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BREAK EVEN ANALYSIS

Prepared by Prof. Dr. Salah Mobarak

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The Cost-Volume-Profit (CVP) Model

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The Cost-Volume-Profit (CVP) Model

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The Cost-Volume-Profit (CVP) Model

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The Break-Even Point

Using the CVP Model, we can determine the breakeven point for sales units.

Using the CVP Model, we can determine the breakeven point for sales units.

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The Break-Even Point

Using the CVP Model, we can determine the breakeven point for sales units.

Using the CVP Model, we can determine the breakeven point for sales units.

Assume breakeven is where Net Income = zero. Then solve for the desired variable.

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The Break-Even PointContribution-margin Approach

To compute breakeven units using the contribution approach,

we set NI = 0 and then algebraically manipulate the

equation to solve for the breakeven units (X).

To compute breakeven units using the contribution approach,

we set NI = 0 and then algebraically manipulate the

equation to solve for the breakeven units (X).

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The Break-Even PointContribution-margin Approach

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The Break-Even PointContribution-margin Approach

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Contribution-margin Approach Example

Bradley, Inc. sells briefcases for $105.00 each. Variable costs are $45.00 each and fixed cost is

$240,000.

Compute the breakeven sales volume.

A.2,286 units

B4,000 units

C.5,334 units

D.60 units

Bradley, Inc. sells briefcases for $105.00 each. Variable costs are $45.00 each and fixed cost is

$240,000.

Compute the breakeven sales volume.

A.2,286 units

B4,000 units

C.5,334 units

D.60 units

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Contribution-margin Approach Example

Bradley, Inc. sells briefcases for $105.00 each. Variable costs are $45.00 each and fixed cost is

$240,000.

Compute the breakeven sales volume.

A. 2,286 units

B4,000 units

C.5,334 units

D.60 units

Bradley, Inc. sells briefcases for $105.00 each. Variable costs are $45.00 each and fixed cost is

$240,000.

Compute the breakeven sales volume.

A. 2,286 units

B4,000 units

C.5,334 units

D.60 units

You divided Fixed Cost by Sales Price per Unit?

Think about the formula and try again.

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Contribution-margin Approach Example

Bradley, Inc. sells briefcases for $105.00 each. Variable costs are $45.00 each and fixed cost is

$240,000.

Compute the breakeven sales volume.

A.2,286 units

B4,000 units

C. 5,334 units

D.60 units

Bradley, Inc. sells briefcases for $105.00 each. Variable costs are $45.00 each and fixed cost is

$240,000.

Compute the breakeven sales volume.

A.2,286 units

B4,000 units

C. 5,334 units

D.60 units

You divided Fixed Cost by Variable Price per

Unit? Think about the formula and try again.

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Contribution-margin Approach Example

Bradley, Inc. sells briefcases for $105.00 each. Variable costs are $45.00 each and fixed cost is

$240,000.

Compute the breakeven sales volume.

A.2,286 units

B4,000 units

C.5,334 units

D. 60 units

Bradley, Inc. sells briefcases for $105.00 each. Variable costs are $45.00 each and fixed cost is

$240,000.

Compute the breakeven sales volume.

A.2,286 units

B4,000 units

C.5,334 units

D. 60 units

The Contribution Margin is $60. I don’t know how you turned that

into 60 units! Try again.

The Contribution Margin is $60. I don’t know how you turned that

into 60 units! Try again.

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Contribution-margin Approach Example

Bradley, Inc. sells briefcases for $105.00 each. Variable costs are $45.00 each and fixed cost is

$240,000.

Compute the breakeven sales volume.

A.2,286 units

B 4,000 units

C.5,334 units

D.60 units

Bradley, Inc. sells briefcases for $105.00 each. Variable costs are $45.00 each and fixed cost is

$240,000.

Compute the breakeven sales volume.

A.2,286 units

B 4,000 units

C.5,334 units

D.60 units

Congratulations!

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Target Profit

The Target Profit Model is very useful in planning.

In essence, it is just like a Breakeven problem

where Target Profit > $0.

The Target Profit Model is very useful in planning.

In essence, it is just like a Breakeven problem

where Target Profit > $0.

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Operating Leverage

Operating Leverage (OL) is the effect that fixed costs have on changes in operating income as changes occur in units sold, expressed as changes in contribution marginOL = Contribution Margin Operating Income

Notice these two items are identical, except for fixed costs

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The CVP Model and Income Taxes

Because companies must pay taxes on income, Target Income must be set high enough to cover the taxes.

Because companies must pay taxes on income, Target Income must be set high enough to cover the taxes.

Use the Before-tax Target Income in your Target

Income Model

Use the Before-tax Target Income in your Target

Income Model

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The CVP Model and Income Taxes - Example

Soccer Co. sells a line of soccer balls. The balls sell for $12 each. Variable cost

per ball is $5.30. Fixed costs for the company total $360,000.

Soccer Co. must achieve an after-tax profit of $3 million to meet market

expectations. The company is subject to an average tax rate of 30%.

Soccer Co. sells a line of soccer balls. The balls sell for $12 each. Variable cost

per ball is $5.30. Fixed costs for the company total $360,000.

Soccer Co. must achieve an after-tax profit of $3 million to meet market

expectations. The company is subject to an average tax rate of 30%.

Compute Before-Tax Target Income.

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The CVP Model and Income Taxes - Example

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The CVP Model and Income Taxes - Example

Before-tax Target Income is $4,285,714. Fixed Cost is $360,000. Sales price per unit is $12 and variable cost per unit is $5.30. How many soccer

balls must be sold to meet target profit?

A.53,731 units

B.639,659 units

C.693,390 units

D.357,143 units

Before-tax Target Income is $4,285,714. Fixed Cost is $360,000. Sales price per unit is $12 and variable cost per unit is $5.30. How many soccer

balls must be sold to meet target profit?

A.53,731 units

B.639,659 units

C.693,390 units

D.357,143 units

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The CVP Model and Income Taxes - Example

Before-tax Target Income is $4,285,714. Fixed Cost is $360,000. Sales price per unit is $12 and

variable cost per unit is $5.30. How many sail boats must be sold to meet target profit?

A. 53,731 units

B.639,659 units

C.693,390 units

D.357,143 units

Before-tax Target Income is $4,285,714. Fixed Cost is $360,000. Sales price per unit is $12 and

variable cost per unit is $5.30. How many sail boats must be sold to meet target profit?

A. 53,731 units

B.639,659 units

C.693,390 units

D.357,143 units

You have computed

Breakeven Units. Try again.

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The CVP Model and Income Taxes - Example

Before-tax Target Income is $4,285,714. Fixed Cost is $360,000. Sales price per unit is $12 and

variable cost per unit is $5.30. How many sail boats must be sold to meet target profit?

A. 53,731 units

B. 639,659 units

C. 693,390 units

D. 357,143 units

Before-tax Target Income is $4,285,714. Fixed Cost is $360,000. Sales price per unit is $12 and

variable cost per unit is $5.30. How many sail boats must be sold to meet target profit?

A. 53,731 units

B. 639,659 units

C. 693,390 units

D. 357,143 units

Good try, but you divided the wrong

number by CM? Take another look at the

model and try again.

Good try, but you divided the wrong

number by CM? Take another look at the

model and try again.

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The CVP Model and Income Taxes - Example

Before-tax Target Income is $4,285,714. Fixed Cost is $360,000. Sales price per unit is $12 and

variable cost per unit is $5.30. How many sail boats must be sold to meet target profit?

A. 53,731 units

B. 639,659 units

C. 693,390 units

D. 357,143 units

Before-tax Target Income is $4,285,714. Fixed Cost is $360,000. Sales price per unit is $12 and

variable cost per unit is $5.30. How many sail boats must be sold to meet target profit?

A. 53,731 units

B. 639,659 units

C. 693,390 units

D. 357,143 units

Why did you divide Target Income by Sales Price? That isn’t in the model!

Try again.

Why did you divide Target Income by Sales Price? That isn’t in the model!

Try again.

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The CVP Model and Income Taxes - Example

Before-tax Target Income is $4,285,714. Fixed Cost is $360,000. Sales price per unit is $12 and variable cost per unit is $5.30. How many soccer

balls must be sold to meet target profit?

A.53,731 units

B.639,659 units

C. 693,390 units

D.357,143 units

Before-tax Target Income is $4,285,714. Fixed Cost is $360,000. Sales price per unit is $12 and variable cost per unit is $5.30. How many soccer

balls must be sold to meet target profit?

A.53,731 units

B.639,659 units

C. 693,390 units

D.357,143 units

SCORE!

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Target Profit

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Multiple Products and the Sales Mix

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The previous CVP discussion assumed that the company sold only 1 product.

In most situations, the sales mix includes 2 or more products.

The previous CVP discussion assumed that the company sold only 1 product.

In most situations, the sales mix includes 2 or more products.

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Multiple Products and the Sales Mix

The previous CVP discussion assumed that the company sold only 1 product.

In most situations, the sales mix includes 2 or more products.

The previous CVP discussion assumed that the company sold only 1 product.

In most situations, the sales mix includes 2 or more products.

If the sales mix is not constant, or if the cost

function is curvilinear, CVP analysis is not reliable.

If the sales mix is not constant, or if the cost

function is curvilinear, CVP analysis is not reliable.

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Multiple Products and the Sales Mix

The previous CVP discussion assumed that the company sold only 1 product.

In most situations, the sales mix includes 2 or more products.

The previous CVP discussion assumed that the company sold only 1 product.

In most situations, the sales mix includes 2 or more products.

If the sales mix is not constant, or if the cost

function is curvilinear, CVP analysis is not reliable.

If the sales mix is not constant, or if the cost

function is curvilinear, CVP analysis is not reliable.

When the sales mix is constant, compute a

weighted average unit CM to use with CVP analysis.

When the sales mix is constant, compute a

weighted average unit CM to use with CVP analysis.

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Multiple Products and the Sales Mix - Example

Ayer Planes sells two different planes, a single- engine and a twin-engine. Fixed costs for the

company total $20,000,000.

Ayer Planes must achieve an after-tax profit of $6 million. The company is subject to an

average tax rate of 25%.

Ayer Planes sells two different planes, a single- engine and a twin-engine. Fixed costs for the

company total $20,000,000.

Ayer Planes must achieve an after-tax profit of $6 million. The company is subject to an

average tax rate of 25%.

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Multiple Products and the Sales Mix - Example

Steps for Multiple Product CVP:

Compute Before-tax Target Profit

Compute Weighted Average Unit CM

Compute Target Profit Volume

Steps for Multiple Product CVP:

Compute Before-tax Target Profit

Compute Weighted Average Unit CM

Compute Target Profit Volume

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Multiple Products and the Sales Mix - Example

Click here when you think you have the answer.

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Multiple Products and the Sales Mix - Example

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Multiple Products and the Sales Mix - Example

For each product multiply the CM by the portion of sales accounted for by that product. Then

add the totals together to get a weighted average unit contribution margin (WAUCM).

Click here when you think you know the answer.

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Multiple Products and the Sales Mix - Example

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Multiple Products and the Sales Mix - Example

Click here when you think you know the answer.

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Multiple Products and the Sales Mix - Example

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Alternative Income Statement Formats

End of Chapter 2

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