Cost-Volume-Profit Review Problems (For Exam 1)

QUESTION 1
Bridal Shoppe sells wedding dresses. The cost of each dress is comprised of
the following: Selling price of $1,000 and variable (flexible) costs of $400.
Total fixed (capacity-related) costs for Bridal Shoppe are $90,000.

A. What is the contribution margin per dress?

Revenues – Flexible Costs = CM

$1,000 - $400 = $600

B. What is the Bridal Shoppe’s total profit when 200 dresses are sold?

Revenues – Flexible Costs – Capacity-Related Costs = Total Profit

200 ($1,000) – 200($400) - $90,000 = $30,000

C. How many dresses must Bridal Shoppe sell to reach the breakeven point?

X = Capacity-Related Costs/Contribution Margin

X = $90,000/$600
X = 150 dresses

D. How many dresses must Bridal Shoppe sell to yield a profit of $60,000?

Total Revenues – Total Costs = Total Profit

$1,000X - $400X - $90,000 = $60,000

$600X = $150,000
X = $150,000/$600
X = 250 dresses

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QUESTION 2
Northenscold Company sells several products. Information of average revenue and costs
are as follows:

Selling price per unit $20.00

Variable costs per unit:
Direct materials $4.00
Direct manufacturing labor $1.60
Manufacturing overhead $0.40
Selling costs $2.00
Annual fixed costs $96,000

1. Calculate the contribution margin per unit.

$20 - $4 - $1.60 - $0.40 - $2 = $12

2. Calculate the number of units Northenscold’s must sell each year to break even.

20X - 8X - 96,000 = 0; X = 8,000 units

3. Calculate the number of units Northenscold’s must sell to yield a profit of

$144,000.

20X – 8X – 96,000 = $144,000; X = 20,000 units

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QUESTION 3
Berhannan’s Cellular sells phones for $100. The unit variable cost per phone is
$50 plus a selling commission of 10%. Fixed manufacturing costs total $1,250 per
month, while fixed selling and administrative costs total $2,500.

A. What is the contribution margin per phone?

CM per phone = $100 - $50 - 0.1($100) = $40

B. What is the breakeven point in phones?

N = Breakeven in phones
$100N - $50N - $10N - $1,250 - $2,500 = 0
$40N - $3,750 = 0
N = $3,750 / $40 = 93.75 phones
Breakeven Point = 94 phones

c. How many phones must be sold to earn a targeted profit of $7,500?

N = Phones to be sold
$100N - $50N - $10N - $1,250 - $2,500 = $7,500
$40N = $11,250
N = $11,250 / $40 = 281.25 phones
To achieve target profit: Must sell 282 phones

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Beta company sells blouses in Washington, USA. Blouses are imported from Pakistan and are
sold to customers in Washington at a profit. Salespersons are paid basic salary plus a decent
commission of $14 on each sale made by them. Selling price and expense data is given below:

Required:

1. Compute the break-even point in units and in dollars using the information given above.
2. Prepare a CVP graph (break-even chart) and show the break-even point on the graph.
3. What would be net operating income or loss if company sells 18,500 blouses in a year?
4. If the manage is paid a commission of $6 blouse (in addition to the salesperson’s
commission), what will be the effect on company’s break-even point?
5. As an alternative to (3) above, company is thinking to pay $6 commission to manager on
each blouse sold in excess of break-even point. What will be the effect of these changes
on the net operating income or loss of the Beta company if 23,500 blouses are sold in a
year?
6. Refer to the original data. What will be the break-even point of the company if commission
is entirely eliminated and salaries are increased by $214,000?

Solution:

(1) Calculation of break-even point:

a. Equation method:

SpQ = VeQ + Fe

$80Q = $50Q + $600,000

$80Q – $50Q = $600,000

$30Q = $600,000

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 Q = $600,000/$30

Q = 20,000 blouses

20,000 blouses × $80.00 per blouse = $1,600,000

b. Contribution margin method:

Break-even point = Fixed expenses/Contribution margin per unit

= $600,000/$30*

= 20,000 blouses

20,000 blouses × $80.00 per blouse = $1,600,000

*$80 – $50 = $30

Alternatively;

Break-even point = Fixed expenses/CM ratio

= $600,000/0.375*

= $1,600,000

*$30/$80 = 0.375

(2) CVP graph or break-even chart:

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(3). Net operating income or loss if 18,500 blouses are sold in a year

An alternative and more simple approach is given below:

Net operating loss = Sales short of break-even × Contribution margin per unit

= 1,500 blouses × $30

= $45,000

(4) Break-even point if manager is also paid a commission of $6 per

blouse sold:

The payment of a commission of $6 to manager will increase variable expenses and decrease
contribution margin. Now the variable expenses will be $56 ($50 + $6) per unit and contribution
margin will be $24 ($80 – $56) per unit.

a. Equation method:

SpQ = VeQ + Fe

$80Q = $56Q + $600,000

$80Q – $56Q = $600,000

$24Q = $600,000

Q = $600,000/$24

Q = 25,000 blouses

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 25,000 blouses × $80.00 per blouse = $2,000,000

b. Contribution margin method:

Break-even point in units = Fixed expenses/Contribution margin per unit

$600,000/$24*

25,000 blouses

25,000 blouses × $80.00 per blouse = $2,000,000

*$80 – $56 = $24

Alternatively;

Break-even point = Fixed expenses/CM ratio

= $600,000/0.30*

= $2,000,000

*$24/$80 = 0.30

(4) Effect on net operating income or loss if manager is paid a commission

of $6 on each blouse sold after break-even point:

Alternatively the net operating income of $84,000 may also be computed by using the
following simple approach:

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3,500 shirts × $24 per shirt* = $84,000 profit

*[$80 – ($50 + $6)] = $24

(5) Break-even point after elimination of commission and increase in

salaries:

The new variable expenses are $36 (invoice cost, no commission) and new fixed expenses are
$814,000 ($600,000 + $214,000).

a. Equation method:

SpQ = VeQ + Fe

$80Q = $36Q + $814,000

$80Q – $36Q = $814,000

$44Q = $814,000

Q = $814,000/$44

Q = 18,500 blouses

18,500 blouses × $80.00 per blouse = $1,480,000

b. Contribution margin method:

= $814,000/$44*

= 18,500 blouses

18,500 blouses × $80 = $1,480,000

*$80 – $36 = $44

Alternatively;

Break-even point = Fixed expenses/CM ratio

= $814,000/0.55*

= $1,480,000

*$44/$80 = 0.55

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The Digital World company sells three products – Product A, Product B and Product C. The
budgeted contribution margin income statement of the company for the coming month is given
below:

Budgeted break-even point = Fixed expenses/CM ratio

= $447,200/0.52

= $860,000

The actual sales data for the month is given below:

 Product A: $320,000
 Product B: $400,000
 Product C: $280,000
 Total: $320,000 + $400,000 + $280,000 = $1,000,000

Required:

Compute the break-even point of Digital World company based on the actual sales. Explain the
reason of difference (if any) between the break-even point computed on the basis of budgeted
sales and the break-even point computed on the basis of actual sales data.

Solution:

Before computing break-even point based on the actual sales, we need to prepare an income
statement based on the actual sales.

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 Actual break-even point = Fixed expenses/CM ratio

= $447,200/0.43

= $1,040,000

The reason of difference in break-even point in dollar sales:

The difference in break-even point is because of shift in sales mix.

A shift in sales mix from the products generating high contribution margin to the products
generating low contribution margin decreased the overall contribution margin ratio of the
company from 52% to 43% and increased the dollar sales required to break-even from $860,000
to $1,040,000

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ECG company sells lightweight tables. One table is sold for $45. Variable and fixed expenses
data is given below:

 Variable expenses per unit: $18

 Fixed expenses per year: $540,000

Required:

1. Compute contribution margin ratio (CM ratio).

2. Compute break-even point in dollars using CM ratio computed in part 1.
3. Using contribution margin ratio calculate increase in net operating income if sales are
increased by $135,000.
4. During the last year, ECG company sold 24,000 lightweight tables.
(a). Compute the degree of operating leverage at the last year’s level of sales.
(b). If ECG company manages to increase the sales by 15% next year, by how much
should net operating income increase? (Use degree of operating leverage for your
answer).

Solution:

(1) Calculation of CM ratio:

Contribution margin = Selling price – Variable expenses

= $45 – $18

= $27

Contribution margin ratio (CM ratio) = Contribution margin/Sales

= $27/$45

= 0.60 or 60%

(2) Calculation of break-even point:

Break-even point in sales = Fixed cost/CM ratio

= $540,000/0.60

= $900,000

(3) Increase in net operating income:

$135,000 × 0.6

$81,000

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(4) Degree of operating leverage:

(a). Degree of operating leverage = Contribution margin/Net operating income

= $648,000 / $108,000

=6

(b). The degree of operating leverage is 6. It means if sales are increased by 15%, there will be a
90% increase in net operating income as computed below:

15% × 6 = 90%

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