Basic Cost-Volume Profit (CVP) Analysis Stratford Company distributes a lighweight lawn chair that sells for $15

per unit. Variable costs are $6 per unit, and fixed costs Required: Answer the following independent questions: 1. What is the products CM ratio? 2. Use the CM ratio to determine the break-even point in sales dollars. 3. The company estimates that sales will increase by $45,000 during the coming year due to increased demand. By how much 4. Assume that the operating results for last year were as follows: Sales $360,000 Variable Expenses 144,000 Contribution Margin Fixed expenses Net Operating Income $216,000 180,000 $ 36,000

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

5. Refer to the original data. Assume that the company sold 28,000 units last year. The sales manager is convinced that a

SOLUTION TO PROBLEM NO.:1:

REQUIREMENT NO.:1: PRODUCT'S CM RATIO: Selling price per unit less:Variable cost per unit CONTRIBUTION PER UNIT Contribution margin ratio = Contribution margin per unit/Selling price per unit REQUIREMENT NO.:2: Break-even point in total sales dollars= Fixed expenses/CM ratio Fixed expenses CM ratio Break-even point in total sales dollars REQUIREMENT NO.:3: Increase in sales less:Variable cost($45,000/$15)*$6 Increase in net operating income REQUIREMENT NO.:4: Sales less:Variable expenses Contribution Margin Fixed expenses Net Operating Income Degree of Operating Leverage= Contribution Margin/Net Income Increase in sales @15% Increase in variable expenses @15% INCREASE IN NET OPERATING INCOME $ $ $ $ $ 360,000 144,000 216,000 180,000 36,000 6 $ $ $ 54,000 21,600 32,400 $ $ $ 45,000 18,000 27,000 $ $ 180,000 60% 300,000 $ $ $ 15 6 9

60%

REQUIREMENT NO.:5: INCOME STATEMENT BASED ON RESULTS OF LAST YEAR OPERATIONS Sales in units 28,000 Selling price per unit $ 15 Sales $ 420,000 less:Variable expenses @ $6 per unit $ 168,000 CONTRIBUTION MARGIN $ 252,000

less:Fixed Expenses NET OPERATING INCOME

$ $

180,000 72,000

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

$ $

$ $ $ $ $

315,000 252,000 63,000 70,000 (7,000) COMPARATIVE INCOME STATEMENTS PRESENT 28,000 UNITS EXPECTED 42,000 UNITS TOTAL PER UNIT TOTAL PER UNIT 420,000 $ 15 $ 567,000 $ 13.50 168,000 $ 6 $ 252,000 $ 6 252,000 $ 9 $ 315,000 $ 7.50 180,000 $ 250,000 72,000 $ 65,000

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

$ $ $ $ $

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

$ $ $ $ $

DIFFERENCE 147,000 84,000 63,000 70,000 (7,000)

Basics of CVP Analysis: Cost Structure

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

Required: 1. Compute the companys CM ratio and its break-even point in both units and dollars 2. The sales manager feels that an $8,000 increase in the monthly advertising budget, combined with an intensified effort by the sales staff, w 3. Refer to the original data. The president is convinced that a 10% reduction in the selling price, combined with an increase of $35,000 in t 4. Refer to the original data. The companys advertising agency thinks that a new package would help sales. The new package being propos 5. Refer to the original data. By automating certain operations, the company could slash its variable expenses in ahlf. However, fixed costs a. Compute the new CM ratio and the new break-even point in both units and dollars. b. Assume that the company expects to sell 20,000 units next month. Prepare two contribution format income statements, one assuming th c. Would you recommend that the company automate its operations? Explain. SOLUTION TO PROBLEM NO.:2:
Sales (13,500 units @ $20 per unit) less:Variable expenses CONTRIBUTION MARGIN less:Fixed expenses NET OPERATING LOSS REQUIRMENT NO.:1: $ $ $ $ $ 270,000 189,000 81,000 90,000 (9,000)

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

30%

15000

300,000

REQUIRMENT NO.:2: Incremental increase in sales Incremental increase in contribution margin less: Incremental increase in advertising expense Incremental increase in net operating income REQUIRMENT NO.:3: INCOME STATEMENT BASED ON CHANGES PROPOSED BY THE PRESIDENT Sales in units(increase by 50%) Selling price (reduced by 10%) Unit contribution margin Sales less:Variable expenses CONTRIBUTION MARGIN less:Fixed expenses NET OPERATING LOSS 20250 18.00 5.40 364,500 255,150 109,350 125,000 (15,650) $ $ $ $ 70,000 21,000 8,000 13,000

$ $ $ $ $ $ $

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

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

17500 units

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

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

65%

16000

320,000

INCOME STATEMENT NO AUTOMATION Sales in units Selling price per unit Sales less:Variable expenses @ $14 per unit CONTRIBUTION MARGIN less:Fixed Expenses NET OPERATING INCOME INCOME STATEMENT AUTOMATION Sales in units Selling price per unit Sales less:Variable expenses @ $7 per unit CONTRIBUTION MARGIN less:Fixed Expenses NET OPERATING INCOME 20,000 20 400,000 140,000 260,000 208,000 52,000 $ $ $ $ $ $ 20,000 20 400,000 280,000 120,000 90,000 30,000

$ $ $ $ $ $

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