Basic Cost-Volume Profit (CVP) Analysis

Stratford Company distributes a lighweight lawn chair that sells for $15 per unit. Variable costs are $6 pe Required: Answer the following independent questions:

1. What is the products CM ratio? 2. Use the CM ratio to determine the break-even point in sales dollars. 3. The company estimates that sales will increase by $45,000 during the coming year due to increased de 4. Assume that the operating results for last year were as follows: Sales $360,000 Variable Expenses 144,000 Contribution Margin Fixed expenses Net Operating Income $216,000 180,000 $ 36,000

a. Compute the degree of operating leverage at the current level of sales. b. The president expects sales to increase by 15% next year. By how much should net o

5. Refer to the original data. Assume that the company sold 28,000 units last year. The sales manag

SOLUTION TO PROBLEM NO.:1:

REQUIREMENT NO.:1: PRODUCT'S CM RATIO: Selling price per unit less:Variable cost per unit CONTRIBUTION PER UNIT Contribution margin ratio = Contribution margin per unit/Selling price per unit REQUIREMENT NO.:2: Break-even point in total sales dollars= Fixed expenses/CM ratio Fixed expenses CM ratio Break-even point in total sales dollars $ $ 180,000 60% 300,000 $ $ $ 15 6 9

60%

REQUIREMENT NO.:3: Increase in sales less:Variable cost($45,000/$15)*$6 Increase in net operating income REQUIREMENT NO.:4: a Sales less:Variable expenses Contribution Margin Fixed expenses Net Operating Income Degree of Operating Leverage= Contribution Margin/Net Income Increase in sales @15% Increase in variable expenses @15% INCREASE IN NET OPERATING INCOME $ $ $ $ $ 360,000 144,000 216,000 180,000 36,000 6 $ $ $ 54,000 21,600 32,400 $ $ $ 45,000 18,000 27,000

REQUIREMENT NO.:5: INCOME STATEMENT BASED ON RESULTS OF LAST YEAR OPERATIONS Sales in units Selling price per unit $ Sales $ less:Variable expenses @ $6 per unit $ CONTRIBUTION MARGIN $ less:Fixed Expenses $ NET OPERATING INCOME $

28,000 15 420,000 168,000 252,000 180,000 72,000

INCOME STATEMENT BASED ON CHANGES PROPOSED BY THE SALES MANAGER Sales in units(increase by 50%) Selling price (reduced by 10%) Decrease in Unit contribution margin Expected total contribution margin with lower selling price: Present total contribution margin (28,000 units *9) INCREMENTAL CONTRIBUTION MARGIN Change in fixed costs: Less:Incremental advertising expense 42000 13.50 7.50

$ $

$ $ $ $

315,000 252,000 63,000 70,000

Reduction in net income

(7,000) COMPARATIVE INCOME STATEMENTS PRESENT 28,000 UNITS TOTAL PER UNIT 420,000 $ 15 168,000 $ 6 252,000 $ 9 180,000 72,000

Sales less:Variable expenses Contribution margin less:Fixed expenses Net Income

$ $ $ $ $

Based on the comparative income statements it is evident that the suggestion of the sales manager will result in reduction of net income by $7,000. S0, the changes should not be made.

per unit. Variable costs are $6 per unit, and fixed costs total $180,000 annually.

e coming year due to increased demand. By how much should net operating income increase?

rrent level of sales. t year. By how much should net operating income increase?

0 units last year. The sales manager is convinced that a 10% reduction in the selling price, combined with a $70,000 increase in

NCOME STATEMENTS EXPECTED 42,000 UNITS TOTAL PER UNIT DIFFERENCE 567,000 $ 13.50 $ 147,000 252,000 $ 6 $ 84,000 315,000 $ 7.50 $ 63,000 250,000 $ 70,000 65,000 $ (7,000)

$ $ $ $ $

of the sales manager will result in

with a $70,000 increase in advertising expenditures, would cause annual sales in units to increase by 50%. Prepare two contribut

0%. Prepare two contributing format income statements, one showing the results of last years operations and one showing what

erations and one showing what the results of operations would be if these changes were made. Would you recommend that the c

Would you recommend that the company do as the sales manager suggests?

Basics of CVP Analysis: Cost Structure

Memofax, Inc. produces memory enhancement kits for fax machines. Sales have been very erratic with so Sales(13,500 units at $20 per unit) $270,000 Variable expenses 189,000 Contribution Margin 81,000 Fixed expenses 90,000 Net operating loss $ (9,000)

Required: 1. Compute the companys CM ratio and its break-even point in both units and dollars 2. The sales manager feels that an $8,000 increase in the monthly advertising budget, combined with an i 3. Refer to the original data. The president is convinced that a 10% reduction in the selling price, combin 4. Refer to the original data. The companys advertising agency thinks that a new package would help sa 5. Refer to the original data. By automating certain operations, the company could slash its variable expe a. Compute the new CM ratio and the new break-even point in both units and dollars. b. Assume that the company expects to sell 20,000 units next month. Prepare two contribution format c. Would you recommend that the company automate its operations? Explain. SOLUTION TO PROBLEM NO.:2:
Sales (13,500 units @ $20 per unit) less:Variable expenses CONTRIBUTION MARGIN less:Fixed expenses NET OPERATING LOSS REQUIRMENT NO.:1: $ $ $ $ $ 270,000 189,000 81,000 90,000 (9,000)

Contribution margin ratio = Contribution margin /Sales Break-even point in units sold = Fixed expenses/Unit contribution margin Break-even point in total sales dollars= Fixed expenses/CM ratio

30%

15000

300,000

REQUIRMENT NO.:2: Incremental increase in sales Incremental increase in contribution margin less: Incremental increase in advertising expense $ $ $ 70,000 21,000 8,000

Incremental increase in net operating income REQUIRMENT NO.:3:

13,000

INCOME STATEMENT BASED ON CHANGES PROPOSED BY THE PRESIDENT Sales in units(increase by 50%) Selling price (reduced by 10%) Unit contribution margin Sales less:Variable expenses CONTRIBUTION MARGIN less:Fixed expenses NET OPERATING LOSS 20250 18.00 5.40 364,500 255,150 109,350 125,000 (15,650)

$ $ $ $ $ $ $

REQUIRMENT NO.:4: Fixed expenses Selling price per unit Variable expense per unit(present) Increase in packaging cost per unit Total variable expense Contribution margin per unit Target profit $ $ $ $ $ $ $ 90,000 20 14 0.60 14.60 5.40 4,500

Units sold to attain the target profit = Fixed expenses+Target Profit/Contribution margin per unit

17500 units

REQUIRMENT NO.:5: Selling price per unit Variable expenses per unit CONTRIBUTION MARGIN Fixed expenses($90,000+$118,000) ORIGINAL $ $ $ AUTOMATION 20 $ 20 14 $ 7 6 $ 13 $ 208,000

Contribution margin ratio = Contribution margin /Sales Break-even point in units sold = Fixed expenses/Unit contribution margin

65%

16000

Break-even point in total sales dollars= Fixed expenses/CM ratio b INCOME STATEMENT NO AUTOMATION Sales in units Selling price per unit Sales less:Variable expenses @ $14 per unit CONTRIBUTION MARGIN less:Fixed Expenses NET OPERATING INCOME INCOME STATEMENT AUTOMATION Sales in units Selling price per unit Sales less:Variable expenses @ $7 per unit CONTRIBUTION MARGIN less:Fixed Expenses NET OPERATING INCOME

320,000

$ $ $ $ $ $

20,000 20 400,000 280,000 120,000 90,000 30,000

$ $ $ $ $ $

20,000 20 400,000 140,000 260,000 208,000 52,000

The company should automate its operations since the net operating income has increased by $22,000. And with increase in sales the income will directly increase with the contribution margin per unit.

have been very erratic with some months showing a profit and some months showing a loss. The companys contribution format

g budget, combined with an intensified effort by the sales staff, will result in a $70,000 increase in monthly sales. If the sales ma on in the selling price, combined with an increase of $35,000 in the monthly advertising budget will cause unit sales to double. W a new package would help sales. The new package being proposed would increase packaging costs by $0.60 per unit. Assuming y could slash its variable expenses in ahlf. However, fixed costs would increase by $118,000 per month. and dollars. pare two contribution format income statements, one assuming that operations are not automated and one assuming that they are.

mpanys contribution format income statement for the most recent month is given below:

monthly sales. If the sales manager is right, what will be the effect on the companys monthly net operating income or loss? (use cause unit sales to double. What will the new contribution format income statement look like if these changes are adopted? by $0.60 per unit. Assuming no other changes, how many units would have to be sold each month to earn a profit of $4,500?

d one assuming that they are.

operating income or loss? (use the incremental approach in preparing your answer). these changes are adopted? th to earn a profit of $4,500?