1 Chapter 5- Cost-Volume-Profit-Analysis. Summer, 2011. Edited May 23, 2011. Copyright © 2011, Dr. Howard Godfrey This file contains illustrative problems

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Chapter 5- Cost-Volume-Profit-Analysis.

Summer, 2011. Edited May 23, 2011.Copyright © 2011, Dr. Howard Godfrey

This file contains illustrative problems that will be used in the lecture to illustrate important concepts and procedures.

Copyright 2011. Dr. Howard Godfrey - M11-Chp-05-1A- Cost-Volume-Profit-Analysis -2011-0523

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After studying Chapter 5, you should be able to:LO1 Explain how changes in activity affect contribution margin and

net operating income.LO2 Prepare and interpret a cost volume-profit (CVP) graph and a

profit graph.LO3 Use the contribution margin ratio (CM ratio) to compute

changes in contribution margin and net operating income resulting from changes in sales volume.

LO4 Show the effects on net operating income of changes in variable costs, fixed costs, selling price, and volume.

LO5 Determine the level of sales needed for a desired target profit.LO6 Determine the break-even point.LO7 Compute the margin of safety and explain its significance.LO8 Compute degree of operating leverage and explain how it can be

used to predict changes in net operating income.LO9 Compute the break-even point for a multiproduct company and

explain the effects of shifts in the sales mix on contribution margin and the break-even point.

Introduction3

American Motors-1A company reported the following sales and earnings over a four-year period: Year Units Sold Pretax Earnings 1 194,000 $(16,700,000) 2 104,000 (30,000,000) 3 119,000 (11,000,000) 4 189,000 26,000,000Does this seem to be a misprint? Unit sales were less in year 4, than in year 1, but pretax earnings were dramatically higher.

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American Motors-2Results of a company in trouble: American Motors Corp. In 1957, (year 3 above) the company had only 2% of the automobile market. The company bounced back, and by 1960, its market share had tripled, and it reported an operating profit of $105 million.

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American Motors-3Break-even analysis was an important part of the company's strategy. The company's 1956 annual report noted: "The primary automotive objective since the merger has been to reduce the automotive break-even point, and simultaneously, to develop new lines of cars needed to increase sales to profitable levels."

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Your salespersons are paid a commission on their sales. Are you concerned when you find that you are paying more sales commissions. [Sales drives commissions.]Does an increase in sales also cause an increase in fuel costs for delivery trucks. Are fuel costs affected by the distance to customers? Does an increase in sales cause an increase in insurance premiums on the delivery trucks?

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Break-Even Point-QuestionAt break-even point, the

contribution margin equals total:

a. Variable Costsb. Sales revenuesc. Selling and admin. Expensesd. Fixed costs

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Jan makes and sells fruit baskets. A basket (& fruit) sells for: $10.00Cost for a basket (and fruit in basket) is: $6.00Monthly store rent is: $2,000She has no other cost.How many must be sold eachmonth for her to break even? a. 400 b. 500 c. 1,000 d. 2,000

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Selling price per unit 10.00$

Variable cost per unit

Contribution per unit

Fixed costs

Breakeven in units

Fruit Baskets

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Selling price per unit $10.00

Variable cost per unit $6.00

Contribution per unit $4.00

Fixed costs $2,000

Breakeven in units 500

Fruit Baskets

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Sales [500 at $10]

Cost of sales

Gross Margin

Fixed costs

Profit

Fruit Baskets - Net Income

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Fruit Basket RevisedSuppose Jan finds a supplier that charges less for the fruit. She reduces the total cost per basket and fruit to $5.What does that do to break-even?

Suppose she also negotiates a reduction in the monthly rent, from $2,000 to $1,500.

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Fixed costs

Breakeven in units

Fruit Baskets

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1: CVP concepts

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Concept QuestionThe cost-volume-profit analysis for a

breakeven chart does not assume that a. Price will remain fixed. b. Production will equal sales.c. Some costs vary inversely with volume. d. Costs are linear and continuous over the

relevant range.

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Concept QuestionThe most important information to be derived form a

break-even chart is:a. The volume of operations at which a company exactly

breaks evenb. The relationship between revenues and costs at

various levels of outputc. The amount of variable revenues needed to cover

exactly the fixed costs of the companyd. The amount of sales revenue needed to cover the

variable costs incurred by the company

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Concept QuestionAt breakeven point of 400 units sold, variable costs were $400 and fixed costs were $200. What will the 401st unit sold contribute to profit before income taxes?a. $0 b. 0.50 c. $1.00 d.$1.50

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Total UnitSales in dollars 600$ 1.50$ Variable costs 400 1.00 Contribution 200 0.50 Fixed costs 200 0.50 Net Income or Loss -$ -$

Concept Question

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Fixed and Variable CostsEner the missing information in the shaded cells.

Case A Case A-2 Case B Case C

Selling price per unit $8.00 $8.00 $10.00

Variable cost per unit $6.00 $6.00 $5.00

Contribution margin $2.00 $2.00 $5.00

Fixed Costs $100,000 $100,000 $200,000

Number of units sold 100,000 110,000 80,000 50,000

Revenue $800,000 $500,000

Variable costs ($600,000)

Contribution margin $200,000 $200,000

Fixed Costs ($100,000)

Net income (Loss) $100,000 $160,000

Bas

ic In

form

atio

nIn

com

e St

atem

ent

2: CVP and profit graphs

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Break-even ChartYou have a opportunity tosell kites at the World's Fair.Selling price per kiteVariable cost per kiteMonthly Booth rental Prepare break-even chart on next slide.

$5.00$3.00

$1,000

Worlds Fair

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Graph Approach Break-even Chart - World's Fair ProblemSelling price per unitVariable cost per unitMonthly Booth rental - Fixed

$4,000 C

O $3,000 S

T $2,500

& $2,000

R $1,500 E

V $1,000 N

U $500 E

-0-

Units Sold800100 200 300 400 500 600 700

$5.00

$3.00

$1,000

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Graph Approach Break-even Chart - World's Fair Problem Selling price per unitVariable cost per unitMonthly Booth rental - Fixed Profit Wedge

$4,000 C

O $3,000 S

T $2,500

& $2,000

R $1,500 E

V $1,000 N

U $500 E

-0-

Units Sold800100 200 300 400 500 600 700

$5.00

$3.00

$1,000

Fixed Cost

Total RevenueTotal

Costs(Fixed and Variable)

LossWedge

Break-evenPoint

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3: CM ratio

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Super Glue - BreakevenSuper Glue sells for $2.00 per tube and has variable costs of $1.20 per tube. Fixed production expenses are $48,000 per month. How many tubes of Super Glue must be sold each month for the Super Glue Company to break even?(Ignore selling and administration costs.)a. 45,000 b. 60,000 c. 90,000 d. 135,000

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Fixed costs

Breakeven in units

Super Glue

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Selling price per unit $2.00

Variable cost per unit $1.20

Contribution per unit $0.80

Fixed costs $48,000

Breakeven in units 60,000

Super Glue

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Kalik Co. sells radios for $60 each. Variable expenses are $40 per unit, while fixed expenses total $30,000. What total dollar amount must Kalik sell to break even?a. $40,000 b. $75,000 c. $90,000 d. $120,000

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Selling price per unit



Contribution %

Fixed costs

Breakeven in dollars

Kalik - 1

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Selling price per unit $60.00Variable cost per unit $40.00Contribution per unit $20.00Contribution % 33.33%Fixed costs 30,000 Breakeven in dollars 90,000$

Kalik - 1

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Kalik Co. sells radios for $60 each. Variable expenses are $40 per unit, while fixed expenses total $30,000. How many radios must Kalik sell to earn an operating income of $70,000?a. 5,000 b. 3,500 c. 2,500 d. 1,500

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Selling price per unitVariable cost per unitContribution per unitFixed costsDesired profitTotal Contribution neededSales needed - in units

Kalik-2

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Selling price per unit $60.00Variable cost per unit $40.00Contribution per unit $20.00Fixed costs $30,000Desired profit $70,000Total Contribution needed $100,000Sales needed - in units 5,000

Kalik-2

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Koby Co. has sales of $200,000 with variable expenses of $150,000, fixed expenses of $60,000, and an operating loss of $10,000. (Variable costs are always 75% of sales.)By how much would Koby have to increase its sales in order to have operating income of 10% of sales?a. $400,000 b. $251,000 c. $231,000 d. $200,000

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Koby Co. has sales of $200,000 with variable expenses of $150,000, fixed expenses of $60,000, and an operating loss of $10,000. (Variable costs are always 75% of sales.)By how much would Koby have to increase its sales in order to have operating income of 10% of sales?a. $400,000 b. $251,000 c. $231,000 d. $200,000 Increase

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KobySales = Variable + Fixed + Profit

Costs Costs

X = .75X + $60,000 + .1X

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KobySales = Variable+ Fixed + Profit

Costs Costs

X = .75X + $60,000 + .1XX = .85X + $60,000

.15X = + $60,000

X = $400,000 Total38

Roxford Company - 1Roxford Company had sales of $3,000,000, variable costs of $1,800,000 and fixed costs of $800,000 for a product. What are sales dollars at a level which generates net income of $160,000?a. $2,000,000 b. $2,400,000 c. $2,600,000 d. $2,760,000 e. none of these

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Sales in DollarsVariable costsContribution MarginContribution Margin - %Fixed costsDesired ProfitContribution neededTarget Sales in Dollars

Roxford - 2

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Sales in Dollars 3,000,000$ Variable costs 1,800,000 Contribution Margin 1,200,000 Contribution Margin - % 40.00%Fixed costs 800,000 Desired Profit 160,000 Contribution needed 960,000 Target Sales in Dollars 2,400,000$

Roxford - 3

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4: Effects of changes in parameters

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Kern Company prepared the following forecast concerning product A for 2010: Sales $500,000 Selling price per unit $ 5.00 Variable costs $300,000 Fixed costs $150,000If the unit selling price is increased by 20%, volume is expected to decrease of only 10%. With these changes in its 2010 forecast, what will be the operating income from product A?a. $66,000 b. $90,000 c. $120,000 d. $145,000 43

Units Per Unit Total

Sales in dollars 100,000 5.00$ 500,000$

Variable costs 100,000 3.00 300,000

Contribution 100,000 2.00 200,000

Fixed costs 100,000 1.50 150,000

Net Income 100,000 0.50$ 50,000$

Kern-1Current

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Units Per Unit Total

Sales in dollars 90,000 6.00$ 540,000$

Variable costs 90,000 3.00 270,000

Contribution 90,000 3.00 270,000

Fixed costs 90,000 1.67 150,000

Net Income 90,000 1.33$ 120,000$

Kern-2New Budget

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5: Target profit analysis

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Calculate sales volume in total dollars and total units for a target profit.

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Sales to generate target profitSuper Glue sells for $2.00 per tube and has variable costs of $1.20 per tube. Fixed production expenses are $48,000 per month. How many tubes of Super Glue must be sold each month for the Super Glue Company to have a monthly income (before income taxes) of $60,000?a. 45,000 b. 60,000 c. 90,000 d. 135,000 48

Selling price per unit $2.00Variable cost per unit $1.20Contribution per unit $0.80Fixed costsDesired profitTotal Contribution neededSales needed - in units

Super Glue

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Selling price per unit $2.00Variable cost per unit $1.20Contribution per unit $0.80Fixed costs $48,000Desired profit $60,000Total Contribution needed $108,000Sales needed - in units 135,000

Super Glue

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6: Break-even analysis

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Koby Co. has sales of $200,000 with variable expenses of $150,000, fixed expenses of $60,000, and an operating loss of $10,000. (Variable costs are 75% of sales.)Compute break-even sales using a formula?a. $400,000 b. $240,000 c. $231,000 d. $200,000

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KobySales = Variable + Fixed

Costs Costs

X = .75X + $60,000.25X = + $60,000

X = $240,00053

Sales $240,000Variable costContributionFixed costsNet Income

Kolby

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Sales $240,000Variable cost (180,000)Contribution 60,000Fixed costs (60,000)Net Income $0

Kolby

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7: Margin of safety

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Big company has sales of $200,000, a contribution margin of 20%, and a margin of safety of $80,000. What is fixed cost?a. $16,000 c. $24,000c. $80,000 d. $96.000

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8: Operating leverage

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9: Multiproduct CVP

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Super Dinner serves dinner each day - 1Company sells a total of 600 dinners per

day: 300 large dinners - price of $10 each. 300 small dinners - price of $6 each.Large dinners have variable cost of $5 each. (Food, napkins, electricity, etc.)Small dinners have variable cost of $4 each.Fixed costs are $2,000 per day for salaries,

rent, insurance, etc.What is the profit or loss per day?See next slide. 60

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Large Small TotalDinners sold per day 300 300 600 Price per Dinner $10 $6Var. costs per dinner $5 $4Meal Revenue $3,000 $1,800 $4,800Variable costsContribution per dayFixed Costs per dayProfit per day

Super Dinner - 2

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Large Small TotalDinners sold per day 300 300 600 Price per Dinner $10 $6Var. costs per dinner $5 $4Meal Revenue $3,000 $1,800 $4,800Variable costs (1,500) (1,200) (2,700) Contribution per day $1,500 $600 $2,100

Fixed Costs per day $2,000Profit per day $100

Super Dinner - 3

Super Dinner - 4What is break-even sales in

dollars per day?See next slide.

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64

Large Small TotalDinners sold per day 300 300 600 Price per Dinner $10 $6Var. costs per dinner $5 $4Meal Revenue $3,000 $1,800 $4,800Variable costs (1,500) (1,200) (2,700) Contribution per day $1,500 $600 $2,100

50% 33%

Fixed Costs per dayBreak-even-Sales Dollars Per Day

Super Dinner - 5

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Large Small TotalDinners sold per day 300 300 600 Price per Dinner $10 $6Var. costs per dinner $5 $4Meal Revenue $3,000 $1,800 $4,800Variable costs (1,500) (1,200) (2,700) Contribution per day$1,500 $600 $2,100

50% 33% 43.75%

Fixed Costs per day $2,000Break-even-Sales Dollars Per Day $4,571

Super Dinner - 5A

Super Dinner -6 Super Dinner is able to change the mix of 600 dinners per day to:400 large and 200 small dinners. How does that affect profit?See next slide.(Chic-Fil-A began advertising its chicken salad sandwich along with other sandwiches on its product board. Sales of chicken salad sandwiches increased 300%.)

66

67

Large Small TotalDinners sold per day 400 200 600 Price per Dinner $10 $6Var. costs per dinner $5 $4Meal Revenue $4,000 $1,200 $5,200Variable costsContribution per dayFixed Costs per dayProfit per day

Super Dinner - 7

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Large Small TotalDinners sold per day 400 200 600 Price per Dinner $10 $6Var. costs per dinner $5 $4Meal Revenue $4,000 $1,200 $5,200Variable costs (2,000) (800) (2,800) Contribution per day $2,400Fixed Costs per day $2,000Profit per day $400Compare with profit on earlier slide-600 meals

Super Dinner - 7A

Sales MixThomas sells products X, Y and Z. Thomas sells 3 units of X for each unit of Z and 2 units of Y for each unit of X. The contribution margins are $1.00 per unit for X, $1.50 per unit for Y, and $3.00 per unit for Z. Fixed costs are $600,000. How many units of X would Thomas sell at break-even point?a. 40,000 b. 120,000 c. 360,000 d. 400,000

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X Y Z TotalUnits Sold (Mix)

Sales of Z 1Sales of X 3Sales of Y 6

Contribution/Unit 1.00$ 1.50$ 3.00$ Subtotal 3.00$ 9.00$ 3.00$ Combined Contribution $15.00Fixed Costs $600,000Number of sets to be sold 40,000 Number of units of X to be sold 120,000

ProductThomas - Sales Mix

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Compute cost-volume-profit relationships on an after-tax basis

71

Sticky Glue sells for $2.00 per tube and has related variable expenses of $1.50 per tube. Fixed expenses of producing Sticky Glue are $100,000 per month. Sticky Glue is in the 40% income tax bracket. How many tubes of Sticky Glue must be sold each month for the Sticky Glue Company to have a monthly income (after income taxes) of $60,000?a. 400,000 b. 300,000c. 200,000 d. 135,000 e. 450,000 72

Sticky GlueNet = Net income - IncomeIncome before tax Tax

Net = Net income - 40% x Net IncomeIncome before tax before tax

Net = 60% x Net IncomeIncome before tax

Net = Net IncomeIncome before tax

60%73

74

After tax goal $60,0001-tax rate 60%Before-Tax Profit GoalFixed CostsTotal Contribution neededContribution per unitSales required (in units)

Sticky Glue - 2

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After tax goal $60,0001-tax rate 60%Before Tax Profit Goal 100,000 Fixed Costs 100,000Total Contribution needed $200,000Contribution per unit $0.50Sales required (in units) 400,000

Sticky Glue - 3

Additional practice problems are

provided in the following slides

76

Reliable Racket Co. makes tennis rackets. This year, fixed costs are expected to be $150,000. Each racket requires $10 of variable cost to produce and will be sold for $15. 1. What is the break-even point in units?a. 10,000 b. 15,000 c. 6,000 d. 30,000 e. 45,000

2. What is the break-even point in dollars?a. $300,000 b. $450,000 c. $150,000 d. $90,000 e. $675,000

3. How many rackets must be sold to earn an annual profit of $20,000?a. 4,000 b. 14,000 c. 24,000 d. 34,000 e. 44,000

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Selling price per unit 15.00$ Variable cost per unit 10.00$ Contribution per unit 5.00$ Fixed costsSales needed - in units

Reliable Racket-1

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Selling price per unit 15.00$ Variable cost per unit 10.00$ Contribution per unit 5.00$ Fixed costs 150,000$ Sales needed - in units 30,000

Reliable Racket-1

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Selling price per unit 15.00$ Variable cost per unit 10.00$ Contribution per unit 5.00$ Contribution percentageFixed costsSales needed - in dollars

Reliable Racket-2

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Selling price per unit 15.00$ Variable cost per unit 10.00$ Contribution per unit 5.00$ Contribution percentage 33.3333%Fixed costs 150,000$ Sales needed - in dollars 450,000

Reliable Racket-2

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Selling price per unitVariable cost per unitContribution per unitFixed costsDesired profitTotal Contribution neededSales needed - in units

Reliable Racket-3

82

Selling price per unit 15.00$ Variable cost per unit 10.00$ Contribution per unit 5.00$ Fixed costs 150,000$ Desired profit 20,000$ Total Contribution needed 170,000$ Sales needed - in units 34,000

Reliable Racket-3

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Reliable Racket Co. makes tennis rackets. This year, fixed costs are expected to be $150,000. Each racket requires $10 of variable cost to produce and will be sold for $15. Continued…

4. If 25,000 rackets are sold this year, and fixed costs are increased to $160,000, the overall profit or loss will bea. $25,000 profit b. $25,000 loss c. $35,000 loss. d. $45,000 loss. e. $45,000 profit.

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Sales in DollarsVariable costsContributionFixed costsProfit

Reliable Racket - 4

85

Sales in Dollars 375,000$ Variable costs 250,000 Contribution 125,000 Fixed costs 160,000 Profit (Loss) (35,000)$

Reliable Racket - 4

86

Zarlin Co. is considering an expansion program based on the following data:Expected sales $600,000 Variable costs 400,000 Fixed expenses 105,000What are sales at break-even?a. $400,000 b. $420,000 c. $390,000 d. $315,000 e. none of these

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Sales in Dollars

Variable costs

Contribution Margin

Contribution Margin - %

Fixed costs

Breakeven Sales $

Zarlin

88

Sales in Dollars 600,000$

Variable costs 400,000

Contribution Margin 200,000

Contribution Margin - % 33.3333%

Fixed costs 105,000$

Breakeven Sales $ 315,000$

Zarlin

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A Frosty-Dip Ice Cream Stand has:Selling price per gallon $10.00Variable costs per gallon Ice cream $2.30 Cups, cones, supplies 0.20 Total Fixed Costs per month: Rent $400 Utilities 120 Wages (including benefits) 1,130 Base salary of manager 1,500 Other fixed costs 150 Monthly break-even point in gallons? a. 100 b. 440 c. 550 d. 1,000 90

A Frosty-Dip Ice Cream Stand has:Selling price per gallon $10.00Variable costs per gallon Ice cream $2.30 Cups, cones, supplies 0.20 Total Fixed Costs per month: Rent $400 Utilities 120 Wages (including benefits) 1,130 Base salary of manager 1,500 Other fixed costs 150 Total Fixed Costs per month: $3,300

91

Selling price per unit 10.00$ Variable cost per unit 2.50$ Contribution per unitFixed costsSales needed - in units

Frosty Dip

92

Selling price per unit 10.00$ Variable cost per unit 2.50$ Contribution per unit 7.50$ Fixed costs 3,300$ Sales needed - in units 440

Frosty Dip

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Selling price per gallon 10.00$ Variable costs per gallon Ice cream 2.30$ Cups, cones, supplies 0.20 Total Fixed Costs per month: Rent 400$ Utilities 120 Wages (including benefits) 1,130 Base salary of manager 1,500 Other fixed costs 150 Investor needs after tax profit of $1,500/mo. The investor is in the 40% tax bracket. Sales level needed to reach the goal?

A Frosty-Dip Ice Cream Stand has:

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After Tax Profit required 1,500$ Factor: (1-income tax rate) 60%Before Tax Profit Needed 2,500$ Fixed costs 3,300$ Contribution needed 5,800$ Contribution per unit 7.50$ Sales needed - in units 773.33

Frosty-Dip Ice Cream Stand

95

The most likely strategy to reduce break-even point would be to:

a. Increase both fixed costs and the contribution margin.

b. Decrease both fixed costs and the contribution margin.

c. Decrease fixed costs and increase contribution margin.

d. Increase fixed costs and decrease contribution margin.

96

Del Company has fixed costs of $100,000 and breakeven sales of $800,000. What is its projected profit at sales of $1,200,000?a. $50,000 b. $150,000c. $200,000 d. $400,000

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The End

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Documents

1 Chapter 5- Cost-Volume-Profit-Analysis. Summer, 2011. Edited May 23, 2011. Copyright © 2011, Dr. Howard Godfrey This file contains illustrative problems