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Cost-Volume-Profit Analysis
Chapter 7
Cost-Volume-Profit Analysis
Quick Check
Answers:
QC-1. d
QC-2. c
QC-3. b
QC-4. c
QC-5. a
QC-6. c
QC-7. b
QC-8. b
QC-9. c
QC-10. d
Short Exercises
(5-10 min.) S7-1
a.
$ 50
20
$ 30
b.
$30
50
60%
c.
$330,000
210,000
$120,000
d.
$294,000
210,000
$84,000
(5 min.) S7-2
The unit contribution margin tells managers how much income is earned on each unit of sales
before considering fixed costs. Each sale contributes its unit contribution margin towards
covering fixed costs and generating a profit. Therefore, if the number of dinner cruises sold
increases by 600 and each sale generates $30 of contribution margin, operating income will
increase (or operating loss will decrease) by $18,000 (= 600 passengers $30 per passenger).
7-1
$210,000 + 0
$30*
=
=
7,000 passengers
*Contribution margin
per passenger
$50 sales
price
7,000
$50
$350,000
(5 min.) S7-4
Sales in units
=
=
=
Variable expenses
Fixed
expenses
Operating
income
Variable cost
Units
per unit
sold
Fixed
expenses
Operating
income
$210,000
$210,000
Units sold
= $45,000
= $45,000
= 8,500 tickets
To earn target income of $45,000, the cruiseline must sell 8,500 dinner cruise tickets.
7-2
Chapter 7
Cost-Volume-Profit Analysis
(5 min.) S7-6
a.
b.
c.
d.
e.
f.
g.
h.
i.
j.
7-3
Req. 1
If the sales price declines to $40, then the new unit contribution margin is $20 ($40 $20). The
new breakeven point in units is:
Fixed expenses + Operating income
=
Sales in units
Contribution margin per unit
$210,000 + $0
$20
=
=
To achieve breakeven, sales revenue needs to be $420,000 (10,500 passengers $40 sales
price per passenger). Also can be calculated as:
Fixed expenses + Operating income
=
Sales in $
Contribution margin ratio
$210,000 + $0
0.50*
=
=
Variable expenses
Variable cost
per unit
Units
sold
Fixed
expenses
Operating
income
Fixed
expenses
Operating
income
$210,000
$210,000
Units sold
=
Sales
in dollars
=
=
$40 $20
$20
0.50
Fixed expenses + Operating income
Contribution margin ratio
=
=
=
= $0
= $0
= 10,500
passengers
$210,000 + $0
0.50
$420,000
All else being constant, a decrease in sales price will decrease the contribution margin per unit
and the contribution margin ratio. The breakeven point will therefore increase. Increases in sales
price will have the opposite effect.
7-4
Chapter 7
Cost-Volume-Profit Analysis
(continued) S7-7
Req. 2
If the variable cost decreases to $10, then the new unit contribution margin is $40 ($50 $10).
The new breakeven point in units is:
Fixed expenses + Operating income
=
Sales in units
Contribution margin per unit
$210,000 + $0
$40
=
=
To achieve breakeven, sales revenue needs to be $262,500 (5,250 passengers $50 sales price
per ticket).
Or, using the equation approach:
Sales revenue
Variable expenses
Fixed
expenses
Operating
income
Variable cost
Units
per unit
sold
Fixed
expenses
Operating
income
$210,000
$210,000
Units sold
= $0
= $0
= 5,250
passengers
=
=
Sales
in dollars
$50 10
$50
0.80
Fixed expenses + Operating income
Contribution margin ratio
=
=
=
$210,000 + $0
0.80
$262,500
All else being equal, a decrease in variable costs will increase the contribution margin per unit
and the contribution margin ratio. The breakeven point will therefore decrease. An increase in
variable costs will have the opposite effect.
7-5
=
=
Variable expenses
Variable cost
per unit
Units
sold
Fixed
expenses
Operating
income
Fixed
expenses
Operating
income
$180,000
$180,000
$30 Units sold
Units sold
=
=
Sales
in dollars
$50 20
$50
0.60
Fixed expenses + Operating income
Contribution margin ratio
=
=
=
7-6
$180,000 + $0
0.60
$300,000
=
=
=
=
$0
$0
$180,000
6,000
passengers
Chapter 7
Cost-Volume-Profit Analysis
(continued) S7-8
Req. 2
The breakeven point is lower than in S7-3. By cutting fixed costs, the cruiseline was able to
decrease its breakeven point by 1,000 passengers (7,000 - 6,000).
All else being equal, a decrease in fixed costs will decrease the breakeven point, while an
increase in fixed costs will increase the breakeven point.
Total
5
$210
$ 42.00
A simple average contribution margin would be $60 [(30 + 90) / 2]. The weighted-average is
less than the simple average because the cruiseline sells more regular cruises (with the lower
contribution margin) than executive cruises.
The weighted average contribution margin ($42.00) is higher than the contribution margin of
regular cruises ($30) because the cruiseline sells some executive cruises, and executive cruises
have a higher contribution margin ($90) than regular cruises.
Because the new sales mix creates a higher weighted average contribution margin, the
cruiseline will need to sell fewer cruises, in total, to breakeven than when it just sold regular
cruises.
=
=
= 5,000 passengers
*Weighted-average contribution margin per unit from S7-9.
b.
Breakeven sales of regular cruises (5,000 4/5)
Breakeven sales of executive cruises (5,000 1/5)......
Total cruise passengers...................................
4,000
1,000
5,000
7-7
Margin of safety
in units
Expected sales
in units
=
=
8,750 7,000*
1,750 passengers
Breakeven sales
in units
*(from S7-3)
b.
Margin of safety
in dollars
Target level
sales dollars
=
=
$437,500a - $350,000b
$87,500
a
Breakeven
sales dollars
c.
Margin of safety
as a percentage
of expected sales
$87,500
$437,500
=
=
20%
$262,500
210,000
$52,500
=
Contribution margin
Operating income
$262,500
$52,500
5.0
b.
If volume increases 10%, operating income will increase 50% (operating leverage factor
of 5.0 multiplied by 10%).
c.
If volume decreases by 5%, operating income will decrease by 25% (operating leverage
factor of 5.0 multiplied by 5%).
Margin of safety
Expected sales
Breakeven sales
Chapter 7
in units
Cost-Volume-Profit Analysis
in units
=
1,500 750*
750 posters
in units
Margin of safety
in dollars
Target level
sales dollars
=
=
$67,500** - $33,750***
$33,750
Breakeven
sales dollars
Margin of safety
as a percentage
of expected sales
=
=
33,750
67,500
50%
7-9
$30,000
15,000
$15,000
Contribution margin
Operating income
$30,000
$15,000
=
2.0
If volume increases 20%, operating income will increase 40% (operating leverage factor of 2.0
multiplied by 20%).
Proof:
Original volume (posters)
..
Add: Increase in volume (20% 1,500)
1,500
300
1,800
$20
$36,000
(15,000
)
$21,000
(15,000
)
Increase in operating
income...
$6,000
7-10
40%
Chapter 7
Cost-Volume-Profit Analysis
Req. 1
Product: Cupcakes
Selling price per unit
Less: Variable cost per unit
CM
$
$
$
6.00
4.00
2.00
$ 2,600
0
$ 2,600
0.30
$ 1,700
3,000
900
$2,600
Since the number of units is 2,200 and is less than the 3,000 point of indifference, option 2
would be the lowest cost option.
Option 1 costs = $2,600
Option 2 costs = $1,700 + ($6 x 0.05) x 2,200) = $2,360
Req. 2
Option 1 is the better option for 4,500 units
Option 1 costs = $2,600
Option 2 costs = $1,700 + (($6 x 0.05) x 4,500) = $3,050
7-11
Exercises (Group A)
(15 min.) E7-17A
Req. 1
Global Travel
Contribution Margin Income Statements
Sales revenue
Less: Variable expenses (30% of sales revenue*)
Contribution margin (70% of sales revenue**)
Fixed expenses
Operating income (loss)
__________
*$120,000 / $400,000 = 0.30
**$280,000 / $400,000 = 0.70 (CM ratio)
$270,000
81,000
189,000
170,800
$ 18,200
$410,000
123,000
287,000
170,800
$ 116,200
Req. 2
Breakeven sales
$170,800 + $0
1 0.30
$170,800 + $0
0.70
= $244,000
Fixed expenses
Contribution margin ratio
$24,000
Contribution margin ratio
$24,000
$48,000
= .50
Next, fill in the given data in the contribution margin income statement:
Sales.
Less: Variable expenses.
Contribution margin.
Less: Fixed expenses..
Operating income..
7-12
$
?
42,000
?
24,000
$
?
Chapter 7
Cost-Volume-Profit Analysis
(continued) E7-18A
Because the contribution margin ratio
50% of sales revenue. Therefore:
Variable expenses
$ 42,000
$ 84,000
Or alternatively:
Sales $42,000
Sales 50% Sales
50% Sales
Sales
Sales
=
=
=
=
50% Sales
$42,000
$42,000
$42,000
50%
$84,000
Once sales revenue is found, the rest of the income statement follows:
Sales.
$ 84,000
Less: Variable expenses.
42,000
Contribution margin.
$ 42,000
Less: Fixed expenses..
24,000
Operating income.
$ 18,000
Therefore, at the current level of operations, the companys sales revenue is $84,000 and its
operating income is $18,000.
$1.80
0.90
$0.90
$0.90
$1.80
0.50
Req. 2
Breakeven sales in units
=
=
= 100,000 packages
=
=
= $180,000
7-13
(continued) E7-19A
Req. 3
Sales in units
=
=
= 120,000 packages
=
=
$1.80
0.80
$1.00
= 123,000 packages
The company would have to sell 3,000 more packages of socks (123,000 120,000 from E719A) to earn $18,000 of operating income. The increase in fixed costs was not completely offset
by the decrease in variable costs at the prior target profit volume of sales. Therefore, the
company will need to sell more units in order to achieve its target profit level.
7-14
Chapter 7
Req. 1
Contribution
margin ratio
=
=
=
Breakeven sales
in dollars
Cost-Volume-Profit Analysis
$5.25 $2.10
$5.25
0.60
Fixed expenses + Operating income
Contribution margin ratio
=
=
=
$7,500 + $0
0.60
$12,500
Req. 2
If franchisees require a monthly operating income of $7,500
Target sales
Fixed expenses + Operating income
=
in dollars
Contribution margin ratio
=
=
$7,500 + $7,050
0.60
$24,250
Yes, the franchising concept is a good idea. Most locations are expected to sell more ($25,000)
than the sales required to earn the target profit ($24,250).
7-15
=
=
=
$630,000 + $0
0.70
$900,000
Req. 2
Grovers Steel Parts
Operating Income Projections
at Different Sales Levels
Sales revenue
$ 520,000
Contribution margin ratio
0.70
Contribution margin
364,000
Less: Fixed expenses
630,000
Operating income (loss)
$(266,000)
$1,010,000
0.70
707,000
630,000
$ 77,000
Req. 3
Yes, the income projections at the two different sales levels make sense given the breakeven
sales level ($900,000) computed in Req. 1. Req. 2 shows that if the companys revenue is only
$520,000 (short of the revenue required to breakeven) the company incurs a loss. On the other
hand, if revenue is $1,010,000 (higher than the revenue required to breakeven), the company
earns a profit.
=
=
=
Req. 2
Fixed expenses + Operating income
Contribution margin ratio
Sales in dollars
$1,010,000
$404,000
$327,000
Fixed expenses
Fixed expenses can only be $327,000 to maintain the prior profit level of $77,000 per month.
Therefore, Grover will have to save at least $303,000 per month in fixed costs ($630,000
$327,000) by moving operations overseas if he plans to maintain his prior profit level.
7-16
Chapter 7
Cost-Volume-Profit Analysis
Req. 1
(Fixed expenses + Operating income) / CM per unit = Breakeven in units
($240,000 + $0) / ($2,400 - $1,000 - $200) = 200 units
7-17
$350,000
$350,000 .20
Fixed expenses
$70,000
Fixed expenses
After buying the equipment, the companys fixed expenses will be $125,000 ($70,000 +
$55,000 increase). Calculate breakeven (in sales) at the new level of fixed expenses:
Fixed expenses
Sales needed to breakeven
=
Contribution margin ratio
=
=
$125,000
.20
$625,000
The company will now have to generate $625,000 of sales revenue to breakeven.
$24.00
.625
$15.00
Find the number of scarves needed to breakeven on (or pay for) the extra entrance fee cost of $120 (= $1,200 10%
increase):
Fixed expenses
Breakeven in units
=
Contribution margin per unit
Alternatively:
Breakeven in sales revenue
$120
$15.00
8 scarves
Fixed expenses
Contribution margin ratio
=
=
$120
.625
Chapter 7
Cost-Volume-Profit Analysis
Oak
$35.00
10.00
$25.00
1
$25.00
Total
5
$75.00
$15.00
$300 + $0
$15
= 20 units
Breakeven sales of twig stands (20 4/5)
Breakeven sales of oak stands (20 1/5).
16 units
4 units
By charging her husband part of the craft fair entrance fees, the wifes fixed costs will decrease.
Therefore, the wife will need to sell fewer scarves to breakeven than before her husband
decided to share her craft booths.
Total
5
$ 85
$ 17
=
=
$18,700 + $0
$17
= 1,100 units
Breakeven sales of standard scooters (1,100 3/5)
Breakeven sales of chrome scooters (1,100 2/5)...
660 units
440 units
7-19
(continued) E7-29A
$18,700 + $13,600
$17
= 1,900 units
Target sales of standard scooters (1,900 3/5)........
Target sales of chrome scooters (1,900 2/5)............................
1,140 units
760 units
Classic
215
3
645
Sales in
total units
2,100
$195,000 + $36,000
Weighted-average contribution margin per unit
Weighted-average
contribution
margin per unit
=
=
7-20
Digital
$225
160
65
x7
$455
$231,000
2,100
$110 / unit
Total
10
1,100
$ 110
Chapter 7
Cost-Volume-Profit Analysis
(continued) E7-30A
b
Weighted-average
contribution
margin per unit
Contribution
margin per
Classic watch
$455 + X
10
$110
$1,100
$455 + X
$645
$645
$215
Contribution margin
per Classic watch
5,712,000
6,800,000
=
=
$6,800,000
1,088,000
5,712,000
1,512,000
$4,200,000
84%
Req. 3
Breakeven in sales dollars
1,512,000
84%
=
=
$1,800,000
Req. 4
If the company embarks on this advertising campaign, sales revenue and variable costs will rise
by 14%, which will cause the contribution margin to increase by 14%. Fixed costs will rise by
only $250,000 due to the advertising campaign. Overall operating income will increase by
$549,680 See the computations to follow.
The change in operating income can be computed as follows:
Current contribution margin
Percentage increase
Increase in contribution margin
Less: Increase in fixed costs of advertising campaign
Increase in operating income
$5,712,000
14%
799,680
250,000
$549,680
7-21
1.00 0.60
0.40
=
=
Target sales in dollars
Margin of safety
Req. 2
Margin of safety as
a percentage of target sales
$12,000 + $0
0.40
$30,000
Fixed expenses + Operating income
Contribution margin ratio
=
=
$12,000 + $20,000
0.40
$32,000
0.40
$80,000
$80,000 $30,000
$50,000
$50,000
$80,000
$80,000
.40
$32,000
12,000
$20,000
=
Contribution margin
Operating income
$32,000
$20,000
1.60
Req. 4
If volume decreases 12%, operating income will decrease 19.20% (operating leverage factor of
1.60 multiplied by 12%).
7-22
Chapter 7
Cost-Volume-Profit Analysis
$60,000
.35
$21,000
$21,000
Operating income
Operating income
$21,000
1.40
Operating income
= $15,000
1.40
7-23
$ 3,000
0
$ 3,000
$ 1,650
750
$ 2,400
The more attractive lease option is Option B because it results in the lowest total lease costs.
Req. 2
To solve the question, you need to set the costs of Option A equal to the costs of Option B:
$3,000 = $1,650 + (10% x $30 x CANDLES)
Then solve for CANDLES:
CANDLES = 450
Req. 3
The lease option that is more attractive for the company if the company plans to sell 600
candles a month is option A, the fixed lease payment because the sales volume is more than
the indifference point.
7-24
Chapter 7
Req. 1
Breakeven in units
Fixed expenses
Contribution margin per unit
=
=
=
Req. 2
2a.
2b.
Cost-Volume-Profit Analysis
Selling price
Less: variable cost
per unit
CM per unit
$600
$30*
20 grooming kits
$62
$32
$30
=
=
$600 + $900
$30
$1,500
$30
50 grooming kits
50 units x $62/each
$3,100
2c.
Condensed Income Statement
Sales
Less: variable expenses (50 x
$32)
$3,100
Contribution margin
$1,500
$600
Operating income
$900
$1,600
7-25
(continued) E7-35A
Req. 3
Margin of safety in dollars:
Sales at target level:
Sales at B/E level:
Margin of safety in dollars
Margin of safety in units:
Sales at target level:
Sales at B/E level:
Margin of safety in units
Margin of safety in %:
Margin of safety in dollars:
Sales at target level:
$1,860/$3,100 =
$3,100
$1,240*
$1,860
50
20
30
$1,860
$3,100
60.00%
7-26
Chapter 7
Cost-Volume-Profit Analysis
Per Unit
$81,250
$25
100%
48,750
15
60%
Contribution Margin
$32,500
$10
40%
13,000
Operating income
$19,500
=
=
$13,000
$10
1,300 units
2b.
Breakeven sales in dollars
Fixed expenses
Contribution margin per unit
=
=
=
Req. 3
3a.
Sales in units to reach desired
profit
$13,000 + $53,000
$10
$66,000
$10
6,600 units
7-27
(continued) E7-36A
3b.
Budgeted Sales Units
3,250
1,300
1,950
3c.
Budgeted Sales
$81,250
$32,500
$48,750
$48,750
$81,250
Margin of Safety %
60.0%
$25.00
$18.00
$ 7.00
$7.00
$25.00
.28
28%
$ 3,500,000
(2,520,000)
$ 980,000
2.
170,000
x $7.00
$1,190,000
(739,200)
$450,800
3.
Sales revenue
Contribution margin ratio..
Contribution margin
Less: fixed expenses.
Operating income.
$4,500,000
x
28%
$1,260,000
(739,200)
$ 520,800
4.
7-28
$739,200
$7.00
$739,200
28%
105,600
units
$2,640,000
Chapter 7
Cost-Volume-Profit Analysis
7-29
(continued) E7-37A
5.
6.
$739,200 + $269,500
$7.00
$0.60
$6.40
$739,200
24,000
$763,200
$763,200
$6.40
8.
Increase in volume..
Operating leverage factor..
New fixed expenses
9.
Margin of safety
$ 240,800
=
Margin of safety as a percentage
=
$860,000
$3,500,000
16 GB
$25
18
$ 7
6
$42
.25
(rounded
)
32 GB
Total
$50
22
$28
1
$28
7
$70
4.07
= (rounde
d)
$980,000
8%
4.07
32.6%
(rounded)
Sales price..
Less: Variable cost..
Contribution margin.
Sales mix.
Multiply by: Contribution margin.
119,250
Units
$980,000
(739,200)
$ 240,800
=
$739,200 + $269,500
$10
7-30
10.
$7.00
144,100 units
25%
= (rounded
)
$10.00
100,870
units
86,460 units
(rounded)
14,410 units
(rounded)
Chapter 7
Cost-Volume-Profit Analysis
The target profit volume is lower than before (Req. 5) because now the company is selling a
product with a much higher unit contribution margin.
Exercises (Group B)
(15 min.) E7-38B
Req. 1
Contribution Margin Income Statements
Sales revenue
Less: Variable expenses (35% of sales revenue*)
Contribution margin (65% of sales
revenue**)
Fixed expenses
Operating income (loss)
__________
*$192,500 / $550,000 = 0.35
**$357,500 / $550,000 = 0.65 (CM ratio)
$190,000
66,500
123,500
176,800
$ (53,300)
$420,000
147,000
273,000
176,800
$ 96,200
Req. 2
Breakeven sales
$176,800 + $0
1 0.35
$176,800 + $0
0.65
= $272,000
7-31
Fixed expenses
Contribution margin ratio
$30,000
Contribution margin ratio
$30,000
$40,000
= .75
Next, fill in the given data in the contribution margin income statement:
Sales.
Less: Variable expenses.
Contribution margin.
Less: Fixed expenses..
Operating income..
$
?
45,000
?
30,000
$
?
Because the contribution margin ratio is 75% of sales revenue, the variable expenses must be
25% of sales revenue. Therefore:
Variable expenses
$ 45,000
$180,000
=
=
=
Sales $45,000
Sales 75% Sales
25% Sales
Sales
=
=
=
=
Sales
75% Sales
$45,000
$45,000
$45,000
25%
$180,000
Or alternatively:
Once sales revenue is found, the rest of the income statement follows:
Sales.
Less: Variable expenses.
Contribution margin.
Less: Fixed expenses..
Operating income.
$180,000
45,000
$135,000
30,000
$ 105,000
Therefore, at the current level of operations, the companys sales revenue is $180,000, and its
operating income is $105,000.
7-32
Chapter 7
Cost-Volume-Profit Analysis
Req. 1
Contribution margin per unit:
Sale price......................................
Less: Variable expenses..................................
Contribution margin per unit....................
Contribution margin ratio:
Contribution margin per unit
Sale price per unit
$1.60
0.80
$0.80
$0.80
$1.60
0.50
Req. 2
Breakeven sales in units
=
=
= 100,000 packages
=
=
= $160,000
Req. 3
Sales in units
=
=
= 131,250 packages
=
=
$1.60
0.60
$1.00
= 120,000 packages
(continued) E7-41B
7-33
=
=
Breakeven sales
in dollars
$6.25 $2.50
$6.25
0.60
Fixed expenses + Operating income
Contribution margin ratio
=
=
=
$8,250 + $0
0.60
$13,750
Req. 2
If franchisees require a monthly operating income of $6,600
Target sales
Fixed expenses + Operating income
=
in dollars
Contribution margin ratio
=
=
$8,250 + $6,600
0.60
$24,750
No, the franchising concept is not a good idea. The sales required to earn the target profit
($24,750) are more than the expected sales generated ($24,000).
7-34
Chapter 7
Cost-Volume-Profit Analysis
Req. 1
Prior to changes, the average restaurant location had the following operating income:
Contribution margin per unit (from E7-42B)
$ 3.75
Average sales volume units
5,500
Contribution margin..
$20,625
Less: Fixed expenses.
(8,250)
Operating income...
$12,375
Req. 2
After the price cut and advertising fees, the average restaurant location will have the following
operating income:
New contribution margin per unit ($5.75 sales price
$2.50 variable cost.
New sales volume (units).
Contribution margin...
Less: New fixed expenses
($8,250 + $500 advertising fee)
New operating income..
$ 3.25
6,000
$19,500
(8,750)
$ 10,750
Assuming volume increases according to plan, cutting the sales price and advertising will allow
the franchise owners to reach their target profits of $6,600 per month.
=
=
=
Req. 2
Sales revenue
Contribution margin ratio
Contribution margin
Less: Fixed expenses
Operating income (loss)
$1,020,000
0.80
816,000
620,000
$ 196,000
Req. 3
Yes, the income projections at the two different sales levels make sense given the breakeven
sales level ($775,000) computed in Req. 1. Req. 2 shows that if the companys revenue is only
$520,000 (short of the revenue required to breakeven) the company incurs a loss. On the other
hand, if revenue is $1,020,000 (higher than the revenue required to breakeven), the company
earns a profit.
7-35
=
=
=
Req. 2
Sales in dollars
$1,020,000
$510,000
$314,000
Fixed expenses
Fixed expenses can only be $314,000 to maintain the prior profit level of $196,000 per month.
Therefore, the company will have to save at least $306,000 per month in fixed costs ($620,000
$314,000) by moving operations overseas if it plans to maintain its prior profit level.
(continued) E7-46B
7-36
Chapter 7
Cost-Volume-Profit Analysis
Req. 5
However, the new control system would reduce waste and contribute to the companys
sustainability objective. The company should take into account not only the financial measures
such as operating income, breakeven point, and operating leverage, but also the sustainability
impact of the decision.
Student answers may vary.
$500,000
$500,000 .50
Fixed expenses
$250,000
Fixed expenses
Fixed expenses
.50
After buying the equipment, the companys fixed expenses will be $300,000 ($250,000 +
$50,000 increase). Calculate breakeven (in sales) at the new level of fixed expenses:
Sales needed to breakeven
Fixed expenses
Contribution margin ratio
=
=
=
$300,000
.50
$600,000
The company will now have to generate $600,000 of sales revenue to breakeven.
$14.00
.625
$8.75
Find the number of scarves needed to breakeven on (or pay for) the extra entrance fee cost of
$350 (= $1,400 25% increase):
Fixed expenses
Breakeven in units
=
Contribution margin per unit
=
=
$350
$8.75
40 scarves
7-37
(continued) E7-48B
Fixed expenses
Contribution margin ratio
=
=
$350
.625
Oak
$38.00
8.00
$30.00
1
$30.00
Total
5
$90.00
$18.00
=
=
$360 + $0
$18
= 20 units
Breakeven sales of twig stands (20 4/5)
Breakeven sales of oak stands (20 1/5).
16 units
4 units
By charging her husband part of the craft fair entrance fees, the wifes fixed costs will decrease.
Therefore, the wife will need to sell fewer scarves to breakeven than before her husband
decided to share her craft booths.
7-38
Chapter 7
Cost-Volume-Profit Analysis
Total
5
$70
$ 14
$9,800 + $0
$14
= 700 units
Breakeven sales of standard scooters (700 3/5)
Breakeven sales of chrome scooters (700 2/5)...
420 units
280 units
$9,800 + 8,400
$14
= 1,300 units
Target sales of standard scooters (1,300 3/5)........
Target sales of chrome scooters (1,300 2/5).........................
780 units
520 units
7-39
2,200
$200,000 + $75,000
Weighted-average contribution margin per unit
$275,000
2,200
Weighted-average
contribution
margin per unit
Contribution margin
per Classic watch
$125 / unit
Total sales mix contribution margin
Total sales mix units
$640 + X
10
$125
$1,250
$640 + X
$610
$610
$305
10
1,250
$ 125
Contribution
margin per
Classic watch
7-40
305
2
610
Total
Sales in
total units
Weighted-average
contribution
margin per unit
Classic
Chapter 7
Cost-Volume-Profit Analysis
$6,100,000
1,342,000
4,758,000
1,248,000
$3,510,000
Req. 2
Contribution margin ratio
=
Req. 3
Breakeven in sales dollars
$4,758,000
$6,100,000
78%
$1,248,000
78%
= $1,600,000
The company will have to generate $1,600,000 in sales in order to break even.
Req. 4
If the company embarks on this advertising campaign, sales revenue and variable costs will rise
by 16%, which will cause the contribution margin to increase by 16%. However, fixed costs will
rise by $260,000 dollars due to the advertising campaign.
The change in operating income can be computed as follows:
Current contribution margin
Percentage increase
Increase in contribution margin
Less: Increase in fixed costs of advertising campaign
Increase in operating income
$4,758,000
16%
761,280
260,000
$501,280
7-41
1.00 0.40
0.60
=
=
Target sales in dollars
Req. 2
Margin of safety as
a percentage of target sales
$7,500 + $0
0.60
$12,500
$7,500 + $30,000
0.60
Margin of safety
$37,500
0.60
$62,500
$62,500 $12,500
$50,000
$50,000
$62,500
$62,500
.60
$37,500
7,500
$30,000
=
Contribution margin
Operating income
$37,500
$30,000
1.25
Req. 4
If volume decreases 12%, operating income will decrease 15.0% (operating leverage factor of
1.25 multiplied by 12%).
Chapter 7
Sales
Contribution margin ratio..
Contribution margin
Cost-Volume-Profit Analysis
$45,000
.20
$ 9,000
$9,000
Operating income
Operating income
$9,000
1.60
Operating income
= $5,625
1.60
16
$ 3,600
0
$ 3,600
$ 990
1,710
$2,700
The more attractive lease option is Option B because it results in the lowest total lease costs.
Req. 2
To solve the question, you need to set the costs of Option A equal to the costs of Option B:
$3,600 = $990 + (20% x $45 x CANDLES)
Then solve for CANDLES:
CANDLES = 290
Req. 3
The lease option that is more attractive for the company if the company plans to sell 490
candles a month is option A, the fixed lease payment because the sales volume is more than
the indifference point.
Lease costs under option A: #3,600
Lease costs under option B: $990 + (20% x $45 x 490) = $5,400
Fixed expenses
Contribution margin per unit
7-43
Req. 2
2a.
2b.
Selling price
Less: variable cost
per unit
CM per unit
$720
$40*
18 grooming kits
$73
$33
$40
Fixed expenses + Operating Income
Contribution margin per unit
=
=
$720 + $1,080
$40
$1,386
$40
45 grooming kits
45 units x $73/each
$3,285
2c.
Condensed Income Statement
Sales (45 x $73)
Less: variable expenses (45 x
$33)
$3,285
Contribution margin
$1,800
7-44
$1,485
$720
$1,080
Chapter 7
Cost-Volume-Profit Analysis
(continued) E7-56B
Req. 3
Margin of safety in dollars:
Sales at target level
Sales at B/E level:
($720 / 40) x $73
Margin of safety in dollars
$3,285
$1,314
$1,971
45
18
27
Margin of safety in %:
Margin of safety in dollars:
Sales at target level:
$1,971/ $3,285
$1,971
$3,285
60.0%
Per Unit
$115,000
$50
100%
57,500
25
50%
Contribution Margin
$57,500
$25
50%
11,500
Operating income
$46,000
7-45
(continued) E7-57B
Req. 2
2a.
Breakeven in units
Fixed expenses
Contribution margin per unit
$11,500
$25
460 units
2b.
Breakeven sales in dollars
=
=
=
Req. 3
3a.
=
=
$11,500 + $58,000
$25
$69,500
$25
2,780 units
3b.
Budgeted Sales Units
2,300
460
1,840
3c.
Budgeted Sales
$115,000
$23,000
$92,000
3d.
Margin of Safety in Dollars
Divided by Budgeted Sales Dollars
Margin of Safety %
7-46
$92,000
$115,000
80.0%
Chapter 7
Cost-Volume-Profit Analysis
$25.00
$22.00
$ 3.00
$3.00
$25.00
.12
12%
$ 2,500,000
(2,200,000)
$ 300,000
2.
130,000
x $25.00
$390,000
(288,900)
$101,100
3.
Sales revenue
Contribution margin ratio..
Contribution margin
Less: Fixed expenses ($121,800+$167,100)
Operating income
$4,000,000
x
12%
$480,000
(288,900)
$ 191,100
4.
5.
$288,900
$3.00
$288,900
12%
$288,900 + $260,100
$3.00
=
=
96,300
units
$2,407,500
183,000 units
7-47
(continued) E7-58B
6.
$3.00
$0.80
$2.20
$288,900
23,500
$312,400
$312,400
$2.20
8.
Increase in volume..
Operating leverage factor..
New fixed expenses
9.
Margin of safety
$300,000
$11,100
92,500
2,500,000
.037
32 GB
$50
27
$23
1
$23
$121,800 + $167,100 +
$260,100
$5.00
3.7%
Total
10
$50
27.03
(rounded)
3%
27.03
81.1%
(rounded)
Sales price..
Less: Variable cost..
Contribution margin.
Multiply by: Sales mix.
Contribution margin.
$300,000
(288,900)
$11,100
=
10.
142,000
Units
$5.00
109,800 units
=
98,820 units
10,980 units
The target profit volume is lower than before (Req. 5) because now the company is selling a
product with a much higher unit contribution margin.
7-48
Chapter 7
Cost-Volume-Profit Analysis
Problems (Group A)
(30-45 min.) P7-59A
Req. 1
Cost-Volume-Profit Analysis
Companies Q, R, S, T
Target sales
Less: Variable expenses
Less: Fixed expenses
Operating income
Units sold
Contribution
per unit
margin
Q
$625,000
125,000
370,000
$130,000
80,000
$
COMPANY
R
$445,000
178,000
159,000
$ 108,000
106,800
6.25
Contribution margin
0.80
ratio
Computations (top to bottom for each company)
Q:
2.50
S
$236,000
118,000
94,000
$ 24,000
12,500
$
0.60
9.44
0.50
T
$780,000
156,000
493,000
$131,000
16,000
$
39.00
0.80
R:
S:
7-49
(continued) P7-59A
T:
Req. 2
Breakeven Sales:
Q
B/E
$370,000
0.80
$462,500
R:
B/E
$159,000
0.60
$265,000
S:
B/E
$94,000
0.50
$188,000
Lowest breakeven point
T:
B/E
$493,000
0.80
$616,250
Company Ss low breakeven point is primarily due to its low fixed expenses.
$66,000
$ 10,800
19,200
$30,000
7-50
Chapter 7
Cost-Volume-Profit Analysis
(continued) P7-60
Sales revenue
Variable expenses
Fixed expenses
Operating income
Operating income
$0
Revenue
per
show
Number
of
shows
Variable
Number
exp. per
of
Fixed expenses
show
shows
$66,000
Number
of
shows
$30,000
Number
of
$969,000
shows
= $1,224,000
=
=
=
$1,224,000
$1,224,000
$36,000
34 shows
= $66,000 $30,000
= $36,000
Fixed expenses + Target operating income
Contribution margin per unit
$1,224,000 + $3,888,000
$36,000
$5,112,000
$36,000
= 142 shows
This profit goal is unrealistic since the show currently performs 115 times a year.
Req. 4
Fiddler on the Roof
Contribution Margin Income Statement
For the Year Ended December 31
Sales revenue (115 $66,000)
Less: Variable expenses (115 $30,000)
Contribution margin
Less: Fixed expenses
Operating income
$7,590,000
3,450,000
4,140,000
1,224,000
$2,916,000
7-51
Variable expenses
Variable
cost
per unit
Units sold
Fixed expenses
= Operating income
Fixed expenses
= Operating income
= $0
= $1,095,000
= $1,095,000
=
$1,095,000
$10.00
= 109,500 cartons
= $2,300,000
Req. 3
Team Spirit Calendars
Contribution Margin Income Statement
Month Ended June 30
Sales revenue (450,000 $16.50)
Less Variable expenses:
Cost of goods sold (450,000 $6.50 0.68)
$1,989,250
Operating expenses (450,000 $3.50 0.32)
936,000
Contribution margin
Less: Fixed expenses
Operating income
7-52
$7,425,000
2,925,000
4,500,000
1,095,000
$3,405,000
Chapter 7
Req. 4
Margin of
Margin of
Margin of
Margin of
Cost-Volume-Profit Analysis
(continued) P7-61A
safety
safety
safety
safety
=
=
=
=
Req. 5
If volume increases 16%, then operating income will increase 21.15% (operating leverage factor
of 1.322 multiplied by 16%).
Proof:
Original volume (cartons).....
450,000
Add: Increase in volume (16% 450,000)
72,000
New volume (cartons)...
522,000
Multiplied by: Unit contribution margin
$10.00
New total contribution margin
$5,220,000
Less: Fixed expenses.
(1,095,000)
New operating income.
$4,125,000
vs. Operating income before change in
volume..
3,405,000
Increase in operating income.
$ 720,000
Percentage change ($720,000 / $3,405,000)
21.15% (rounded)
0.03
$9,000 + $0
0.75
= $12,000
Breakeven sales in units =
(trades)
$12,000
$500
= 24 trades
(continued) P7-62A
Req. 2
Copyright 2015 Pearson Education, Inc.
7-53
Target operating
income
$14,250
0.75
Req. 4
Breakeven sales in dollars (from Req. 1)
$12,000
$12,000
$300
40 trades
The decrease in the average trade revenue increases the breakeven point from 24 to 40 trades.
Total
Chapter 7
Sales price per unit
Less: Variable expense per unit
Contribution margin per unit
Multiply by: Sales mix in units
Contribution margin per unit
Cost-Volume-Profit Analysis
$3.00
1.50
$1.50
3
$4.50
$5.00
2.50
$2.50
1
$2.50
4
$7.00
$1.75
$28,000 + $0
$1.75
16,000 units
12,000 units
4,000 units
Proof:
Westlake Coffee
Contribution Margin Income Statement
Month Ended February 29
Sales revenue [(12,000 $3) + (4,000 $5)]
Less: Variable expenses [(12,000 $1.50) + (4,000 $2.50)]
$56,000
28,000
28,000
28,000
$
0
Contribution margin
Less: Fixed expenses
Operating income
Req. 2
Margin of safety
Margin of safety
$126,000 $56,000*
=
$70,000
*Breakeven sales from proof in Req. 1.
7-55
(continued) P7-63A
= Contribution Margin
Operating income
= $63,000
$35,000
= 1.80
A 15% increase in volume will lead to 27% increase in operating income (15% multiplied by the
operating leverage factor of 1.80). Therefore, the new operating income will be $44,450
($35,000 old operating income 1.27).
Proof:
Westlake Coffee
Effect on Operating Income of 15% Increase in Sales Volume
Increase in sales revenue ($126,000 0.15)
$18,900
Increase in variable expenses ($63,000 0.15)
9,450
9,450
0
35,000
$44,450
Alternatively,
Westlake Coffee
Effect on Operating Income of 15% Increase in Sales Volume
Sales revenue ($126,000 1.15)
$144,900
Variable expenses ($63,000 1.15)
72,450
Contribution margin
72,450
Fixed expenses
28,000
Operating income
7-56
$ 44,450
Chapter 7
Cost-Volume-Profit Analysis
Problems (Group B)
(30-45 min.) P7-64B
Req. 1
Cost-Volume-Profit Analysis
Companies Q, R, S, T
Q
$757,500
242,400
340,000
$ 175,100
85,000
Target sales
Less: Variable expenses
Less: Fixed expenses
Operating income
Units sold
Contribution
per unit
margin
Contribution
ratio
margin
COMPANY
R
$445,000
178,000
159,000
$ 108,000
106,800
6.06
0.68
2.50
S
$162,500
32,500
81,000
$ 49,000
15,625
$
0.60
8.32
0.80
T
$1,000,000
360,000
488,000
$152,000
20,000
$
32.00
0.64
R:
S:
7-57
(continued) P7-64B
T:
Req. 2
Breakeven Sales:
Q:
B/E
$340,000
0.72
$500,000
R:
B/E
$159,000
0.60
$265,000
S:
B/E
$81,000
0.80
$101,250
$488,000
0.64
T:
B/E
$762,500
Company Ss low breakeven point is primarily due to its low fixed expenses.
$91,000
$ 8,400
20,800
$29,200
7-58
Chapter 7
Cost-Volume-Profit Analysis
(continued) P7-65B
Req. 2
Sales revenue
Variable expenses
Fixed expenses
Operating income
Operating income
$0
Revenue
Number
per
of
show
shows
Variable
Number
exp. per
of
Fixed expenses
show
shows
Number
of
shows
$29,200
$91,000
Number
of
$2,163,000
shows
$2,163,000
$2,163,500
=
=
$2,163,500
$61,800
35 shows
= $91,000 $29,200
= $61,800
Fixed expenses + Target operating income
Contribution margin per unit
$2,163,000 + $3,708,000
$61,800
$5,871,000
$61,800
= 95 shows
This profit goal is realistic. The show already performs 100 times a year.
Req. 4
Wicked
Contribution Margin Income Statement
For the Year Ended December 31
Sales (100 x $91,000)
Less: Variable expenses (100 $29,200)
Contribution margin
Less: Fixed expenses
Operating income
$9,100,000
2,920,000
6,180,000
2,163,000
$4,017,000
7-59
Sales Revenue
Sale
price Units sold
per
unit
Variable expenses
Variable
cost
per unit
Units sold
Fixed expenses
= Operating income
Fixed expenses
= Operating income
= $0
= $1,125,000
= $1,115,000
=
$1,125,000
$15.00
= 75,000 cartons
Req. 2
Contribution margin = $19.50 $4.50
= $15.00
Contribution margin ratio = $15.00 / $19.50
= 0.77 (rounded)
Target sales in dollars =
Target sales in dollars =
=
= $1,900,000
Req. 3
Dudley Calendars
Contribution Margin Income Statement
Month Ended June 30
Sales revenue (475,000 $19.50)
Less variable expenses:
Cost of goods sold (475,000 $4.50 0.74)
$1,581,750
Operating expenses (475,000 $4.50 0.26)
555,750
Contribution margin
Less: fixed expenses
Operating income
7-60
$9,262,500
2,137,500
7,125,000
1,125,000
$6,000,000
Chapter 7
Req. 4
Margin of
Margin of
Margin of
Margin of
Cost-Volume-Profit Analysis
(continued) P7-66B
safety
safety
safety
safety
=
=
=
=
Req. 5
If volume increases 13%, then operating income will increase 15.44% (operating leverage factor
of 1.188 multiplied by 13%).
Proof:
Original volume (cartons)..
Add: Increase in volume (13% 475,000)
New volume (cartons)
Multiplied by: Unit contribution margin
New total contribution margin
Less: Fixed expenses
New operating income
vs. Operating income before change in
volume.
Increase in operating income
Percentage change ($926,250 / $6,000,000)
475,000
61,750
536,750
$15.00
$8,051,250
(1,125,000)
$6,926,250
6,000,000
$ 926,250
15.43% (rounded)
7-61
0.02
$6,000 + $0
0.60
= $10,000
Breakeven sales in units =
(trades)
$10,000
$500
= 20 trades
Req. 2
Sales revenue Variable expenses Fixed expenses
Target operating
income
$11,400
0.60
7-62
Chapter 7
Cost-Volume-Profit Analysis
(continued) P7-67B
Req. 3
Req. 4
$10,000
$10,000
$400
25 trades
The decrease in the average trade revenue increases the breakeven point from 20 to 25 trades.
7-63
Req. 1
Margot Coffee
Weighted-Average Contribution Margin per Unit
Small
Large
Sale price per unit
$3.00
$5.00
Less: Variable expense per unit
1.50
2.50
Contribution margin per unit
$1.00
$2.50
Multiply by: Sales mix in units
3
1
Contribution margin per unit
$4.50
$2.50
Weighted-average contribution margin per unit ($5.00 / 4
units)
Breakeven sales in total units:
Fixed expenses + Operating income
Weighted-average contribution
margin per unit
Total
4
$7.00
$1.75
$42,000 + $0
$1.75
24,000 units
18,000 units
6,000 units
Proof:
Margot Coffee
Contribution Margin Income Statement
Month Ended February 29
Sales revenue [(18,000 $3) + (6,000 $5)]
Less: Variable expenses [(18,000 $1.50) + (6,000 $2.50)]
Contribution margin
Less: Fixed expenses
Operating income
Req. 2
Margin of safety
Margin of safety
$154,000 $84,000*
$84,000
42,000
42,000
42,000
$
0
=
$70,000
*Breakeven sales from proof in Req. 1.
Req. 3
Operating leverage factor:
= Contribution margin
Operating income
= $77,000
$35,000
= 2.2
A 15% increase in volume will lead to 33% increase in operating income (15% multiplied by the
operating leverage factor of 2.2). Therefore, the new operating income will be $46,550
($35,000 old operating income 1.33).
7-64
Chapter 7
Cost-Volume-Profit Analysis
(continued) P7-68B
Proof:
Margot Coffee
Effect on Operating Income of 15% Increase in Sales Volume
Increase in sales revenue ($154,000 0.15)
$23,100
Increase in variable expenses ($77,000 0.15)
11,550
11,550
0
35,000
$46,550
Alternatively,
Hemingway Coffee
Effect on Operating Income of 15% Increase in Sales Volume
Sales revenue ($154,000 1.15)
$177,100
Variable expenses ($77,000 1.15)
88,550
Contribution margin
88,550
Fixed expenses
42,000
Operating income
$ 46,550
7-65
3. The purchasing manager for Rockwell Fashion Bags has been able to purchase the
material for its signature handbags for $2 less per bag. Keeping everything else
the same, what effect would this reduction in material cost have on the breakeven
point for Rockwell Fashion Bags? Now assume that the sales manager decides to
reduce the selling price of each handbag by $2. What would the net effect of both
of these changes be on the breakeven point in units for Rockwell Fashion Bags?
A decrease in the material costs, and keeping everything else the same, would lower the
variable expenses for each handbag, which would increase the contribution margin per bag.
This would, in turn, lower the breakeven point. If the manager reduces the selling price by
$2 along with the $2 decrease in variable costs, the contribution margin would stay the
same and so would the breakeven point.
4. Describe three ways that cost-volume-profit concepts could be used by a service
organization.
C-V-P can be used by a service organization to help them determine:
1. the breakeven point
2. the volume needed to reach target profit and
3. how changes in costs, sales price, and volume affect the companys profit.
5. Breakeven analysis isnt very useful to a company because companies need to
do more than break even to survive in the long run. Explain why you agree or
disagree with this statement.
Its true that companies need to do more than break even to survive in the long run, but
breakeven analysis allows the manager to see the level that must be reached to cover costs.
This becomes the starting point for determining target profits and analyzing how changes in
selling prices, costs, and volume will affect profits.
6. What conditions must be met for cost-volume-profit analysis to be accurate?
The following conditions must be met for C-V-P analysis to be accurate:
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The sales mix of products will not change. Sales mix is the combination of products that
make up total sales. If profits differ across products, changes in sales mix will affect CVP
analysis.
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Describe your product. What market are you targeting this product for? What
price will you sell your product for? Make projections of your sales in units over
each of the upcoming five years.
I make beaded necklaces for women who are interested in unique, yet affordable
accessories to their wardrobes. The necklaces will sell for an average of $100 each.
Sales Projections
2012
150
2.
2013
175
2014
200
1
25
10
30 inches
1
$15
$6
$3
$2
$1
$27
Make a list of all of the equipment you will need to make your product.
Estimate the cost of each piece of equipment that you will need.
Equipment
Tools
Storage boxes for materials
Beading boards
Miscellaneous supplies
TOTAL
4.
2016
250
Make a detailed list of all of the materials needed to make your product.
Include quantities needed of each material. Also include the cost of the material
on a per-unit basis.
Materials per Necklace
Pendants
Beads
Silver findings
Wire
Clasp
TOTAL
3.
2015
225
$100
$75
$50
$50
$275
Make a list of all other expenses that would be needed to create your product.
Examples of other expenses would be rent, utilities, and insurance. Estimate the
cost of each of these expenses per year.
Rent
Utilities
Insurance
TOTAL
$1,800
$120
$50
$1,970
Copyright 2015 Pearson Education, Inc.
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Fixed
Fixed
Fixed
6. Calculate how many units of your product you will need to sell to breakeven in
each of the five years you have projected.
Fixed expenses / Unit contribution margin = Unit breakeven point
$1,850 / ($100 - $27) = 26 necklaces
7.
Calculate the margin of safety in units for each of the five years in your
projection.
Margin of Safety = Projected Sales Breakeven Sales
2012
2013
2014
150-26=124
175-26=149
200-26=174
$15,000$17,500
$20,000
$2,600
$2,600
$2,600
$12,400
$14,900
$17,400
8.
2015
225-26=199
$22,500
$2,600
$19,900
2016
250-26=224
$25,000
$2,600
$22,400
Now decide how much you would like to make in before-tax operating income
(target profit) in each of the upcoming five years. Calculate how many units you
would need to sell in each of the upcoming years to meet these target profit
levels.
Fixed expenses + Target profit / Unit CM = Yearly sales volume
$1,850 + $12,000 / ($100 - $27) = 190 necklaces
9.
How realistic is your potential venture? Do you think you would be able to
break even in each of the projected five years? How risky is your venture (use the
margin of safety to help answer this question). Do you think your target profits
are achievable?
The venture looks realistic. The breakeven point is only 26 necklaces, which means I would
need to sell on average less than three necklaces a month. The margin of safety is
promising as long as the projected sales can be made. The target profits appear achievable,
but will require implementing a solid marketing plan.
Student answers will vary.
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