before taxes 26 000 750 000 642 000 364 000 26 000 -372 000 -830 000 -1 348 000
Income taxes @ 30% 7 800 225 000 192 600 109 200 7 800 -111 600 -249 000 -404 400
Profit after taxes 18 200 525 000 449 400 254 800 18 200 -260 400 -581 000 -943 600
3 The use of electronic spreadsheets to conduct a sensitivity analysis is very useful to management. It
enables managers to determine the effect on profit of changing certain key variables, such as changing
selling prices and sales volumes.
1
$405 000
Unit contribution margin =
1 800 tonnes
= $225per tonne
fixed costs
Break - even point (in tonnes) =
unit contribution margin
= $247 500 / $225 = 1100 tonnes
2 The companys net profit would increase from this years $157 500 to next years net profit of
$225 500, if the sales volume is increased to 2100 tonnes next year. The revised contribution margin
statement is as follows:
Variable costs:
Fixed costs:
Administrative 40 000
Variable costs:
Fixed costs:
Administrative 40 000
4 If the firms current net profit of $157 500 is to be maintained, the firm will need to break even on its
sales in the new territory. The breakeven point on the new territory activity is 308 tonnes, as shown in
the following workings:
Contribution margin in new territory = $225 $25 = $200
BE units in new territory = $61 500 / $200
= 308 units (rounded)
5 The new break-even volume is 1224 tonnes and $612 000 in sales dollars, should the firm adopt
automation for its manufacturing process. The workings are shown below:
Contribution margin with automated process = $225 + $25 = $250
BE units with automated process = ($247 500 + $58 500) / $250 per tonne
= 1224 tonnes
BE sales dollars with automated process
= 1224 tonnes x $500 = $612 000
6 The new break-even sales dollars is $1 140 000, as shown below:
Contribution margin = $225 ($500 x 0.10) $40 = $135
Contribution margin ratio = $135/$450 = 0.30
Sales dollars to earning a net profit of $94 500
= $(247 500 + 94 500 )/ 0.30
= $1 140 000
1 Current profit:
AudioFriend has a contribution margin of $72 [($4 032 000 $1 008 000) 42 000 units] and desires to
increase profit to $576 000 (i.e. $288 000 2). In addition, the current selling price is $96 ($4 032 000
42 000 units). Thus:
Required sales = (fixed costs + target net profit) unit contribution margin
= ($2 736 000 + $576 000) $72
= 46 000 sets or $4 416 000 (46 000 sets @ $96)
2 If operations are shifted to China, the new unit contribution margin will be $74.40 ($96.00 $21.60).
Thus:
Break-even point = fixed costs unit contribution margin
= $2 380 800 $74.40
= 32 000 units
3 (a) AudioFriend desires a 32 000-unit break-even point with a $72 unit contribution margin. Fixed
costs must therefore drop by $432 000, from $2 736 000 to $2 304 000, as follows:
Let X = fixed costs
X $72 = 32 000 units
X = $2 304 000
(b) As the following calculations show, AudioFriend will have to generate a contribution margin of
$85.50 to produce a 32 000-unit break-even point. Based on a $96.00 selling price, this means
that the company can incur variable costs of only $10.50 per unit. Given the current variable cost
of $24.00 ($96.00 $72.00), a decrease of $13.50 per unit ($24.00 $10.50) is needed.
Let X = unit contribution margin
$2 736 000 X = 32 000 units
X = $85.50
4 (a) Increase
(b) No effect
(c) Increase
(d) No effect
Total contribution margin $1 500 000 $3 000 000 $5 100 000 $9 600 000
* Variable selling cost increases. Thus, the unit contribution decreases to $57 [$108 ($36 + $12 + $3)].
The variable manufacturing cost increases 20 per cent. Thus, the unit contribution
decreases to $36 [$144 (1.2 $75) $18].
Sales proportions:
2 (a) Yes. Plan A sales are expected to total 65 000 units (19 500 + 45 500), which compares
favourably with current sales of 60 000 units.
(b) The sales staff would be likely to promote Standard because it has a higher selling price than
Deluxe ($86 versus $74) and sales staff earn a commission based on gross dollar sales under plan
A. As the following figures show, Deluxe sales will comprise a greater proportion of total sales
under Plan A.
Current Plan A
(c) Yes. Commissions will total $535 600 ($5 356 000 10 per cent), which compares favourably
against the current flat salaries of $400 000.
(d) No. The company would be less profitable under the new plan.
Current Plan A
Sales revenue:
Deluxe: 21 000 units $86; 45 500 units $86 ........................... $1 806 000 $3 913 000
Standard: 39 000 units $74; 19 500 units $74 ........................ 2 886 000 1 443 000
Deluxe: 21 000 units $65.00; 45 500 units $65.00 ................. $1 365 000 $2 957 500
Standard: 39 000 units $41.00; 19 500 units $41.00 .............. 1 599 000 799 500
Plan A Plan B
(b) Plan B is more attractive than Plan A, both to the sales force and to the company. Salespeople also earn more
money under Plan B than the current flat salary ($549 900 vs. $400 000). However, the company is more
profitable in the current situation ($1 328 000) than under either plan ($1 283 100 for Plan B and $1 063 400
for plan A).
Current Plan B
Sales revenue:
Deluxe: 21 000 units $86; 26 000 units $86 ....................... $1 806 000 $2 236 000
Standard: 39 000 units $74; 39 000 units $74..................... 2 886 000 2 886 000
Deluxe: 21 000 units $65.00; 26 000 units $65.00 ............. $1 365 000 $1 690 000
Standard: 39 000 units $41.00; 39 000 units $41.00........... 1 599 000 1 599 000
Unit-related costs: Unit costs Total costs Unit costs Total costs
Packaging 6 4
Materials 70 52
Batch-related costs:
Setting-up 80 90
Inspection 60 50
Moving material 60 50
Product-related costs:
Total product, batch and unit $11 280 000 $4 745 000 $16 025 000
related costs
totalbatch,productandfacility costs
Break - even points(Timber &Polystyrene)
weightedaveragecontributiononmargin
($145 000 $80 000 $360 000)
$20 perunit
($585 000 / $20 perunit)
29 250 units
3 Assuming that the batch size for the Polystyrene crates is changed to 2000 units, then the batch related
cost for polystyrene crates is $4750 (= $190 x 25 batches) and the total batch related cost for the two
products is $54 750. The new break-even point is calculated as follows:
Break - even points (Timber &Polystyrene) = total batch, product and facility costs
weighted average contribution on margin
= ($54 750 + $80 000 + $360 000)
$20 per unit
= $494 750 / $20 per unit
= 24 738 units(rounded)
4 While the increase in batch size has caused a reduction in the break-even point, reducing batch sizes
may not be the best solution for the company.
Larger batch sizes might actually cause costs (facility costs) to increase. This is due to the costs
associated with inventory build-ups, including increased storage, insurance, spoilage and obsolescence
costs, and the opportunity costs associated with tying up funds in excessive levels of inventories.
2 Operating leverage refers to the proportion of fixed costs in an organisations overall cost structure. An
organisation that has a relatively high proportion of fixed costs and low proportion of variable cost has a
high operating leverage.
Plan A Plan B
Plan A has a higher percentage of variable costs to sales (72.5 per cent) compared to Plan B (62.5 per
cent). Plan Bs fixed costs are 13.75 per cent of sales, compared to Plan As 4.58 per cent.
Operating leverage factor = contribution margin net profit
Plan A: $297 000 $247 500 = 1.2
Plan B: $405 000 $256 500 = 1.58 (rounded)
Plan B has the higher operating leverage, as it has a higher reliance on fixed costs.
Plan A Plan B
6 Heavily automated manufacturers have sizable investments in plant and equipment, so have a high
percentage of fixed costs in their cost structures. As a result, there is a high degree of operating
leverage.
In a severe economic downturn, when sales volume decreases, these firms suffer a significant decrease
in profitability. Such firms would be a more risky investment compared with firms that have a low
degree of operating leverage. Of course, when times are good, the increase in sales volume would have
a favourable impact on profitability in a company with high operating leverage.
Labour-intensive Computer-assisted
production system manufacturing system
Variable costs:
2 Zodiacs management would be indifferent between the two manufacturing methods at the
volume (X) where total costs are equal.
3 Operating leverage is the extent to which a firms operations employ fixed operating costs. The greater
the proportion of fixed costs used to produce a product, the higher the operating leverage. Thus, the
computer-assisted manufacturing method utilises a higher level of operating leverage.
The higher the operating leverage, the greater the change in operating profit (loss) relative to a small
fluctuation in sales volume. Thus, there is a higher degree of variability in operating profit if operating
leverage is high.
5 Zodiacs management should consider many other business factors before selecting a manufacturing
method. These include:
the variability or uncertainty with respect to demand quantity and selling price
the ability to produce and market the new product quickly
the ability to discontinue production and marketing of the new product while incurring the least
amount of loss.
Break-even point:
0 = revenue variable cost fixed cost
0 = $120X + ($8000 0.2X 0.3)* $16X $5 967 920
0 = $120X + $480X $16X $5 967 920
$584X = $5 967 920
X = 10 220 clients (rounded)
* Revenue calculation: $120X represents the $60 consultation fee per client. ($8 000 .2X .30)
represents the predicted average settlement of $8 000, multiplied by the 20% of the clients whose
judgments are expected to be favourable, multiplied by the 30% of the judgment that goes to the
firm.
2 Safety margin:
Safety margin = budgeted sales revenue break-even sales revenue
Budgeted (expected) number of clients = 50 360 = 18 000
Break-even number of clients = 10 220 (rounded)
Safety margin = [($120 18 000) + ($8 000 18 000 0.20 0.30)] [($120 10 220) + ($8 000
10 220 0.20 0.30)]
= [$120 + ($8 000 .20 .30)] (18 000 10 220)
= $600 7 780
= $4 668 000
Increase in revenue
(20 additional beds 90 days $720 charge per day) $1 296 000
Increase in expenses:
Salaries
Net change in earnings from rental of additional 20 beds $(1 456 000)
Manufacturing overhead* 27 12 6 45
Commissions 50 40 20 110
Advertising 50 30 20 100
Licenses 50 20 15 85
Fixed costs:
(c) The answer in part (a) and the first calculation in part (b) do not allow for the non-product related
costs and to ignore these costs could lead to inaccurate decisions. The analyst would need to allow a
margin to cover these other fixed costs.
The last break-even point (1 362 000 kg of dog food; 340 000 kg of cereal; 340 000 kg of breakfast
bars) takes into account all fixed costs. In sales revenues this break-even point is $681 000 of dog
food, $272 000 of cereal and $136 000 of breakfast bars. It should be noted that the calculation does
make an assumption that the sales mix will be constant, i.e. sales levels would rise and fall
proportionately.
Initial data
Inspection 11 $650
Packaging 4
$155
Delivery 140
$210
Handling complaints 75
2 Break-even point
Unit CM 50
3 Profit target
Unit CM 50
4 Margin of safety
28 162
The margin of safety is the excess of forecast sales over break-even sales and indicates the amount by
which sales may fall before the firm starts to incur losses.
* This solution assumes the batch size and order size do not change, and therefore the number of batches and
customers increases proportionately.
* This solution assumes the batch size and order size do not change, and therefore the number of batches and
customers increases proportionately
7 The impact of the proposed changes to the original budget can be seen in the table below.
Original
budget Option 5 (a) Option 5 (b) Option ( 6)
$ $ $ $
Profit (loss) $1 408 125 $365 625 ($26 875) $1 493 625
Increase (decrease) over original --------- ($1 042 500) ($1 435 000) 85 500
Total contribution margin $3 750 000 $2 975 000 $2 850 000 $3 000 000
Other activity costs $2 341 875 $2 609 375 $2 876 875 $1 506 375
Decreasing the selling price is not an effective strategy at either level, since the new profit is lower than
the original forecast. This is due to the loss of contribution margin and increase in other activity costs. If
management wishes to pursue a price sensitivity strategy, it needs to seek cost reductions in the
activities associated with batch level and order level costs. To be profitable, the firm should consider
increasing both average batch size and average order sizes.
By changing the marketing strategy, which involves ceasing trading with camping equipment suppliers,
the firm loses $750 000 in contribution margin but saves $835 500 in activity costs above unit level. As
a result, profit increases by $85 500.
Cool Camping Company can use the information generated by the financial model to investigate the
outcomes of various strategies as the model indicates the factors which management should consider
when evaluating a particular strategy.