Cvpanalysis

COST-VOLUME-PROFIT ANALYSIS

CHAPTER 3

GROUP 4


Learning Objectives:

1. Determine the break-even point and output to achieve

target operating income

2. Incorporate income tax considerations into CVP analysis

3. Determine and explain operating leverage

4. Draw the breakeven graph and the cost-volume-profit graph


Cost-Volume-Profit Analysis-deals with

the effects of changes in the variables of

profit

EXAMPLE:

Richko Enterprises produces and sells product KE and makes

available to you the following data:

Unit Sales Price P 80

Unit Variable Cost 50

Total Fixed Cost 600,000

Units Sold 45,000

What would the new CMR, BEP (pesos), operating profit if:

Case A-Unit sales price increases by 20%

Case B-Unit variable costs increase by 10%

Case C-Total Fixed Cost decrease to P450,000

Case D-Units sold increase by 20%

Case E- Unit sales price increases to P100; Unit

Variable Cost increase by 15%; and

total fixed cost increase by 5%

COST-OLUME-PROFIT ANALYSIS

COST-OLUME-PROFIT ANALYSIS

ANALYSIS:

Unit Contribution Margin= (P80-P50) = P30

Old CMR = (P30/P80) = 37.50%

BEP = (P600,000/37.5%) = P1,600,000

Operating Profit =

CM (45,000 units x P30) P1,350,000

Less: FC 600,000

Operating Profit P 750,000

COST-VOLUME-PROFIT ANALYSISNew CMR, BEP (pesos), and Profit

CASE ADJUSTED DATA CMR BEP (pesos) PROFIT

A

USP (P80x120%) PHP 96.00CMR = P46/96 BEP = P600,000/47.92% CM (45,000 X P46) PHP 2,070,000.00

UVC 50.00 Less: FC 600,000.00

UCM 46.00 47.92% 1,252,174.00 PHP 1,470,000.00

B

USP PHP 80.00CMR = P25/80 BEP = P600,000/31.25% CM (45,000 X P25) PHP 1,125,000.00

UVC (P50x110%) 55.00 Less: FC 600,000.00

UCM PHP 25.00 31.25% PHP 1,920,000.00 PHP 525,000.00

C

FC PHP 450,000.00CMR = P30/80 BEP = P450,000/37.50% CM (45,000 X P30) PHP 1,350,000.00

Less: FC 450,000.00

PHP 450,000.00 37.50% PHP 1,200,000.00 PHP 900,000.00


CASE ADJUSTED DATA CMR BEP (pesos) PROFIT

D

Units Sold (45,000 x 120%)

PHP 54,000.00CMR = P30/80 BEP = P600,000/37.5% CM (54,000 X P30) PHP 1,620,000.00

Less: FC 600,000.00

PHP 54,000.00 37.50% PHP 1,600,000.00 PHP 1,020,000.00

E

USP PHP 100.00CMR = P42.50/100 BEP = P630,000/42.50% CM (45,000 X P42.50) PHP 1,912,500.00

UVC (P50x115%) 57.50 Less: FC 630,000.00

UCM 42.50 42.50% 1,482,352.94 PHP 1,282,500.00

FC (600,000 X 1.05%) PHP 630,000.00


CHANGE CMR BEP OI MARGIN OF

SAFETY

Increase in USP

Decrease in USP

Increase

Decrease

Decrease

Increase

Increase

Decrease

Increase

Decrease

Increase in UVC Decrease Increase Decrease Decrease

Increase in FC No Effect Decrease Increase Increase

A change in the number of units sold does not affect

unit sales price, Unit variable costs and fixed cost but

affect CM, Profit and Margin of Safety

COST-VOLUME-PROFIT ANALYSISSample Problem 2

Richman Corp., which is subject to a 40% income tax rate had the

following operating data for the period:

Selling price per unit P 60

Variable cost per unit 22

Fixed Costs 472,000

Management is contemplating to improve the quality of its product sold by

(1) replacing a component that costs P3.50 with the higher grade unit that

cost P6 and (2) acquiring P765,000 packing machine to be depreciated

over a 10-year life. The company want to earn after-tax income of

P172,800. The applicable income tax rate is 40%.

Required: The number of units the company must sell to earn the desired

profit before and after the improvement.

COST-VOLUME-PROFIT ANALYSISSample Problem 2 SOLUTION

No. of units to

sell=FC+IBIT/UCM

Profit before

tax=P288,000

(172,800/1-40)

UVC increase by P2.50

(6.00-3.50)

TFC increases by

P76,500 (765,000/10

yrs)

BEFORE AFTER

USP 60 60.00

Less:

UVC

22 25.50 (22+2.5)

UCM 38 35.50

FC 465,000 548,500

No of

units to

sell

20,000 23,563

FC+IBIT/

UCM

(472,000+

288,000/38)

(548,500+288,000/

35.50)


The Break-Even Point

The break-even point is that quantity of output where

total revenues equals total costs – that is, where the

operating income is zero.

An aspect of sensitivity analysis is margin of safety, which is

the amount of budgeted revenues over and above breakeven

revenues.

COST-VOLUME-PROFIT ANALYSISThe BEP GRAPH

Trulyrich Company expects to sell 200,000 units of its product M

priced at P20 per unit. The product’s variable cost per unit is P12

and its total fixed costs and expenses is P800,000. Given varying

production levels, the sales, cost and profit are estimated as:

PRODUCTION

TOTAL

SALES TFC TVC

TOTAL

COST

(TFC-TVC)

PROFIT(LOSS)

(TS-TC)

0 0 800,000 - 800,000 (800,000)

100,000 2,000,000 800,000 1,200,000 2,000,000 0

200,000 4,000,000 800,000 2,400,000 3,200,000 800,000

300,000 6,000,000 800,000 3,600,000 4,400,000 1,600,000

400,000 8,000,000 800,000 4,800,000 5,600,000 2,400,000


-

1,000,000

2,000,000

3,000,000

4,000,000

5,000,000

6,000,000

7,000,000

8,000,000

9,000,000

0 100,000 200,000 300,000 400,000

TOTAL SALES

TFC

TVC

TOTAL COST

BEP

Contribution

Margin (TS-TVC)

Margin of Safety

(BS-BES)

The BEP GRAPH


Economist believe that the behavior of revenues and cost is

non-linear which is direct contradiction with the linearity

assumption in the relevant range.

CVP graph focus on the behavior or trend of profit over

different levels of production and not on the behavior of cost

and revenues.

The CVP graph (or “profit-volume graph”) emphasizes the

profit (loss) line. The profit (loss) line starts from P800,000

which is the amount of FC and expenses. The loss gradually

diminishes as peso sales increase because of the increasing

trend in CM.

The CVP graph is used for long-term analysis.


(1,000,000)

(500,000)

0

500,000

1,000,000

1,500,000

2,000,000

2,500,000

3,000,000

0 2,000,000 4,000,000 6,000,000 8,000,000

CVP GRAPH

BEP

FC-(800,000)


Operating Leverage of Profit is the Contribution Margin

or (OL=CM)

Degree of Operating Leverage (DOL) – refers to the ability of

the business to increase its profit powered by its contribution

margin. Profit, as used in this topic means EBIT or the

earnings before interest and taxes. (DOL = CM/P)

Degree of Operating Leverage (DOL) = Contribution Margin/EBIT

or; Degree of Operating Leverage (DOL) = Percentage ▲ in EBIT

Percentage ▲ in Sales

The DOL is a multiplier of profit based on the change in contribution margin

(CM). Once the DOL is determined, the percentage change in EBIT is

computed as follows:

Percentage ▲ in EBIT = Percentage ▲ in Sales x DOL


The DOL signifies the percentage change in EBIT (earnings

before interest and tax) given a certain percentage change in

sales. To amplify this premise, let us say:

Unit sales price P 200

Unit variable costs 120

Total Fixed cost 550,000

Units Sold 10,000

What would happen to EBIT if sales increase by 40%?


If sales increase by 40%, EBIT will increase by 128%.

First, let us determine the DOL ratio. The contribution margin

(CM) and profit are determined below:

Contribution Margin

(CM)

(10,000 units

x P80)

P 800,000

Less: FC 550,000

EBIT 250,000

Therefore:

Degree of Operating Leverage = P800,000/250,000 = 3.2

Then, the percentage change in EBIT is:

Percentage change in EBIT =Percentage change in Sales x DOL

= 40% X 3.2

= 128%


BEFORE AFTER PESO

CHANGE

PERCENTAGE

CHANGE

Sales (10,000 x P200) 2,000,000 2,800,000 800,000 40%

Less: Variable Cost 1.200,000 1,680,000 480,000 40%

CM 800,000 1,120,000 320,000 40%

Less: FC 550,000 550,000 - -

EBIT 250,000 570,000 320,000 128%

Sales (after) = P2M x 140% = P2.8M

Variable Cost (after) = P1.2M x 140% = P1.68M

Percentage change in EBIT = Amount of change in EBIT/Original EBIT balance


If the operating leverage ratio is higher than 3.2, the percentage change in profit would be

higher. In case of increasing pattern in sales, it would be better to have a high DOL. In case

of decreasing trend in sales, it is better to have a low DOL. To summarize:

When Sales are DOL Should be To

Increasing Higher Maximize the

Percentage Change

in EBIT

Decreasing Lower Minimize the

Percentage Change

in EBIT


Stark Corporation based its profit planning on the following operating data; Unit sales

price (USP), P400; Unit Variable Cost (UVC), P240; Total Fixed Cost (TFC),

P8M; Sales Volume, 80,000 units.

Required:

1. Based on the original data, determine the CMR, BEP

pesos, operating profit, MSR, and the DOL.

2. Based on the following changes in the variables of

profit, determine the new CMR, BEP in pesos, operating

profit, MSR, and DOL.

a. Units sales price increases by 10%

b. Unit variable costs decrease by 5%

c. Total fixed costs and expenses by P500,000.

d. Quantity sold increases by P10,000.

e. Unit Sales price decreases by P20, unit variable costs increase by 10%

total fixed costs decrease by 5%, and unit sold increases to 100,000

3. Comment on the data determined in requirement 2.


CMR =UCM/USP WHERE: CMR= Contribution Margin

Rate

BEPP =FC/CMR MSR= Margin of Safety Rate

P =CM-FC BEPP= Breakeven point in

pesos

MSR =MS/BS DOL= Degree of operating

leverage

DOL =1/MSR P= Profit


Requirements 1 & 2:

Changes USP UVC TFC QS CMR BEPP

(FC/CMR)

P

(CM-FC)

MSR

(MS/BS)

DOL

1. Original data P400 P240 P8M 80,000 40% 20M 4.8M 37.5% 2.67

2a. USP ↑ by 10% 440 240 P8M 80,000 45.45% 17.602M 17.598M 50% 2

b. UVC ↓ by 5% 400 228 P8M 80,000 43% 18.605M 5.760M 41.86% 2.39

c. FC ↑ by

P500,000

400 240 P8.5M 80,000 40% 21.250M 4.3M 33.59% 2.98

d. QS ↑ by 10,000 400 240 P8M 90,000 40% 20M 6.4M 44.44% 2.25

e. USP ↓ by P20

UVC ↑ by 10%

FC ↓ by 5%

QS ↑ to 100,000

380 264 P7.6M 100,000 30.53% 24.894M 4M 35.49% 2.82


Base on the data contained in the preceding table, the

following comments may apply:

a. Profit is the measure of short-tem performance. The

DOL reflects the medium term performance

b. Profit and DOL relate inversely. This suggest what may

be good for business in the short term will not result to

better performance in the medium term.

c. For example, an increase in unit sales price

immediately reduces DOL. A decrease in unit variable

cost increase profit and increase DOL

d. On the other hand, and increase in fixed cost reduces

profit and increases DOL

Requirement 3:


THANK YOU

References:

Management Advisory Services by Agamata, Franklin

Business

Cvpanalysis