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Chapter 09 - Short-Term Profit Planning: Cost-Volume-Profit (CVP) Analysis

CHAPTER 9:
SHORT-TERM PROFIT PLANNING:
COST-VOLUME-PROFIT (CVP) ANALYSIS
EXERCISES

9-21 Profit Planning (20-25 min)


1. B= Sales variable costs fixed cost
= (30,000 $67) (30,000 $34) $480,500
= $509,500
2. BE units: $67Q = $34Q + $480,500
Q = 14,561 units
3. B = (35,000 $67) (35,000 $34) $480,500 $200,000
= $474,500
(Operating profit falls by $35,000 = ($33 5,000) $200,000, from
$509,500 to $474,500 as a result of the plan to increase sales with
increased advertising.)
4. BE units: $67Q = $34Q + $680,500
Q = 20,622 units (rounded up)
(Operating profit is lower, per part 3 above, and breakeven is also
higher.)
Contribution Income Statement:

9-21 (Continued)
9-1
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manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.

Chapter 09 - Short-Term Profit Planning: Cost-Volume-Profit (CVP) Analysis

(the slight difference between the indicated operating profit,


$26, and zero is due to rounding up the breakeven point to the
nearest whole number, 20,622 units)

Slight difference in the above answers is due


to rounding on sales volume, Q. The primary
point, however, is that a given percentage
change in fixed cost leads to an equivalent
percentage change in the breakeven point.
(This can be confirmed precisely if the above
5. $509,500 = $67Q $34Q $680,500
Q = 36,061 units
(To justify the advertising plan, sales would have to rise to at least
36,061 units, somewhat above the projected level of 35,000 units.)

9-2
2013 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any
manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.

Chapter 09 - Short-Term Profit Planning: Cost-Volume-Profit (CVP) Analysis

9-23 The Role of Income Taxes (20 min)


1. Pre-tax income = $70,000 (1 0.35) = $107,692.31
2. Contribution margin fixed cost = before tax profit
Contribution margin $240,000 = $107,692
therefore, CM = $347,692.31
3. total sales - total variable cost = total contribution margin
total sales (variable cost ratio sales) = $347,692.31
total sales (0.75 sales) = $347,692.31
0.25 sales = $347,692.31
sales = $1,390,769.23
4. Contribution margin ratio (CMR) = $347,692.31 $1,390,769.31 =
0.25
Breakeven point = fixed costs CMR
= $240,000 0.25 = $960,000

9-3
2013 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any
manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.

Chapter 09 - Short-Term Profit Planning: Cost-Volume-Profit (CVP) Analysis

9-24 CVP Analysis with Taxes (20-25 min)


1.

BE units = F + B =
(p v)

2.

BE dollars = F + B
(p v)
p

$75,000 + 0 = 18,750 units


$10 $6
=

$75,000 + 0 = $75,000 = $187,500


$10 $6
0.40
$10

OR: 18,750 units $10 = $187,500


3.

Q = F + B
(p v)

4.

pQ = F + B =
(p v)
p

5. Q =

$75,000 + $40,000 =
($10 $6)

28,750 units

$75,000 + $35,000 = $110,000 = $275,000


$10 $6
0.40
$10

F + A/(1 t)
(p v)

Q = $75,000 + $25,000/(1 0.3) = $75,000 + $35,714


$10 $6
$4
= 27,679 units (rounded up to the nearest whole unit)
Using the contribution margin ratio (CMR):
pQ = F + B/(1 t) = $75,000 + $35,714 = $110,714 = $276,785
pv
$10 $6
0.40
p
$10
OR: 27,679 units $10/unit = $276,790 (difference due to
rounding)
9-4
2013 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any
manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.

Chapter 09 - Short-Term Profit Planning: Cost-Volume-Profit (CVP) Analysis

9-26 Degree of Operating Leverage (DOL) (20 min)


1. DOL = contribution margin operating profit
A's DOL = $50,000 $35,000 = 1.43
B's DOL = $70,000 $30,000 = 2.33
If sales increase, company B will benefit more. Company B has a
higher proportion of fixed costs in relation to variable costs; therefore
it has a higher operating leverage than does Company A. The degree
of operating leverage (DOL) is a measure, at a specific level of sales,
of how a percentage change in sales volume will affect profits. The
higher the operating leverage, the more sensitive profits are to
changes in sales volume.
2.

COMPANY A
Amount
%
Sales
$110,000 100
Less variable costs
55,000 50
Contribution margin
$ 55,000 50
Less fixed costs
15,000
Operating income
$ 40,000

COMPANY B
Amount
%
$110,000 100
33,000
30
$ 77,000
70
40,000
$ 37,000

As change in profits = ($40 35) $35 = 14.3%

= 10% 1.43

Bs change in profits = ($37 30) $30 = 23.33%

= 10% 2.333

Yes, these results are what we expected. Operating leverage


indicates what change in operating profit can be expected from a
change in sales volume. A DOL of 1.43 implies that the change in
operating profit will be 1.43 times as large as the percentage change
in sales volume. Therefore, if sales volume increased by 10%,
operating profit should increase by 14.3%. This is precisely what
happened. The same logic applies to Company B.
3. Further interpretation of DOLin what sense is DOL a measure of
risk? As indicated by the above responses, DOL measures how
sensitive operating profits are to changes in sales volume. If DOL is
high, then even small (%) changes in sales will lead to large (%)
9-5
2013 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any
manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.

Chapter 09 - Short-Term Profit Planning: Cost-Volume-Profit (CVP) Analysis

changes in operating income. It is this magnification process that


9-26 (Continued)
captures what is called business or operating risk (as compared, for
example, to financial risk). As level of operation changes (i.e., as
sales volume changes) so too does operating profit, both on the
upside and the downside. A high DOL means that profits are very
sensitive to changes in level of operations; a low DOL means that
profits are relatively insensitive to the level of operations. Thus, DOL
relates to the concept of operating (or business) risk.
Finally, we note that DOL can be defined as: % change in operating
income/% change in sales (i.e., the percentage change in operating
income for each percentage change in sales volume from point Q).
9-28 Cost Planning; Gasoline Prices (20-25 min)
1. Solve for the indifference point in miles (M) where 15 is the mpg, and
$2.99 is the guarantee price and $5.00 is the expected price:
Savings for the guarantee = Savings for the discount
$5 (M/15) $2.99 (M/15) = $4,500
M = 33,582 miles over three years
If the car buyer expects to drive more than 33,582 miles in three years,
or 11,194 miles per year, then the option of the gasoline price guarantee
is preferred.
2. Solve for the indifference point in gasoline price (G) where 15 is the
mpg, and $2.99 is the guaranteed price and 8,500 is the expected
annual mileage (8,500 3 years = 25,500 miles for three years):
Total cost without the guarantee = Total cost with guaranteed gas price
[G (25,500 15)] $4,500 = [$2.99 (25,500 15)]
G = $5.637 average gas price for the next three years
If the car buyer expects to drive 8,500 miles per year for three years,
then the option of the gasoline price guarantee is preferred as long as
9-6
2013 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any
manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.

Chapter 09 - Short-Term Profit Planning: Cost-Volume-Profit (CVP) Analysis

gasoline exceeds $5.637 (on average) over the next three years.
3. Some important decision factors include:
Do I need a new car, or should I save the money by fixing up my
present car, including a tune up and new tires which could help
improve gas mileage
Will gasoline prices fall? (as of December 1, 2008, gasoline prices
had fallen to below $2.00 per gallon, and Chryslers promotion would
have made no sense; but gasoline had increased to $2.60 per gallon
in June of 2009)
Should I look to use mass transit and reduce the gas I use in that
way?
Should I look for a vehicle which gets much better gas mileage than
the one described?
If in an urban area or where it is available, should I use car-share
programs?
9-30 Cost Structure of Retailers; the Internet; Operating Leverage (10
min)
1. A retailer can significantly reduce its operating leverage and reduce
costs during a period of initial growth in e-commerce by outsourcing
its e-commerce activity to service-providers. The term ESP for ecommerce service provider is sometimes used for this type of
service. The concept could make very good sense for a retailer that is
just getting its feet wet in online sales and service over the Internet.
Not only does it reduce the required investment in fixed costs, but it
also provides a partner with the expertise to help the retailer become
successful.
2. Globalization presents an opportunity for the retailer to obtain the
outsourcing service in low-cost countries throughout the world.
Some of the most reliable and lowest-cost ESPs are located in India
and other Asian countries.

9-7
2013 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any
manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.

Chapter 09 - Short-Term Profit Planning: Cost-Volume-Profit (CVP) Analysis

9-32 Multiple Product CVP Analysis (40-45 min)

9-8
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manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.

Chapter 09 - Short-Term Profit Planning: Cost-Volume-Profit (CVP) Analysis

Ex. 9-32 (Continued)


4. If machine hours are limited (i.e., if they represent a scare resource),
then information regarding the machine-hour consumption of each of the
two products would be important for product-planning purposes. That is,
such information could be used to calculate the contribution margin per
machine hour for each of the two products. This information, in turn, would
help guide the product-mix decision: the greater the contribution margin per
machine hour, the greater the profitability (and therefore desirability) of the
product.
An Excel spreadsheet that provides the solution for this exercise is
embedded below:

9-9
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manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.

Chapter 09 - Short-Term Profit Planning: Cost-Volume-Profit (CVP) Analysis

9-34 Contribution Income Statements; Sensitivity Analysis; Goal Seek


(Excel) (40-45 min)
1. A variety of possible spreadsheets could satisfy this requirement. One
example is the spreadsheet embedded below. The sensitivity analysis
shows sales levels from 20% to 200% of 2013 expected sales of 2,400
units, and the related effect on operating profit.
HFIs degree of operating leverage (DOL) from a sales volume of 2,4000
units is 2 2/3, so that from this volume level profits change much faster
(2.667 times faster) than a given change in the sales level.

9-10
2013 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any
manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.

Chapter 09 - Short-Term Profit Planning: Cost-Volume-Profit (CVP) Analysis

9-34 (continued-1)
2. The Goal Seek tool is available under Data//What-if Analysis/Goal Seek
in Excel. An example of how it is used is show below. The price would
have to increase to $101.67 in order for HFI to make a $100,000 before
tax profit.

9-11
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manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.

Chapter 09 - Short-Term Profit Planning: Cost-Volume-Profit (CVP) Analysis

9-36 Further Analysis--Degree of Operating Leverage (DOL) (30-45 min)


1. Demonstrating that DOL represents the % change in operating income
DOL = CM Operating Income (OI), for any given sales volume (Q)
New level of OI = DOL percentage change in sales volume
= (CM OI) (new sales volume current sales
volume)
= (CM current sales volume) (new sales volume
OI)
= CM ratio (CMR) (new sales volume OI)
= ((CMR new sales volume) (CMR current sales
volume)) OI
= (new CM old CM) OI
= ( in OI) OI
= percentage change in Operating Income (OI)
2. Relationship between definition of operating leverage and the DOL
measure
First, recall the basic profit equation for operating income (OI):
OI = [(p v) Q] F
where p = selling price per unit
v = variable cost per unit
Q = volume (e.g., units)
F = total fixed costs per period
9-12
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manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.

Chapter 09 - Short-Term Profit Planning: Cost-Volume-Profit (CVP) Analysis

9-36 (Continued)
Second, we can rewrite the above as (where CM = total contribution
margin):
F + OI = (p v) Q
= CM
Third,
DOL = CM OI (by definition)
= (F + OI) OI
Finally,
DOL = (F OI) + 1.0
The advantage of the above specification is that we can more readily
see how sensitivity of operating profit is affected by the amount of FC in
the organizations cost structure, that is, by the amount of operating
leverage.

9-13
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manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.

Chapter 09 - Short-Term Profit Planning: Cost-Volume-Profit (CVP) Analysis

PROBLEMS
9-38 Profit Planning: Multiple Products (50-60 min)
1. Break-even in units: weighted-average contribution margin approach
a. Overall breakeven point = F weighted-average contribution
margin/unit
Weighted-average unit contribution per unit
= ($15 80%) + ($40 20%) = $20 per unit
Break-even point = $400,000 $20/unit = 20,000 units
b. Breakdown of breakeven units:
Product A: 20,000 80% = 16,000
Product B: 20,000 20% = 4,000
2. Use Goal Seek (in Excel) to calculate the breakeven point, in terms of
total units:
Step One: Set Up the Equation for Operating Income

Step Two: Run Goal Seek

9-14
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manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.

Chapter 09 - Short-Term Profit Planning: Cost-Volume-Profit (CVP) Analysis

Problem 9-38 (Continued-1)


Step Three: Results (after running Goal Seek)

3. Breakeven point in units: Sales basket approach (assume that each


basket consists of 4 units of Product A and 1 unit of Product B).
a. Overall breakeven point (in baskets) = F contribution
margin/basket
Contribution margin per sales basket = (4 $15) + (1 $40)
= $60 + $40 = $100 per basket
Number of baskets needed to breakeven =
= $400,000 $100/basket = 4,000 baskets, or 4,000
baskets 5 units per basket = 20,000 units
b. Breakdown of breakeven units:
Product A: 4,000 baskets 4 units/basket = 16,000 units
Product B: 4,000 baskets 1 unit/basket = 4,000 units
9-15
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manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.

Chapter 09 - Short-Term Profit Planning: Cost-Volume-Profit (CVP) Analysis

Problem 9-38 (Continued-2)


4. Distribution of breakeven point in terms of sales dollars (based on
weighted-average contribution margin ratio, where the individual
product weights are based on relative sales dollars, not physical unit,
of each product in the standard sales mix).
a. Breakeven ($) = F weighted-average cm ratio
Relative sales dollars (not units), based on standard sales mix:
Product A: 18,000 units $80/unit = $1,440,000
Product B: 4,500 units $140/unit = $630,000
Weights:
Product A: $1,440,000 $2,070,000 = 0.6956522
Product B: $630,000 $2,070,000 = 0.3043478
Weighted-average contribution margin ratio:
A: 0.69565 ($15/$80) = 0.6956522 0.1875 = 0.13043478
B: 0.30435 ($40/$140)= 0.3043478 0.2857 = 0.08695652
0.21739130
Breakeven point in overall dollars ($) = $400,000 0.21739130
= $1,840,000
b. breakdown of total breakeven sales dollars, by product:
Product A: mix % x breakeven sales, in $
= 0.6956522 $1,840,000 = $1,280,000
Product B: mix % x breakeven sales, in $
= 0.3043478 $1,840,000 =

$560,000

5. For the multiproduct firm, there is no breakeven point independent of


the sales mix assumption. For the multiproduct firm, we typically
assume that the outputs are sold in some standard mix, based either
on relative physical units or relative sales dollars. If the individual
products differ in terms of their contribution margin per unit (or
contribution margin ratio), then the weighted-average contribution
9-16
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manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.

Chapter 09 - Short-Term Profit Planning: Cost-Volume-Profit (CVP) Analysis

margin (and contribution margin ratio) will vary in response to changes


Problem 9-38 (Continued-3)
in the sales mix. This, in turn, affects the breakeven point since that
point is defined as the ratio of fixed costs to the weighted-average
contribution margin per unit (or, the weighted-average contribution
margin ratio). Of course, if the unit contribution margins are the same
for each product, then the assumed mix has no impact on the
breakeven calculation. Note, however, that this is a trivial example.
6. Change in the breakeven point (in total units) in response to a 10%
change in fixed costs:
New level of fixed costs = $400,000 + $40,000 = $440,000
Original level of fixed costs
= $400,000
$ change in fixed costs = $40,000
Percentage change in fixed cost = $40,000 $400,000 = 10.00%
New breakeven point = $440,000 $20.00/unit = 22,000 units
Original breakeven point =
20,000 units
Change in breakeven point = 2,000 units
Percentage change in breakeven point = 2,000 20,000 = 10.00%
As seen from the above, the percentage change in fixed cost (here
10%) led to an identical percentage change in the breakeven point.
Because of the linear cost functions assumed in a conventional CVP
model, this finding can be generalized: with everything else held
constant, a given percentage change (+ or -) in the amount of fixed
costs leads to an equivalent percentage change in the breakeven
point.

9-17
2013 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any
manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.

Chapter 09 - Short-Term Profit Planning: Cost-Volume-Profit (CVP) Analysis

9-40 CVP Analysis (45-50 min)


1. Pro-rated per-year fixed cost of blood gases analysis machine =
$800,000 10 years = $80,000 per year
Savings per sample in direct costs if a blood gas analysis machine is
purchased: $125 $75 = $50
Indifference point = FC variable cost per test = $80,000 $50 =
1,600 samples (tests) per year
Alternatively (where X is the number of tests per year):
$125X = $75X + $80,000
$50X = $80,000
X = $80,000 $50
X = 1,600 tests per year
2. Using Goal Seek to determine the indifference point:

Note: Cell D61 contains the formula: =D55 + (D60*E55)


Cell D62 contains the formula: =D60*E56
Cell D63 contains the formula: =D61 D62
9-18
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manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.

Chapter 09 - Short-Term Profit Planning: Cost-Volume-Profit (CVP) Analysis

9-40 (Continued-1)
Step Two: Run Goal Seek

Step Three: Results

Thus, at 1,600 tests per year, the total cost under each of the two
decision alternatives would be the same: $200,000.
3. Current number of patients per year needing analysis = 4,000
# needing blood gas analysis = 4,000 35% = 1,400
The difference = 1,600 1,400 = 200 tests per year
200 is the additional number of blood gas samples (per year)
needed to break even at the $125 charge. To generate 200
additional charges, we need 200 0.35 = 571 additional patients.
9-19
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manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.

Chapter 09 - Short-Term Profit Planning: Cost-Volume-Profit (CVP) Analysis

9-40 (Continued-2)
4. The amount the diagnostic screening center would have to charge
clients at the current patient level:
Let p = required charge (service fee)
Current # of tests performed per year = 4,000 0.35 = 1,400
To solve for the breakeven charge rate (per test):
p 1,400 = ($75 1,400) + $80,000
p = ($105,000 + $80,000) 1,400 tests per year
p = $132.14 per test
Note: the above result could have been obtained, as well, through
the use of Goal Seek.
5. Additional factors to be considered:
a. time-value-of-money (opportunity cost of capital)the decision at
hand is really a capital budgeting problem
b. quality and reliability of the in-house testing alternative versus
outsourcing the testing procedure
c. are there alternative, more pressing needs for the proposed
$800,000 outlay? Put another way, is the proposed capital
expenditure strategically important to the organization?
d. operating riskincreasing operating leverage (i.e., the proportion
of fixed costs in the organizations cost structure) exposes the
hospital to greater fluctuations in its operating income: operating
income for organizations with greater amounts of operating
leverage is more sensitive to changes in volume.
e. would the purchase of the machine now provide a disincentive to
invest in this area in the future?

9-20
2013 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any
manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.

Chapter 09 - Short-Term Profit Planning: Cost-Volume-Profit (CVP) Analysis

9-42 CVP Analysis; Sensitivity Analysis; Multiple Products (50-60 min)


1. GoGo Juices profit (loss) before tax from implementing the promotional
coupon with no change in sales volume and sales mix is ($6,500)

Sales Revenue
Coupons redeemed
(note 1)
Cost of Sales (note
2)
Contribution Margin
Fixed costs (note 3)
Loss before tax

Gasoline
$100,000
(15,000)
(75,000)
$10,000

Food &
Beverage
$60,000

Other
$40,000

(36,000) =
(20,000) =
0.6 60,000 0.5 40,000
$24,000
$20,000

Total
$200,000
(15,000)
(131,000)
54,000
60,500
$(6,500)

Note 1: Coupons redeemed: total sales of ($200,000 75%) 10 ($1 per


$10) = $15,000
Note 2: Gasoline cost of sales: $100,000 $2.50 price per gallon = 40,000
gallons; 40,000 gallons $1.875/gallon = $75,000
Note 3: Fixed costs
Labor ($10,000 + $2,500)
$12,500
Rent, power, supplies, etc.
40,000
Depreciation
7,500
Coupon printing cost
500
Total monthly fixed costs
$60,500
2. The breakeven point in sales dollars for GoGo, based on the weightedaverage contribution margin ratio (CMR) approach:
Weighted-average contribution margin ratio = total contribution
margin total sales dollars
= $54,000 $200,000 = 27.0%
Breakeven in total sales dollars = total fixed costs weightedaverage contribution margin ratio
= $60,500 0.27 = $224,074
9-21
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manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.

Chapter 09 - Short-Term Profit Planning: Cost-Volume-Profit (CVP) Analysis

9-42 (continued-1)
3. Allocation of total breakeven sales dollars across the three product lines
(based on sales mix determined on the basis of relative sales dollars, not
units, of the three products):
Total breakeven sales dollars (#2 above) = $224,074
Sales mix percentages, based on relative sales dollars:
Gasoline: $100,000 $200,000 =
Food/beverage: $60,000 $200,000 =
Other: $40,000 $200,000 =

0.50
0.30
0.20

Breakdown of total breakeven sales dollars ($224,074):


Gasoline:
0.50 $224,074 =
Food/beverage: 0.30 $224,074 =
Other:
0.20 $224,074 =
Total =

$112,037
67,222
44,815
$224,074

4.
Sales revenue ($200,000 1.2)
$240,000
Variable costs (sales CM)
156,000
Contribution margin ($240,000 35%) 84,000
Less fixed costs
60,500
Profit before tax
$23,500
5. Sensitivity analysis is used to deal more effectively with uncertainty or
risk. Sensitivity analysis is a "what-if' type of analysis used to determine
the outcomes if any parameters change from the initial assumptions. For
example, revenues or costs could be changed from the initial
assumptions and a new break-even sales volume calculated.
At least three factors that make sensitivity analysis prevalent in decisionmaking today include the following:
The availability of computers and spreadsheet software has made it very
quick and easy to compute the impact of changing one or more
9-22
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manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.

Chapter 09 - Short-Term Profit Planning: Cost-Volume-Profit (CVP) Analysis

9-42 (Continued-2)
assumptions in a financial model.
As the business environment is becoming more dynamic and
competitive, sensitivity analysis provides management with an
understanding of the impact of changes in the environment. The
increased emphasis on productivity, competitive marketplace, changing
consumer demand, shorter product life cycle times, and faster
obsolescence of technology makes sensitivity analysis more widely
used.
Sensitivity analysis aids management in identifying the key variables
and assumptions, so the variables can be monitored or a decision made
to obtain additional information on these variables.
6. Methods, as discussed in the chapter, that can be used to address
uncertainty in the profit-planning process:
Conventional measures associated with CVP analysis:
o Degree of operating leverage (DOL)
o Margin of safety (MOS) and margin of safety ratio (MOS%)
Sensitivity analysis:
o Simple what-if analysis/analyses
o Preparation of decision tables/decision trees/expected values
(based on probability information regarding one or more variables
in the CVP model)
o Monte Carlo simulation analysis (random and independent draws
from probability distributions associated with one or more variables
in the CVP model, to generate a probability of outcomes--for
example, operating incomes)

9-23
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manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.

Chapter 09 - Short-Term Profit Planning: Cost-Volume-Profit (CVP) Analysis

9-44 CVP Analysis; Uncertainty/Sensitivity Analysis (60-75 min)


1. In order to break even, during the first year of operations, 3,649 clients
(rounded up) must visit the law office being considered by Don Carson
and his colleagues as calculated below.

Breakeven Calculation:
$0 = Total revenue variable cost (supplies) fixed cost
(from above)
$0 = (Initial consultation fees + Settlement fees) VC F
$0 = ($30Q + ($15,000 0.3 0.2) Q) $10Q
$3,356,240
Q = $3,356,240 $900 =3,649 clients per year (rounded
up)
2.

Based on the report of the marketing consultant, the expected


number of new clients during the first year is 12,600 as calculated
below. Therefore, it is entirely feasible for the law office to break even
during the first year of operations as the breakeven point is 3,649
clients (see above).
Expected value = (10 0.10) + (20 0.30) + (40 0.40) + (60 0.20)
9-24

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Chapter 09 - Short-Term Profit Planning: Cost-Volume-Profit (CVP) Analysis

= 35 clients per day


= 35 360 days = 12,600 clients in year 1
9-44 (Continued-1)
Since there is uncertainty in the prediction of the number of clients
per year, based on a probability distribution, further sensitivity
analysis should be considered, with the objective of determining the
potential loss if in fact the number of clients falls short of the forecast.
3.

Sensitivity Analysis: Sensitivity analysis is used to deal more


effectively with uncertainty or risk. Sensitivity analysis is a "what-if
type of analysis used to determine the outcomes if any parameters
change from the initial assumptions. For example, revenues or costs
could be changed from the initial assumptions and a new break-even
sales volume calculated.
The availability of spreadsheet software has made it very quick and
easy to compute the impact of changing one or more assumptions in
a financial model. At least three factors that make sensitivity analysis
prevalent in decision making include the following:
As the business environment is becoming more dynamic and
competitive, sensitivity analysis provides management with an
understanding of the impact of changes in the environment.
The increased emphasis on productivity, competitive
marketplace, changing consumer demand, shorter product life
cycle times, and faster obsolescence of technology makes
sensitivity analysis more prevalent.
Sensitivity analysis aids management in identifying the key
variables and assumptions, so the variables can be monitored
or a decision made to obtain additional information.
The use of probability distributions to determine expected
values is an excellent way to conduct a sensitivity analysis.
This approach allows Carson to see the distribution of costs
and profits, as they are affected by the distribution of potential
demand (number of clients). Carson can enhance this analysis
9-25

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manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.

Chapter 09 - Short-Term Profit Planning: Cost-Volume-Profit (CVP) Analysis

by using standard deviations to measure the dispersion of the


distributions, as a means to get at the degree of uncertainty
higher standard deviations for greater uncertain
9-44 (Continued-2)
4. Basic simulation analysis using the NORMDIST function in Excel:
a. probability that the firm will at least breakeven, given normally distributed
operating income and a standard deviation of $5,000,000, is ~ 95%:

9-26
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manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.

Chapter 09 - Short-Term Profit Planning: Cost-Volume-Profit (CVP) Analysis

9-44 (Continued-3)

9-27
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Chapter 09 - Short-Term Profit Planning: Cost-Volume-Profit (CVP) Analysis

9-44 (Continued-4)
9-28
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Chapter 09 - Short-Term Profit Planning: Cost-Volume-Profit (CVP) Analysis

9-29
2013 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any
manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.

Chapter 09 - Short-Term Profit Planning: Cost-Volume-Profit (CVP) Analysis

9-46 CVP Analysis; Strategy; Uncertainty (60-75 min)


1. Total variable costs per unit for the current plan are $6 + $12.50 + $25
+ $10 = $53.50, and $15 + $13.75 + $30 + $10 = $68.75 under the
proposed plan. Thus, the contribution margin per unit and breakeven
point (in units) for each of the two plans are as follows:
Contributio
n
Margin/Unit
Breakeven*

Current Plan
$100 $53.50 = $46.50

Proposed Plan
$100 $68.75 = $31.25

($6,000,000 + $1,250,000)
$46.50 per unit =
155,914 units

($3,000,000 + $1,250,000)
$31.25 per unit =
136,000 units

*Fixed manufacturing overhead costs are determined from the fixed


overhead rates:
Current Plan
150,000 units
$6,000,000

$40/unit

Proposed Plan
= 150,000 units
$3,000,000

$20/unit

2. To determine the sales volume (in units) at which CG would be


indifferent between the current manufacturing plan and the proposed
plan, solve for the point, Q, in which total relevant cost is the same for
the two decision alternatives. (Revenue from sales is unaffected by
choice of production method. Hence, the point of operating profit
indifference is the same as the point of cost indifference between the
two alternatives.)
Relevant variable costs are$43.50 ($53.50 $10.00) and $58.75
($68.75 $10.00) for the current plan and the proposed plan,
respectively. Relevant fixed costs (per year) are $6,000,000 and
$3,000,000, respectively.
The indifference point, Q, can be found at the point of cost equality, as
follows:
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Chapter 09 - Short-Term Profit Planning: Cost-Volume-Profit (CVP) Analysis

9-46 (Continued-1)
Total Relevant Cost, Current = Total Relevant Cost, Proposed
($43.50 Q) + $6,000,000 = ($58.75 Q) + $3,000,000
($58.75 $43.50) Q = $6,000,000 $3,000,000
Q = $3,000,000 $15.25
Q = 196,722 units
(The above calculations show that at the current level of 150,000 units,
the firm would prefer the low-fixed-cost strategy, that is, the new plan.)
3. Use Goal Seek in Excel to confirm the answer found above in
Requirement 2:
Step #1: Define the Cost-Differential Equation (i.e., Relevant Cost of
Current Production Plan Relevant Cost of Proposed Plan)

Note: Cell C111 contains the formula:


((C101*C108) + C109) ((C101*D108) + D109)
Step #2: Run Goal Seek, as follows:

9-31
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Chapter 09 - Short-Term Profit Planning: Cost-Volume-Profit (CVP) Analysis

9-46 (Continued-2)
Step #3: Generate Results, as follows:

4. CGs strategy is best described as differentiation, since the firm has


succeeded by innovation in product design. Further, the firm operates in
an industry in which innovation and product design are critical to
success. An important element of the firms strategy is also the fact that
the technology, as for many firms in the industry, is not proven. That is,
there is a significant level of risk that the firms product will fail to meet
customers expectations. The overall strategy then must both support
the firms innovative image and also protect against the possibility of
loss due to a failure of the technologythat is, simultaneously, the firm
must advance and market its technological prowess and develop a plan
to deal with the possibility that the technology might fail.
5.
a) The calculations in part 2 above support a decision to go to the
new plan; at the current level of 150,000 units, costs are lower for
the new plan, and will continue to be lower for the new plan as
9-32
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manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.

Chapter 09 - Short-Term Profit Planning: Cost-Volume-Profit (CVP) Analysis

long as volume stays below 196,722 units.


b) Thinking strategically, the new plan is also preferred since it is an
appropriate response to the firms risk, as noted in Part 3 above.
By reducing operating leverage (that is, by reducing manufacturing
fixed costs from $6,000,000 to $3,000,000) the firm is less
9-46 (Continued-3)
exposed to a possible failure of the innovation and the drop off in
sales. The reduction in fixed costs also helps the firm to manage
cash flows. Thus, the new
plan is more consistent with the firms strategy of developing an
innovative product and also dealing with the risk of potential loss
because of a possible failure of the technology in the market place.
Also, one could look at the proposal as consistent with the firms
core strength, which appears to be product innovation. There is no
evidence that the firm is particularly innovative or cost-effective in
manufacturing. Thus, a strategy which goes to less focus on
manufacturing would be consistent with this strategy; more focus
should be retained in product design and development.
c) Sensitivity analysis: since uncertainty is important in this case, CG
Graphics should use some of the tools as illustrated below. Note
that the current method looks good if projected demand rises.

9-33
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manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.

Chapter 09 - Short-Term Profit Planning: Cost-Volume-Profit (CVP) Analysis

9-34
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manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.

Chapter 09 - Short-Term Profit Planning: Cost-Volume-Profit (CVP) Analysis

9-48 Multiple-Product CVP Analysis; Sensitivity Analysis (75-90 min)


1. Contribution margin per unit = subscription price variable costs
Weekly Subscriptions:
Mailing $0.60 per issue 52 =$ 31.20 per subscription
Commission
$ 3.00 per subscription
Administrative
$ 1.50 per subscription
Total variable cost
$35.70
cm per subscription = subscription price - variable cost
= $47.00 $35.70
= $11.30 per subscription
Monthly Subscriptions:
Mailing$0.60 per issue 12 =
Commission
Administrative
Total Variable Cost

$ 7.20 per subscription


$ 3.00 per subscription
$ 1.50 per subscription
$11.70

cm per subscription = subscription price variable cost


= $19.00 $11.70
= $ 7.30 per subscription
2. Contribution Margin Ratio (CMR) = cm per unit subscription price
Weekly: $11.30 $47.00 = 24.0%
Monthly: $ 7.30 $19.00 = 38.4%
3. Breakeven in total sales units (# of subscriptions)
Weighted-average cm per unit = (cm/unit)(weight) i, i = 1,2
$11.30 0.20 = $2.26 HPC-Weekly
$ 7.30 0.80 = $5.84 HPC-Monthly
$8.10 weighted-average contribution margin
9-35
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Chapter 09 - Short-Term Profit Planning: Cost-Volume-Profit (CVP) Analysis

9-48 (Continued-1)
Overall breakeven point = F weighted-average contribution margin/unit
= $306,000 $8.10/subscription = 37,778 subscriptions
Breakdown into individual products:
HPC-Weekly: 37,778 20% = 7,556
HPC-Monthly: 37,778 80% = 30,222
Total
= 37,778
Breakeven point in dollars:
Weight

Selling Price Product

Wtd.-avg. selling price/unit:


Weekly Subscriptions
Monthly Subscriptions

20%
$47.00
$9.40
80%
$19.00
$15.20
100%
$24.60
Breakeven ($):
Total breakeven units (subscriptions)
37,778
weighted-average selling price per unit
$24.60
Total B/E ($) =
$929,333

Breakeven point in dollars--alternative solution:


Breakeven in $ = F weighted-average contribution margin ratio
Weighted-average contribution margin ratio:
cm ratio
Weekly Subscriptions
24.04%
Monthly Subscriptions
38.42%

weight
38.21%
61.79%
100.00%

product
9.19%
23.74%
32.93%

B/E ($) = Annual Fixed Costs weighted-average contribution ratio


Annual Fixed Costs =
$306,000
Weighted-average contribution margin ratio = 32.93%
Breakeven point in total sales dollars = $929,333
9-36
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manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.

Chapter 09 - Short-Term Profit Planning: Cost-Volume-Profit (CVP) Analysis

9-48 (Continued-2)

4. For the multiproduct (or multiservice) firm, there is no breakeven point


independent of the sales mix assumption.
One option for multiproduct CVP analysis is to trace and/or allocate total
fixed costs across the products and then prepare a separate CVP model
for each product. Regardless of the ability to allocate such costs across
products, this approach fails to capture demand interdependencies
among products. Thus, for either of these two reasons, the conventional
approach to multiproduct (or multiservice) CVP analysis is to prepare a
single model under the assumption that the products are sold in a
specified sales mix.
At this point, the analyst can proceed by using one of two approaches to
build a CVP model: (1) the weighted-average contribution margin (and
related weighted-average contribution margin ratio) approach, and (2) a
sales basket approach.
If the products in question have different contribution margins per unit
(or different contribution margin ratios), then there is no unique
breakeven point for the firm. In fact, there is an infinite number of
breakeven points. As the assumed sales mix changes, so too will the
breakeven point for the firm. The breakeven point moves in response to
shifts in the sales mix: as the mix shifts to more profitable products, the
breakeven point decreases, and vice versa. Thus, for the multiproduct
firm, there is no breakeven point independent of the sales mix
assumption. The only exception to this rule is when each product has
the same contribution margin per unit, which is considered a trivial case.

9-37
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manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.

Chapter 09 - Short-Term Profit Planning: Cost-Volume-Profit (CVP) Analysis

9-48 (Continued-3)
5. Sensitivity analysis table: what happens to the breakeven point as the
sales mix changes (in increments of 1%), from 15% to 25% for HPC
Weekly? Of what value to management is this type of analysis?
on%units sold)
WeightedB/ESales
(units)Mix (based
B/E
% Change
in
HPC Weekly
HPC
Monthly
Avg.
CM/Unit
Change from
Weighted15%
85%
$7.90
Base Case
Avg. CM/Unit
16%
84% (from base)
$7.94
17%
83%
$7.98
$7.90
38,734
2.53%
-2.47%
18%
82%
$8.02
$7.94
38,539
2.02%
-1.98%
19%
81%
$8.06
$7.98
38,346
1.50%
-1.48%
Base Case
20%
80%
$8.10
$8.02
38,155
1.00%
-0.99%
21%
79%
$8.14
$8.06
37,965
0.50%
-0.49%
22%
78%
$8.18
$8.10
37,778
0.00%
0.00%
23%
77%
$8.22
$8.14
37,592
-0.49%
0.49%
24%
76%
$8.26
$8.18
37,408
-0.98%
0.99%
25%
75%
$8.30
$8.22
37,226
-1.46%
1.48%
37,046
$8.26
-1.94%
1.98%
36,867
$8.30
-2.41%
2.47%
9-48 (Continued-4)
WeightedAverage
Contribution
Margin/Unit

The above data table provides the results of a sensitivity analysis.


Specifically, we are looking at the sensitivity of the breakeven point to
the assumption regarding sales mix for the two products. Based on the
above results management will form a judgment as to the sensitivity of
the B/E point to changes in the sales mix. The greater the perceived
sensitivity, the greater the uncertainty in the calculations (and therefore
in the CVP model). Given greater uncertainty, management may invest
resources to provide a more refined estimate of sales mix.
6. Given the assumed sales mix (20%:80%), the required sales volume (in
total units) to generate a before-tax profit, B, of $ 75,000 is 47,037
units:
Targeted before-tax profit target, B =

$75,000

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Chapter 09 - Short-Term Profit Planning: Cost-Volume-Profit (CVP) Analysis

Fixed Costs (F) =


F + B =
Weighted-average cm/unit =
Breakeven point in sales units =

$306,000
$381,000
$8.10
47,037

Although not required in the problem, the breakdown by product is:


1) 20% 47,037 = 9,407
2) 80% 47,037 = 37,630
7. Given the assumed sales mix, what is the required sales volume (in total
units) to generate an after-tax profit, A, equal to 10% of sales dollars?
Let Q = the required sales volume (in units) to achieve the profit objective
B= Total sales Total variable cost Total fixed cost (F)
B = A (1 t), where t = tax rate
A (1 t) = Total sales Total variable cost F
9-48 (Continued-5)
(0.10 (sp/unit Q)) (1 t) = Total contribution margin F
(0.10 (sp/unit Q)) (1 t) = (cm per unit Q) F
(0.10 $24.60/unit Q) (1 0.30) = ($8.10 Q) $306,000
$3.5142857 Q = ($8.10 Q) $306,000
$4.5857143 Q = $306,000
Q = $306,000 $4.5857143/unit = 66,729 units
9-39
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Chapter 09 - Short-Term Profit Planning: Cost-Volume-Profit (CVP) Analysis

8. The point of this question is to get the students started thinking about the
competitive context in which the firm operates. There are many different
relevant points that could be made. If the discussion is slow to start, ask
them to think about what a firm like HPC must do to be competitive.
There are a number of critical success factors that are likely to be
important for both domestic and foreign subscriptions. These would
include quality of presentation and timeliness and accuracy of
information, as well as competitive price. However, other factors will differ
across countries. For example, in some countries the cost of distribution
including selling and handling costs are quite high, so that it is critical in
these countries to devise new ways to deliver the subscriptions profitably.
Other factors include changes in literacy rates, the business climate, and
investment opportunities in different countries.

9-40
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manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.

Chapter 09 - Short-Term Profit Planning: Cost-Volume-Profit (CVP) Analysis

Problem 9-50: CVP Analysis; Sustainability; Uncertainty; Decision Tables


(60-75 min)
1. Lifetime cost functions: let Y = lifetime cost, and v = cost per gallon of
gas
Regular model:
Lifetime Cost (Y) = Fixed Cost + Variable Cost
Lifetime Cost (Y) = $17,000 + (v [60,000 miles 23.0 mpg])
Lifetime Cost (Y) = $17,000 + (2,608.7 gals. v)
Hybrid model:
Lifetime Cost (Y) = Fixed Cost + Variable Cost
Lifetime Cost (Y) = ($19,000 - $500) + (v [60,000 miles 27.0 mpg])
Lifetime Cost (Y) = $18,500 + (2,222.2 gals. v)
2. Breakeven gas price (point of cost indifference): let "v" = breakeven price
per gallon
Lifetime Cost--Gas Model

Lifetime Cost--Hybrid Model

$17,000 + (2,608.7 gals. v) = $18,500 + (2,222.2 gals. v)


v = [$18,500 - $17,000] [2,608.7 gals. - 2,222.2 gals.]
= $1,500 386.5 gals. =$3.88 per gallon
3. Graph of Lifetime Cost Function--Regular and Hybrid Models
X (price
per gal.)
$2.750
$3.000
$3.250
$3.500
$3.750

Lifetime Cost
Gas Model
Hybrid
$24,174
$24,611
$24,826
$25,167
$25,478
$25,722
$26,130
$26,278
$26,783
$26,833
9-41

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Chapter 09 - Short-Term Profit Planning: Cost-Volume-Profit (CVP) Analysis

9-50 (Continued-1)
$4.000
$4.250
$4.500
$4.750
$5.000

$27,435
$28,087
$28,739
$29,391
$30,043

$27,389
$27,944
$28,500
$29,056
$29,611

Based on the above analysis and graph, we see that for these two
alternatives (gas-powered vs. hybrid model), and 60,000 miles total usage
over a four-year period, the lifetime costs are close, that is, they are
insensitive to the predicted cost of gas per gallon.
4. Pseudo degree of operating leverage (DOL) measure
Alternative Lifetime Mileage Assumption =
Original Assumption--Lifetime Mileage =
Assumed price-per-gallon of gas =

62,000
60,000
$4.00

9-42
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manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.

Chapter 09 - Short-Term Profit Planning: Cost-Volume-Profit (CVP) Analysis

9-50 (Continued-2)

Option
Gas Powered
Car
Hybrid Model

Lifetime Cost
@ 62,000
miles
$27,783
$27,685

Lifetime Cost
@ 60,000
miles

%
Change
Cost

% Change
Mileage

Pseudo
DOL

$27,435
$27,389

1.2678%
1.0818%

3.333%
3.333%

0.380
0.325

The above pseudo DOL measure for the gas-powered car indicate that from
a baseline of 60,000 lifetime miles, for each 1% change in lifetime miles
driven, lifetime cost changes by 0.38%.
The relevant measure for the hybrid, from this base, is 0.325%. What this
tells us is that for this particular example, lifetime cost for both decision
alternatives is approximately equally sensitive to changes in lifetime miles
driven.
5. Decision Table--Break-even gas price as a function of different
combinations of initial cost differential (Hybrid cost [net of rebate]
Cost of gasoline-powered model) and lifetime miles driven
Initial Cost
Difference
$2,500
$2,000
$1,500
$1,000
$500

Lifetime Miles
Driven
70,000
60,000
50,000

9-43
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Chapter 09 - Short-Term Profit Planning: Cost-Volume-Profit (CVP) Analysis

9-50 (continued-3)

Initial Cost
Differential
$2,500
$2,500
$2,500
$2,000
$2,000
$2,000
Initial Cost
Differential
$1,500
$1,500
$1,500
$1,000
$1,000
$1,000
$500
$500
$500

Lifetime Miles
Driven
70,000
60,000
50,000
70,000
60,000
50,000

Breakeven Gas Price (per


gallon)
$5.545
$6.469
$7.763
$4.436
$5.175
$6.210
Breakeven
Gas Price
(per gallon)
$3.327
$3.881
$4.658
$2.218
$2.588
$3.105
$1.109
$1.294
$1.553

Lifetime Miles
Driven
70,000
60,000
50,000
70,000
60,000
50,000
70,000
60,000
50,000

For example, for the base case ($1,500 initial cost difference and 60,000
lifetime miles driven) the breakeven price per gallon is $3.881 (as found
earlier in part 2). At this price, and all other things equal, you would be
indifferent between the hybrid model and the gasoline-powered model.
Notice from the above table that the higher the initial cost differential for the
hybrid versus the gasoline-powered model, the greater the breakeven point
in terms of cost per gallon of fuel. You also notice that the breakeven gas
price is inversely related to lifetime miles driven. While both conclusions
seem intuitively appealing, the advantage of the decision table is the
structured way in which it allows you to deal quantitatively with uncertainty
surrounding the financial consequence of your decision choice.
9-50 (continued-4)
9-44
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manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.

Chapter 09 - Short-Term Profit Planning: Cost-Volume-Profit (CVP) Analysis

6. Expected value calculations:


10

E(ax) = (Lifetime costi pi)


i=1
x = 1, 2; i = 1,10
Number of Lifetime miles assumed: 60,000

i
1
2
3
4
5
6
7
8
9
10

Event
p
$2.75
0.01
$3.00
0.05
$3.25
0.05
$3.50
0.05
$3.75
0.15
$3.88
0.15
$4.00
0.15
$4.25
0.20
$4.50
0.10
$4.75
0.09
Expected Lifetime cost =

Action (Decision)
Hybrid
Gas Model
$246
$242
$1,258
$1,241
$1,286
$1,274
$1,314
$1,307
$4,025
$4,017
$4,069
$4,069
$4,108
$4,115
$5,589
$5,617
$2,850
$2,874
$2,615
$2,645
$27,360
$27,401

Lifetime cost = initial cost outlay (F) + variable (gas) cost over four-year
period
Example: for the hybrid model, if the probability of gas selling at
$2.75/gallon is 0.01, then the appropriate amount is cost
component for calculating expected lifetime cost is:
(($19,000 $500) + ((60,000 27.0 mpg) $2.75/gal)) 0.01
To minimize the expected lifetime cost, we should choose the hybrid
model. However, these expected values are so close that they are
9-50 (continued-5)
9-45
2013 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any
manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.

Chapter 09 - Short-Term Profit Planning: Cost-Volume-Profit (CVP) Analysis

effectively equal, particularly given uncertainty in the price of gas. Thus, if


total miles driven over the lifetime of each vehicle (4 years) is 60,000,
then the expected lifetime cost of both actions (given the assumed
probability distribution) is approximately equal.
Finally, note that basing the decision solely on expected value (in the
present case, cost) ignores the risk preferences (utility function) of the
decision-maker. The decision table presented above in part 5 can
facilitate this discussion.
7. Student answers will likely differ. Below are representative considerations.
Qualitative Considerations
a. safety record--does this differ between the two models?
b. reliability--does this differ between the two models? (in some cases, the
reliability of new models is considerably less than the reliability of older,
more established models)
c. as noted in conjunction with the discussion of decision tables (above),
we have not given explicit consideration to the decision-makers
attitude toward risk associated with the inputs to the decision model
d. carbon footprint issue--it is true that from an operating standpoint, the
carbon footprint of the hybrid would be less than it is for the related
gasoline-powered model. However, what this comparison ignores is the
total carbon footprint--from manufacture, through use (operation),
through disposal. It is possible, for example, that when one considers
the relatively high energy consumption needed to build the hybrid
model that, depending on total miles driven, its carbon footprint might
be larger than it is for a related gasoline-powered model.
e. relationship between mpg and lifetime miles driven: ignored thus far in
the analysis is the fact that the latter might be a function of the former.
Our analysis has, in fact, assumed that these two variables are
unrelated (i.e., we assumed in the base case that for both decision
alternatives lifetime miles driven = 60,000). However, it is entirely
possible that people who purchase the more fuel-efficient hybrid model
drive more.
9-46
2013 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any
manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.

Chapter 09 - Short-Term Profit Planning: Cost-Volume-Profit (CVP) Analysis

Additional Quantitative Considerations


a. what is the estimated useful life for each vehicle? (this would be
important if the buyer intended to use the vehicle beyond the four-year
planning horizon)
b. related to the above point, what is the estimated salvage/disposal value
of each vehicle at the end of the four-year decision horizon?
c. related to point b above, what is the estimated salvage value at the end
of each of years 1 through 3? (important as a potential bail-out
consideration)
9-50 (continued-6)
d. other operating expenses associated with use of each vehicle (e.g.,
insurance, repairs/maintenance)--how do these compare? In addition,
for the hybrid under consideration, what is the estimated life of the
battery? What is the likelihood that the battery would have to be
replaced during the four-year ownership period?
e. time value of money (discount rate)--the underlying decision is longterm in nature. As such, the decision maker should consider the
present (i.e., discounted) value of costs associated with each decision
alternative (similar to the approach taken in capital budgeting
decisions).
f. the given mpg figures are based on some type of average driving (or
mix between city and highway miles driven). Is the anticipated driving
behavior of the purchaser different from this assumed mix so that the
use of average mpg data would not be appropriate? If most of the
driving is done in the city, this is a distinct advantage for the hybrid,
since electric propulsion would be used more frequently in this context.
On the other hand, if most of the driving will be highway driving, the fuel
efficiency of the hybrid relative to the gasoline-powered engine
decreases significantly. Once the hybrid gets to highway speed it is
being propelled mostly by the gasoline engine.

9-47
2013 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any
manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.

Chapter 09 - Short-Term Profit Planning: Cost-Volume-Profit (CVP) Analysis

Check Figures: Chapter 9


9-21 1. $509,500; 2. 14,561 units; 3. $474,500; 4. 20,622 units (rounded up); 5.
36,061 units
9-22 1. $350,000 (53.85%); 3. MOS = $200,000, Operating Profit = $70,000
9-23 1. $107,692.31; 2. $347,692.31; 3. $1,390,769.23; 4. $960,000
9-24 1. 18,750 units; 2. $187,500; 3. 28,750 units; 4. $275,000; 5. 27,679 units
(rounded up)
9-25 1. Machine A: 100,000; Machine B: 120,000; 2. 197,143 units; 3. Cost for A =
$265,000; cost for B = $264,000
9-26 1. Company A: 1.43; Company B: 2.33; 2. As change in operating income =
14.3%; Bs change in operating income = 23.33%
9-27 For School A, annuity value (today) of $100,000 implies a annual five-year salary
of $23,742; for School B, the present value of $250,000 implies an annual salary
of $59,354.
9-28 1. Indifference point = 33,582 miles over three-year period; 2. $5.637/gallon (on
average)
9-29 1. 165,333 copies per year; 2.$0.0957 per copy; 3. Three-year projected savings
= $2,600
9-30 No check figure.
9-31 No check figure.
9-32 1. Total B/E units = 517.65; 2. Brighter, 207.05882; Cleaner, 310.58824; 3.
$465,882
9-33 1.$25,000,000; 2.$51,666,667; 3. Variable cost ratio = 0.7840; B/E =
$34,722,222
9-34 2. Required price increase = $101.67
9-35 No check figure.
9-36 No check figure.
9-37 1.B/E units = 15,000; B/E $ = $675,000; 2. $75,000; 3. MOS = 17,000 hats
(53.125%); 4. B/E = 17,000 units; operating income = $58,500
9-38 1. B/E = 20,000 units (16,000 of A, and 4,000 of B); 2. Same answer as 1; 3. B/E
= 4,000 baskets (each of which contains five items) (16,000 units of A, and
4,000 units of B); 4. overall breakeven point = $1,840,000 ($1,280,000 for
Product A and $560,000 for Product B); 6. Percentage change in fixed cost =
percentage change in B/E point = 10.00%.
9-39 1.12,000 units; 30%; $1,080,000; 2.13,111.11 units (or, $1,180,000); 3. 13,544
units (rounded up); $1,218,960; 4. $25,013 (difference is due to rounding up on
sales volume); 5. Profits will decrease by $19,500; 6. Decrease $109,400 (to a
loss of $136,400); 7. Net savings = $25,000.
9-40 1.1,600 samples (tests) per year; 3.200 additional blood gas samples (or, 571
additional patients); 4. Required charge = $132.14 per test
9-41 1. $32,000; average billing rate at B/E = $35.56/hour; 2. 800 hours
9-42 1.($6,500); 2. B/E in total sales dollars = $224,074; 3. Gasoline, $112,037;
Food/beverage = $67,222; Other, $44,815; 4. Profit before tax = $23,500.
9-48
2013 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any
manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.

Chapter 09 - Short-Term Profit Planning: Cost-Volume-Profit (CVP) Analysis

9-43 1. B/E = $17,800; 2. Required sales = $30,063 (rounded up); 4. Indifference point
= $14,538 (rounded and in $000s)
9-44 1. B/E = 3,649 clients per year (rounded up); 2. Expected value = 12,600 clients
in year 1; 4. Probability is approximately 95%; probability of generating at least
$3,235,760 of operating income = 84.13%; probability of generating at least
$8,235,760 of operating income = 50%; probability of generating incremental
operating income of at least $8,235,760 = 50%.
9-45 1a. B/E = 480 seminar participants; 1b. 700 seminar participants; 2.1,054.5
participants (1,055 rounded)
9-46 1.contribution margin per unit, current plan = $46.50; contribution margin per unit,
proposed plan = $31.25; B/E, current plan = 155,914 units; B/E, proposed plan =
136,000 units; 2. Indifference point = 196,722 units
9-47 1.exact breakeven points: 156,792 for the current plan, and 132,679 under the
proposed plan; 2. calculated operating incomes at breakeven: $28 for the current
plan, and $19 for the proposed plan (note: these differ from zero because the
above-listed breakeven quantities were rounded up to the next whole number)
9-48 1.contribution margin = $11.30 per weekly subscription; contribution margin =
$7.30 per monthly subscription; 2. contribution margin ratios: 24.0% (weekly);
38.4% (monthly); 3. B/E = 37,778 subscriptions (weekly = 7,556; monthly,
30,222); B/E$ = $929,333 (weekly subscriptions = $355,111; monthly
subscriptions = $574,222); 6. required sales volume = 47,037 units; 7. required
sales volume = 66,729 units
9-49 1.unit contribution margins, $270.00 (current) and $237.50 (proposed); B/E =
134,260 (current), and 96,632 (proposed); 2. Indifference point = 409,231 units;
5. DOL at Q = 400,000 units: 1.51 (current), and 1.32 (proposed); DOL at Q =
600,000 units = 1.29 (current), and 1.19 (proposed).
9-50 1. Lifetime cost (Y) function, regular model: Y = $17,000 + (2,608.7 gals. v),
where v = cost of gas per gallon; 2. B/E gas price = $3.88/gallon; 4. Pseudo
DOL: gas-powered car = 0.380; hybrid model = 0.325; 6. expected value, lifetime
cost: gas-powered car = $27,401; hybrid model = $27,360

9-49
2013 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any
manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.