Cost-Volume-Profit

Analysis

Chapter 8
Part 2 - CVP
Contemporary Engineering Economics
Illustration of Full Cost Concept
Unit Marginal Contribution

 Def: Difference
between the unit
sales price and the
unit variable cost

MC = Sales price – Variable

cost
Contribution Margin and Break-Even Sales
 Profit Function

Break-Even Volume (units)

marginal contribution

Break-Even Sales ($)

marginal contribution rate

Contemporary Engineering Economics, 6 th edition Copyright © 2016 by Pearson Education, Inc.

Park All Rights Reserved
 Break-Even Chart

$600
Point of Desired Profit
500
Desired Total Cost Line
400 Profit Cash Cost Line
)
(in thousands)

c iation
ep re
300 a d )- (D e
ATION Overhe
pe n se s E x pens
I
REC ring s Ex dmin
Dollars

DEPnufactu d Admin ng and A Overhead

200 a i
d M elling an iable Sell iable Mfg.
,
(F i xe
i xedS Var Var D i re ct Labor
F
100
Direct Material

10 18 20 30 40 50 60
Units of Product (in thousands)

Contemporary Engineering Economics, 6 th edition Copyright © 2016 by Pearson Education, Inc.

Park All Rights Reserved
 Useful Break-Even Sales Formulas

 Break-Even Formulas
WSales at break-even point for total cost:
Fixed costs F
QA = = ($)
Marginal Contribution Rate MCR

W Sales at break-even point for cash costs:

Fixed cost - Depreciation
QB = 0 QA
MCR QB

Sales Volume
W Sales required for desired pre-tax profit level:
F
Fixed costs + Desired Profit
QC =
MCR

Contemporary Engineering Economics, 6 th edition Copyright © 2016 by Pearson Education, Inc.

Park All Rights Reserved
Cost Data for Break-Even
Chart
Unit Variable Costs
Direct Materials $2.00
Direct Labor 1.00
Variable Manufacturing Overhead 1.00
Variable Selling and Administrative 1.00
Expenses
Total Unit Variable Cost $5.00

Fixed manufacturing overhead (including Depreciation of $10,000) = $70,000

Fixed Selling and Administrative Expenses = $30,000
Selling Price/Unit = $10
Desired Profit before Taxes = $100,000
 Profit-Volume Graph

$200 Point of Desired Profit e

n
Slope of profit line is fi t Li
PROFITS the marginal contribution Pro
($000s)
$100

0 $100 $200 $300 $400 $500 $600

$100
LOSSES Fixed cost
($000s)
$200

10 20 30 40 50 60
UNITS OF PRODUCT (000s)

Contemporary Engineering Economics, 6 th edition Copyright © 2016 by Pearson Education, Inc.

Park All Rights Reserved
8.4 Future Costs for Business
Decisions
 Differential
(Incremental) cost
 Opportunity cost
 Sunk cost
 Marginal cost
Differential (Incremental)
Costs
 Def: Costs that represent
the differences in total
costs, which results from
selecting one alternative
instead of other
 Cost behavior: Increase or
decrease with the overall
change that a company
experiences by producing
one additional unit of good
Opportunity Costs
 Def: The potential benefit
that is given up as you seek
an alternative course of
action
 Example: When you decide
to pursue a college degree,
your opportunity cost would
include a 4-year’s potential
earnings foregone.
 Normal application for
make-or-buy (outsourcing)
decisions
 Eg. 8.5 pp 428-430
Sunk Costs
 Def:Cost that has already
been incurred by past
actions
 Economic Implications: Not
relevant to future decisions
 Example: $500 spent to
replace brakes last year—
not relevant in making a
selling decision in the future
Marginal Costs

 Def: Added costs that result

from increasing rates of
outputs, usually by single unit
 Example: Cost of electricity—
decreasing marginal rate pp431-
432
Estimating Profit
from Production
Process of Creating a Master
Production Budget

Contemporary Engineering
Economics, 4th edition, © 2007