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Chapter Six
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6-2
Learning Objective 1
McGrawHill/Irwin
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Contribution
Contribution Margin
Margin (CM)
(CM) is
is the
the amount
amount
remaining
remaining from
from sales
sales revenue
revenue after
after variable
variable
expenses
expenses have
have been
been deducted.
deducted.
McGrawHill/Irwin
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McGrawHill/Irwin
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McGrawHill/Irwin
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McGrawHill/Irwin
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McGrawHill/Irwin
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Learning Objective 2
McGrawHill/Irwin
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McGrawHill/Irwin
Income
Income
400
400 units
units
$$ 200,000
200,000
120,000
120,000
$$ 80,000
80,000
80,000
80,000
$$
--
Income
Income
500
500 units
units
$$250,000
250,000
150,000
150,000
$$100,000
100,000
80,000
80,000
$$ 20,000
20,000
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6-12
Dollars
CVP Graph
Units
McGrawHill/Irwin
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6-13
Dollars
CVP Graph
Fixed Expenses
Units
McGrawHill/Irwin
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6-14
Dollars
CVP Graph
Total Expenses
Fixed Expenses
Units
McGrawHill/Irwin
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6-15
CVP Graph
Dollars
Total Sales
Total Expenses
Fixed Expenses
Units
McGrawHill/Irwin
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6-16
CVP Graph
Break-even point
(400 units or $200,000 in sales)
Dollars
Los
a
e
r
A
t
i
f
ro
a
e
r
sA
Units
McGrawHill/Irwin
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Learning Objective 3
McGrawHill/Irwin
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McGrawHill/Irwin
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McGrawHill/Irwin
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500
500 Bikes
Bikes
$$250,000
250,000
150,000
150,000
100,000
100,000
80,000
80,000
$$ 20,000
20,000
McGrawHill/Irwin
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Quick Check
Coffee Klatch is an espresso stand in a downtown
office building. The average selling price of a cup of
coffee is $1.49 and the average variable expense
per cup is $0.36. The average fixed expense per
month is $1,300. 2,100 cups are sold each month
on average. What is the CM Ratio for Coffee
Klatch?
a. 1.319
b. 0.758
c. 0.242
d. 4.139
McGrawHill/Irwin
Copyright2008,TheMcGrawHillCompanies,Inc.
6-22
Quick Check
Coffee Klatch is an espresso stand in a downtown
office building. The average selling price of a cup of
coffee is $1.49 and the average variable expense
per cup is $0.36. The average fixed expense per
month is $1,300. 2,100 cups are sold each month
on average. What is the CM Ratio for Coffee
Klatch?
Unit contribution margin
CM Ratio =
a. 1.319
Unit selling price
b. 0.758
($1.49-$0.36)
=
$1.49
c. 0.242
$1.13
d. 4.139
=
= 0.758
$1.49
McGrawHill/Irwin
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Learning Objective 4
McGrawHill/Irwin
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McGrawHill/Irwin
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6-25
Sales
Sales increased
increased by
by $20,000,
$20,000, but
but net
net operating
operating
income
income decreased
decreased by
by $2,000
$2,000..
McGrawHill/Irwin
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McGrawHill/Irwin
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McGrawHill/Irwin
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Sales
Sales increase
increase by
by $40,000,
$40,000, and
and net
net operating
operating income
income
increases
..
increases by
by $10,200
$10,200
McGrawHill/Irwin
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McGrawHill/Irwin
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6-30
Sales
Sales increase
increase by
by $62,000,
$62,000, fixed
fixed costs
costs increase
increase by
by
$15,000,
$15,000, and
and net
net operating
operating income
income increases
increases by
by $2,000
$2,000..
McGrawHill/Irwin
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McGrawHill/Irwin
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6-32
Sales
Sales increase
increase by
by $37,500,
$37,500, variable
variable costs
costs increase
increase by
by
$31,125,
$31,125, but
but fixed
fixed expenses
expenses decrease
decrease by
by $6,000
$6,000..
McGrawHill/Irwin
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McGrawHill/Irwin
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McGrawHill/Irwin
==
==
==
$$ 20
20 per
per bike
bike
300
300 per
per bike
bike
$$ 320
320 per
per bike
bike
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Learning Objective 5
McGrawHill/Irwin
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Break-Even Analysis
McGrawHill/Irwin
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Equation Method
Profits = (Sales Variable expenses)
Fixed expenses
OR
Sales = Variable expenses + Fixed expenses + Profits
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Break-Even Analysis
McGrawHill/Irwin
Per
PerUnit
Unit
$$ 500
500
300
300
$$ 200
200
Percent
Percent
100%
100%
60%
60%
40%
40%
Copyright2008,TheMcGrawHillCompanies,Inc.
6-39
Equation Method
We calculate the break-even point as follows:
Sales = Variable expenses + Fixed expenses + Profits
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Equation Method
McGrawHill/Irwin
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Equation Method
X = 0.60X + $80,000 + $0
Where:
X = Total sales dollars
0.60 = Variable expenses as a % of sales
$80,000 = Total fixed expenses
McGrawHill/Irwin
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Equation Method
X = 0.60X + $80,000 + $0
0.40X = $80,000
X = $80,000 0.40
X = $200,000
McGrawHill/Irwin
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McGrawHill/Irwin
Fixed expenses
CM per unit
Fixed expenses
CM ratio
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6-44
Fixed expenses
CM ratio
$80,000
= $200,000 break-even sales
40%
McGrawHill/Irwin
Copyright2008,TheMcGrawHillCompanies,Inc.
6-45
Quick Check
Coffee Klatch is an espresso stand in a downtown
office building. The average selling price of a cup
of coffee is $1.49 and the average variable
expense per cup is $0.36. The average fixed
expense per month is $1,300. 2,100 cups are sold
each month on average. What is the break-even
sales in units?
a. 872 cups
b. 3,611 cups
c. 1,200 cups
d. 1,150 cups
McGrawHill/Irwin
Copyright2008,TheMcGrawHillCompanies,Inc.
6-46
Quick Check
Coffee Klatch is an espresso stand in a downtown
office building. The average selling price of a cup
of coffee is $1.49 and the average
variable
Fixed
expenses
Break-even =
CM perfixed
Unit
expense per cup is $0.36. The average
expense per month is $1,300. 2,100
cups are sold
$1,300
= What is the break-even
each month on average.
$1.49/cup - $0.36/cup
sales in units?
$1,300
=
a. 872 cups
$1.13/cup
b. 3,611 cups
= 1,150 cups
c. 1,200 cups
d. 1,150 cups
McGrawHill/Irwin
Copyright2008,TheMcGrawHillCompanies,Inc.
6-47
Quick Check
Coffee Klatch is an espresso stand in a downtown
office building. The average selling price of a cup of
coffee is $1.49 and the average variable expense
per cup is $0.36. The average fixed expense per
month is $1,300. 2,100 cups are sold each month
on average. What is the break-even sales in
dollars?
a. $1,300
b. $1,715
c. $1,788
d. $3,129
McGrawHill/Irwin
Copyright2008,TheMcGrawHillCompanies,Inc.
6-48
Quick Check
Coffee Klatch is an espresso stand in a downtown
office building. The average selling price of a cup of
coffee is $1.49 and the average variable expense
per cup is $0.36. The average fixed expense per
month is $1,300. 2,100 cups are sold each month
on average. What is the break-even sales in
dollars?
a. $1,300
Fixed expenses
Break-even
=
CM Ratio
sales
b. $1,715
$1,300
c. $1,788
=
0.758
d. $3,129
= $1,715
McGrawHill/Irwin
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6-49
Learning Objective 6
McGrawHill/Irwin
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McGrawHill/Irwin
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$80,000 + $100,000
= 900 bikes
$200/bike
McGrawHill/Irwin
Copyright2008,TheMcGrawHillCompanies,Inc.
6-53
Quick Check
Coffee Klatch is an espresso stand in a downtown
office building. The average selling price of a cup of
coffee is $1.49 and the average variable expense
per cup is $0.36. The average fixed expense per
month is $1,300. How many cups of coffee would
have to be sold to attain target profits of $2,500 per
month?
a. 3,363 cups
b. 2,212 cups
c. 1,150 cups
d. 4,200 cups
McGrawHill/Irwin
Copyright2008,TheMcGrawHillCompanies,Inc.
6-54
Quick Check
Unit sales
Fixed expenses + Target profit
to attain =
Unit
CM
Coffee Klatch
is
an
espresso
stand
in
a
downtown
target profit
office building. The average
selling
price of a cup of
$1,300
+ $2,500
= average variable expense
coffee is $1.49 and the
$1.49 - $0.36
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Learning Objective 7
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McGrawHill/Irwin
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McGrawHill/Irwin
Actual
Actual sales
sales
500
500 units
units
$$ 250,000
250,000
150,000
150,000
100,000
100,000
80,000
80,000
$$
20,000
20,000
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6-58
McGrawHill/Irwin
Actual
Actual sales
sales
500
500 units
units
$$ 250,000
250,000
150,000
150,000
100,000
100,000
80,000
80,000
$$
20,000
20,000
Copyright2008,TheMcGrawHillCompanies,Inc.
6-59
McGrawHill/Irwin
Copyright2008,TheMcGrawHillCompanies,Inc.
6-60
Quick Check
Coffee Klatch is an espresso stand in a downtown
office building. The average selling price of a cup of
coffee is $1.49 and the average variable expense
per cup is $0.36. The average fixed expense per
month is $1,300. 2,100 cups are sold each month
on average. What is the margin of safety?
a. 3,250 cups
b. 950 cups
c. 1,150 cups
d. 2,100 cups
McGrawHill/Irwin
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Quick Check
CoffeeMargin
Klatchof
is safety
an espresso
inBreak-even
a downtownsales
= Total stand
sales
office building. The average
price
of cups
a cup of
= 2,100selling
cups
1,150
coffee is $1.49 and the=average
950 cupsvariable expense
per cup is $0.36. The average
or fixed expense per
month is Margin
$1,300.of2,100
cups are
950 sold
cupseach month
safety
= 2,100
= 45%
on average.percentage
What is the margin
of cups
safety?
a. 3,250 cups
b. 950 cups
c. 1,150 cups
d. 2,100 cups
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McGrawHill/Irwin
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Learning Objective 8
McGrawHill/Irwin
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Operating Leverage
A measure of how sensitive net operating
income is to percentage changes in sales.
Degree of
Contribution margin
=
operating leverage
Net operating income
McGrawHill/Irwin
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Operating Leverage
500
500 Bikes
Bikes
$$ 250,000
250,000
150,000
150,000
100,000
100,000
80,000
80,000
$$ 20,000
20,000
$100,000 = 5
$20,000
McGrawHill/Irwin
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Operating Leverage
With an operating leverage of 5, if Racing
increases its sales by 10%, net operating
income would increase by 50%.
Percent increase in sales
Degree of operating leverage
Percent increase in profits
10%
5
50%
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Operating Leverage
Copyright2008,TheMcGrawHillCompanies,Inc.
6-69
Quick Check
Coffee Klatch is an espresso stand in a
downtown office building. The average
selling price of a cup of coffee is $1.49 and
the average variable expense per cup is
$0.36. The average fixed expense per month
is $1,300. 2,100 cups are sold each month
on average. What is the operating leverage?
a. 2.21
b. 0.45
c. 0.34
d. 2.92
McGrawHill/Irwin
Copyright2008,TheMcGrawHillCompanies,Inc.
6-70
Quick Check
Coffee Klatch is an espresso stand in a
downtown office building. The average
selling price of a cup of coffee is $1.49 and
the average variable expense per cup is
$0.36. The average fixed expense per month
is $1,300. 2,100 cups are sold each month
on average. What is the operating leverage?
a. 2.21
Operating Contribution margin
leverage = Net operating income
b. 0.45
$2,373
c. 0.34
= $1,073 = 2.21
d. 2.92
McGrawHill/Irwin
Copyright2008,TheMcGrawHillCompanies,Inc.
6-71
Quick Check
At Coffee Klatch the average selling price of a cup of
coffee is $1.49, the average variable expense per cup
is $0.36, the average fixed expense per month is
$1,300 and an average of 2,100 cups are sold each
month.
If sales increase by 20%, by how much should net
operating income increase?
a. 30.0%
b. 20.0%
c. 22.1%
d. 44.2%
McGrawHill/Irwin
Copyright2008,TheMcGrawHillCompanies,Inc.
6-72
Quick Check
At Coffee Klatch the average selling price of a cup of
coffee is $1.49, the average variable expense per cup
is $0.36, the average fixed expense per month is
$1,300 and an average of 2,100 cups are sold each
month.
If sales increase by 20%, by how much should net
operating income increase?
a. 30.0%
b. 20.0%
c. 22.1%
d. 44.2%
McGrawHill/Irwin
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6-73
McGrawHill/Irwin
Increased
sales
2,520 cups
$
3,755
907
2,848
1,300
$
1,548
20.0%
44.2%
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6-74
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McGrawHill/Irwin
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Learning Objective 9
McGrawHill/Irwin
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$265,000
= 48.2% (rounded)
$550,000
McGrawHill/Irwin
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6-80
Break-even
sales
Fixed expenses
=
CM Ratio
$170,000
=
48.2%
= $352,697
McGrawHill/Irwin
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McGrawHill/Irwin
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McGrawHill/Irwin
End of Chapter 6
Copyright2008,TheMcGrawHillCompanies,Inc.