Managerial Accounting Solutions Chapter 3 PDF

CHAPTER 3
COST-VOLUME-PROFIT ANALYSIS
NOTATIONS USED IN CHAPTER 3 SOLUTIONS
SP: Selling price

VCU: Variable cost per unit
CMU: Contribution margin per unit
FC: Fixed costs
TOI: Target operating income
3-1 The assumptions underlying the CVP analysis outlined in Chapter 3 are
1. Changes in the level of revenues and costs arise only because of changes in the number
of product (or service) units sold.
2. Total costs can be separated into a fixed component that does not vary with the units sold
and a variable component that changes with respect to the units sold.
3. When represented graphically, the behaviors of total revenues and total costs are linear
(represented as a straight line) in relation to units sold within a relevant range and time
period.
4. The selling price, variable cost per unit, and fixed costs are known and constant.
3-2 Three methods to express CVP relationships are the equation method, the contribution
margin method, and the graph method. The first two methods are most useful for analyzing
operating income at a few specific levels of sales. The graph method is useful for visualizing the
effect of sales on operating income over a wide range of quantities sold.
3-3 Breakeven analysis denotes the study of the breakeven point, which is often only an
incidental part of the relationship between cost, volume, and profit. Cost-volume-profit
relationship is a more comprehensive term than breakeven analysis because it describes how
profits change over many different volume levels.
3-4 CVP certainly is simple, with its assumption of output as the only revenue and cost
driver, and linear revenue and cost relationships. Whether these assumptions make it simplistic
depends on the decision context. In some cases, these assumptions may be sufficiently accurate
for CVP to provide useful insights. The examples in Chapter 3 (the software package context in
the text and the travel agency example in the Problem for Self-Study) illustrate how CVP can
provide such insights. In more complex cases, the basic ideas of simple CVP analysis can be
expanded.
3-5 Sensitivity analysis is a “what-if” technique that managers use to examine how an
outcome will change if the original predicted data are not achieved or if an underlying
assumption changes. The advent of the electronic spreadsheet has greatly increased the ability to
explore the effect of alternative assumptions at minimal cost. CVP is one of the most widely
used software applications in the management accounting area.
© 2014 Pearson Education. All rights reserved.

3-1
3-6 Examples include:
Manufacturing––substituting a robotic machine for hourly wage workers.
Marketing––changing a sales force compensation plan from a percent of sales dollars to
a fixed salary.
Customer service––hiring a subcontractor to do customer repair visits on an annual
retainer basis rather than a per-visit basis.
3-7 Examples include:

Manufacturing––subcontracting a component to a supplier on a per-unit basis to avoid
purchasing a machine with a high fixed depreciation cost.
Marketing––changing a sales compensation plan from a fixed salary to percent of sales
dollars basis.
Customer service––hiring a subcontractor to do customer service on a per-visit basis
rather than an annual retainer basis.
3-8 Operating leverage describes the effects that fixed costs have on changes in operating
income as changes occur in units sold, and hence, in contribution margin. Knowing the degree of
operating leverage at a given level of sales helps managers calculate the effect of fluctuations in
sales on operating incomes.
3-9 CVP analysis is always conducted for a specified time horizon. One extreme is a very
short-time horizon. For example, some vacation cruises offer deep price discounts for people
who offer to take any cruise on a day’s notice. One day prior to a cruise, most costs are fixed.
The other extreme is several years. Here, a much higher percentage of total costs typically is
variable.
CVP itself is not made any less relevant when the time horizon lengthens. What happens
is that many items classified as fixed in the short run may become variable costs with a longer
time horizon.
3-10 Yes, gross margin calculations emphasize the distinction between manufacturing and
nonmanufacturing costs (gross margins are calculated after subtracting variable and fixed
manufacturing costs). Contribution margin calculations emphasize the distinction between fixed
and variable costs. Hence, contribution margin is a more useful concept than gross margin in
CVP analysis.
3-11 (10 min.) CVP computations.
Variable Fixed Total Operating Contribution Contribution

Revenues Costs Costs Costs Income Margin Margin %
a. $2,500 $ 800 $200 $ 1,000 $1,500 $1,700 68.0%
b. 2,000 1,500 200 1,700 300 500 25.0%
c. 500 300 200 500 0 200 40.0%
d. 1,600 400 200 600 1,000 1,200 75.0%

3-2
3-12 (20 min.) CVP exercises.
Budgeted
Variable Contribution Fixed Operating
Revenues Costs Margin Costs Income
Orig. $10,500,000G $7,700,000G $2,800,000 $1,400,000G $1,400,000
1. 10,500,000 7,448,000 3,052,000a 1,400,000 1,652,000
2. 10,500,000 7,952,000 2,548,000b 1,400,000 1,148,000
3. 10,500,000 7,700,000 2,800,000 1,442,000c 1,358,000
4. 10,500,000 7,700,000 2,800,000 1,358,000d 1,442,000
5. 11,235,000e 8,239,000f 2,996,000 1,400,000 1,596,000
6. 9,765,000g 7,161,000h 2,604,000 1,400,000 1,204,000
7. 11,445,000i 8,393,000j 3,052,000 1,526,000k 1,526,000
8. 10,500,000 7,469,000l 3,031,000 1,442,000m 1,589,000
Gstands for given.
a$2,800,000 × 1.09; b$2,800,000 × 0.91; c$1,400,000 × 1.03; d$1,400,000 × 0.97; e$10,500,000 × 1.07;
f$7,700,000 × 1.07; g$10,500,000 × 0.93; h$7,700,000 × 0.93; i$10,500,000 × 1.09; j$7,700,000 × 1.09;
k$1,400,000 × 1.09; l$7,700,000 × 0.97; m$1,400,000 × 1.03
Alternative 1, a 9% increase in contribution margin holding revenues constant, yields the highest
budgeted operating income because it has the highest increase in contribution margin without
increasing fixed costs.
3-13 (20 min.) CVP exercises.
1a. [Units sold (Selling price – Variable costs)] – Fixed costs = Operating income
[5,400,000 ($0.60 – $0.40)] – $860,000 = $220,000
1b. Fixed costs ÷ Contribution margin per unit = Breakeven units

$860,000 ÷ [($0.60 – $0.40)] = 4,300,000 units
Breakeven units × Selling price = Breakeven revenues
4,300,000 units × $0.60 per unit = $2,580,000
or,
Selling price -Variable costs
Contribution margin ratio =
Selling price
$0.60 – $0.40
= = 0.333333
$0.60
Fixed costs ÷ Contribution margin ratio = Breakeven revenues
$860,000 ÷ 0.333333 = $2,580,000
2. 5,400,000 ($0.60 – $0.46) – $860,000 = $ (104,000)

3. [5,400,000 (1.20) ($0.60 – $0.40)] – [$860,000 (1.20)] = $ 264,000
4. [5,400,000 (1.35) ($0.36a – $0.28)] – [$860,000 (0.6)] = $ 67,200
5. $860,000 (1.20) ÷ ($0.60 – $0.40) = 5,160,000 units

3-3
6. ($860,000 + $20,000) ÷ ($0.72 – $0.40) = 2,750,000 units
a$0.60 × 0.60; b$0.40 × 0.70
3-14 (10 min.) CVP analysis, income taxes.
1. Monthly fixed costs = $55,000 + $75,000 + $14,000 = $144,000

Contribution margin per unit = $30,000 – $26,000 – $800 = $ 3,200
Monthly fixed costs $144,000
Breakeven units per month = = = 45 cars
Contribution margin per unit $3,200 per car
2. Tax rate 40%

Target net income $59,250
Target net income 59, 250 59,520
Target operating income =   = $99,200
1  tax rate (1  0.40) 0.60
Quantity of output units
required to be sold =
Fixed costs  Target operating income $144, 000  $99, 2000
  76 cars
Contribution margin per unit $3, 200
3-15 (30 min.) CVP analysis, sensitivity analysis.
1. SP = $35.00  (1 – 0.30 margin to bookstore)

= $35.00  0.70 = $24.50
VCU = $4.50 variable production and marketing cost

2.45 variable author royalty cost (0.10  $24.50)
$6.95
CMU = $24.50 – $6.95 = $17.55 per copy

FC = $ 575,000 fixed production and marketing cost
2,500,000 up-front payment to Tomas
$3,075,000

3-4
Solution Exhibit 3-15A shows the PV graph.
SOLUTION EXHIBIT 3-15A

PV Graph for SingleDay Publishers
FC = $3,075,000
$4,000
CMU = $17.55 per book sold
3,000
2,000
Operating income (000’s)
1,000
0 Units sold
100,000 200,000 300,000 400,000 500,000
-1,000
175,214 units
-2,000
$3.075 million
-3,000
-4,000
2a.
Breakeven FC
number of units = CMU
$3,075,000
=
$17.55
= 175,214 copies sold (rounded up)
FC  OI
2b. Target OI =
CMU
$3,075,000 + $850,000
=
$17.55
$3,925,000
=
$17.55

3-5
3a. Increasing the normal royalty to 12% of the net sales price of each book
SP = $35.00  (1 – 0.30)
= $35.00  0.7 = $24.50
VCU = $4.50 variable production and marketing cost
+2.94 variable author royalty cost (0.12  $24.50)
$7.44
CMU = $24.50 – $7.44 = $17.06 per copy
Breakeven FC
number of units =
CMU
$3,075,000
=
$17.06
The breakeven point increases from 175,214 copies in requirement 2 to 180,246 copies.
3b. Increasing the listed bookstore price to $40 while keeping the royalty at 10% of the net
sales price has the following effects:
SP = $40.00  (1 – 0.30)
= $40.00  0.70 = $28.00
VCU = $ 4.50 variable production and marketing cost
+ 2.80 variable author royalty cost (0.10  $28.00)
$ 7.30
CMU= $28.00 – $7.30 = $20.70 per copy
Breakeven $3,075,000
number of units =
$20.70
The breakeven point decreases from 175,214 copies in requirement 2 to 148,551 copies.
3c. Increasing the royalty percentage increases the breakeven point. The breakeven point
increases since the variable cost per book increases. Increasing the sales price decreases the
breakeven point since contribution margin per book increases. In negotiations with Tomas, if
SingleDay publishing increased the selling price of the book, the royalty per book would
increase from $2.45 ($24.50  10%) to $2.80 ($28  10%). This is preferable for both Tomas and
SingleDay Publishing. This assumes, of course, that overall sales would not be affected if the
sales price is increased to $40. Regardless of the effect on the breakeven point, SingleDay should
choose the selling price that will maximize operating income.

3-6
3-16 (10 min.) CVP analysis, margin of safety.
Fixed costs
1. Breakeven point revenues =
Contribution margin percentage
$720,000
Contribution margin percentage =  0.48 or 48%
$1,500,000
Selling price  Variable cost per unit
2. Contribution margin percentage =
Selling price
SP – $13
0.48 =
SP
0.48 SP = SP – $13
0.52 SP = $13
SP = $13 ÷ 0.52 = $25
3. Breakeven sales in units = Revenues ÷ Selling price = $1,500,000 ÷ $25 = 60,000 units
Margin of safety in units = Sales in units – Breakeven sales in units
= 85,000 – 60,000 = 25,000 units
Revenues, 85,000 units  $25 $2,125,000

Breakeven revenues 1,500,000
Margin of safety $ 625,000
4. The risk of making a loss is low. Sales would need to decrease by 25,000 units ÷ 85,000 units
= 29.4% before McKnight Corp. will make a loss. The most likely reasons for this risk to
increase is greater competition, weakness in the economy, or bad management.
3-17 (25 min.) Operating leverage.
1a. Let Q denote the quantity of carpets sold
Breakeven point under Option 1

$850Q  $340Q = $18,870
$510Q = $18,870
Q = $18,870  $510 = 37 carpets
1b. Breakeven point under Option 2

$850Q  $340Q  (0.20  $850Q) = 0
340Q = 0
Q = 0
2. Operating income under Option 1 = $510Q  $18,870

Operating income under Option 2 = $340Q
Find Q such that $510Q  $18,870 = $340Q

$170Q = $18,870
Q = $18,870  $170 = 111 carpets

3-7
Revenues = $850 × 111 carpets = $94,350
For Q = 111 carpets, operating income under both Option 1 ($510 × 111 – $18,870) and
Option 2 ($340 × 111) = $37,740
For Q > 111, say, 115 carpets,

Option 1 gives operating income = ($510  115)  $18,870 = $39,780
Option 2 gives operating income = $340  115 = $39,100
So Curt Rugs will prefer Option 1.
For Q < 111, say, 105 carpets,

Option 1 gives operating income = ($510  105)  $18,870 = $34,680
Option 2 gives operating income = $340  105 = $35,700
So Curt Rugs will prefer Option 2.
Contribution margin
3. Degree of operating leverage =
Operating income
Contribution margin per unit  Quantity of carpets sold

Operating income
Under Option 1, contribution margin per unit = $850 – $340 = 510
Contribution margin = $510  185 = $94,350
Operating income = Contribution margin – Fixed costs = $94,350 – $18,870 = $75,480
$94,350
Degree of operating leverage = = 1. 25
$75,480
Under Option 2, contribution margin per unit = $850 – $340 – 0.20  $850 = $340
Contribution margin = $340  185 units = $62,900 = Operating margin
$62,900
Degree of operating leverage = = 1.0
$62,900
4. The calculations in requirement 3 indicate that when sales are 185 units, a percentage
change in sales and contribution margin will result in 1.25 times that percentage change in
operating income for Option 1, but the same percentage change in operating income for Option
2. The degree of operating leverage at a given level of sales helps managers calculate the effect
of fluctuations in sales on operating incomes.

3-8
3-18 (30 min.) Sales mix, new and upgrade customers.
1.
New Upgrade
Customers Customers
SP $195 $115
VCU 65 35
CMU $130 $ 80
The 60%/40% sales mix implies that, in each bundle, 3 units are sold to new customers and 2
units are sold to upgrade customers.
Contribution margin of the bundle = 3  $130 + 2  $80 = $390 + $160 = $550

$16, 500, 000
Breakeven point in bundles = = 30,000 bundles
$550
Breakeven point in units is:
Sales to new customers: 30,000 bundles  3 units per bundle 90,000 units
Sales to upgrade customers: 30,000 bundles  2 units per bundle 60,000 units
Total number of units to breakeven 150,000 units
Alternatively,
Let S = Number of units sold to upgrade customers
1.5S = Number of units sold to new customers
Revenues – Variable costs – Fixed costs = Operating income
[$195 (1.5S) + $115S] – [$65 (1.5S) + $35S] – $16,500,000 = OI
$407.5S – $132.5S – $16,500,000 = OI
Breakeven point is 120,000 units when OI = $0 because
$275.5S = $16,500,000
S = 60,000 units sold to upgrade customers
1.5S = 90,000 units sold to new customers
BEP = 150,000 units
Check
Revenues ($195  90,000) + ($115  60,000) $24,450,000
Variable costs ($65  90,000) + ($35  60,000) 7,950,000
Contribution margin 16,500,000
Fixed costs 16,500,000
Operating income $ 0

3-9
2. When 220,000 units are sold, mix is:
Units sold to new customers (60%  220,000) 132,000

Units sold to upgrade customers (40%  220,000) 88,000
Revenues ($195  132,000) + ($115 88,000) $35,860,000
Variable costs ($65  132,000) + ($35  88,000) 11,660,000
Operating income $ 7,700,000
3a. At New 40%/Upgrade 60% mix, each bundle contains 2 units sold to new customers and 3
units sold to upgrade customers.
$16,500, 000
$500
Sales to new customers: 33,000 bundles × 2 unit per bundle 66,000 units
Sales to upgrade customers: 33,000 bundles × 3 unit per bundle 99,000 units
Alternatively,
Let S = Number of units sold to new customers
then 1.5S = Number of units sold to upgrade customers
[$195S + $115 (1.5S)] – [$65S + $35 (1.5S)] – $16,500,000 = OI

367.5S – 117.5S = $16,500,000
250S = $16,500,000
S = 66,000 units sold to new customers
1.5S = 99,000 units sold to upgrade customers
BEP = 165,000 units
Check
Revenues ($195  66,000) + ($115  99,000) $24,255,000
Variable costs ($65  66,000) + ($35  99,000) 7,755,000
3b. At New 80%/ Upgrade 20% mix, each bundle contains 4 units sold to new customers and 1
unit sold to upgrade customers.
$16,500, 000
$600
Sales to new customers: 27,500 bundles  4 units per bundle 110,000 units
Sales to upgrade customers: 27,500 bundles  1 unit per bundle 27,500 units

3-10
Alternatively,
Let S = Number of units sold to upgrade customers
then 4S= Number of units sold to new customers
[$195 (4S) + $110S] – [$65 (4S) + $35S] – $16,500,000 = OI
895S – 295S = $16,500,000
600S = $16,500,000
S = 27,500 units sold to upgrade customers
4S = 110,000 units sold to new customers
137,500 units
Check
Revenues ($195  110,000) + ($115  27,500) $24,612,500
Variable costs ($65  110,000) + ($35  27,500) 8,112,500
3c. As Data increases its percentage of new customers, which have a higher contribution
margin per unit than upgrade customers, the number of units required to break even decreases:
New Upgrade Breakeven

Customers Customers Point
Requirement 3(a) 40% 60% 165,000
Requirement 1 60 40 150,000
Requirement 3(b) 80 20 137,500
It is not always better to choose the sales mix that yields lower breakeven point, because this
calculation ignores the demand for the new product and the upgrade product. The company
should look to sell as much of the product to new customers and to upgrade customers to
maximize operating income even if this means that the sales mix results in a higher breakeven
point.

3-11
3-19 (15–25 min.) Sales mix, three products.
1. Sales of A, B, and C are in ratio 24,000 : 96,000 : 48,000. So for every 1 unit of A, 4
(96,000 ÷ 24,000) units of B are sold, and 2 (48,000 ÷ 24,000) units of C are sold.
Contribution margin of the bundle = 1  $5 + 4  $4 + 2  $3 = $5 + $16 + $6 = $27

$405,000
$27
Product A: 15,000 bundles × 1 unit per bundle 15,000 units
Product B: 15,000 bundles × 4 units per bundle 60,000 units
Product C: 15,000 bundles × 2 units per bundle 30,000 units
Alternatively,
Let Q = Number of units of A to break even
4Q = Number of units of B to break even
2Q = Number of units of C to break even
Contribution margin – Fixed costs = Zero operating income
$5Q + $4(4Q) + $3(2Q) – $405,000 = 0

$27Q = $405,000
Q = 15,000 ($405,000 ÷ $27) units of A
4Q = 60,000 units of B
2Q = 30,000 units of C
Total = 105,000 units
2. Contribution margin:
A: 24,000  $5 $120,000
B: 96,000  $4 384,000
C: 48,000  $3 144,000
Contribution margin $648,000
Fixed costs 405,000
Operating income $243,000

3-12
3. Contribution margin
A: 24,000  $5 $120,000
B: 48,000  $4 192,000
C: 96,000  $3 288,000
Fixed costs 405,000
Sales of A, B, and C are in ratio 24,000 : 48,000 : 96,000. So for every 1 unit of A, 2
(48,000 ÷ 24,000) units of B and 4 (96,000 ÷ 24,000) units of C are sold.
Contribution margin of the bundle = 1  $5 + 2  $4 + 4  $3 = $5 + $8 + $12 = $25

$405,000
$25
Product A: 16,200 bundles × 1 unit per bundle 16,200 units
Product B: 16,200 bundles × 2 units per bundle 32,400 units
Product C: 16,200 bundles × 4 units per bundle 64,800 units
Alternatively,
Let Q = Number of units of A to break even
2Q = Number of units of B to break even
4Q = Number of units of C to break even
Contribution margin – Fixed costs = Breakeven point
$5Q + $4(2Q) + $3(4Q) – $405,000 = 0

$25Q = $405,000
Q = 16,200 ($405,000 ÷ $25) units of A
2Q = 32,400 units of B
4Q = 64,800 units of C
Total = 113,400 units
Breakeven point increases because the new mix contains less of the higher contribution
margin per unit, product B, and more of the lower contribution margin per unit, product C.
4. No, it is not always better to choose the sales mix with the lowest breakeven point because
this calculation ignores the demand for the various products. The company should look to and
sell as much of each of the 3 products as it can to maximize operating income even if this means
that this sales mix results in a higher breakeven point.

3-13
3-20 (30 min.) CVP, Not for profit
1. Ticket sales per concert $ 4,500

Variable costs per concert:
Guest performers $ 1,500
Marketing and advertising 1,600
Total variable costs per concert 3,100
Contribution margin per concert $ 1,400
Fixed costs
Salaries $30,000
Lease payments ($4,000 × 12) 48,000
Total fixed costs $78,000
Less donations 29,000
Net fixed costs $49,000

Breakeven point in units = = = 35 concerts
Contribution margin per concert $1,400
Check
Donations $ 29,000
Revenue ($4,500 × 35) 157,500
Total revenue 186,500
Less variable costs

Guest performers ($1,500 × 35) $52,500
Marketing and advertising ($1,600 × 35) 56,000
Total variable costs 108,500
Less fixed costs

Salaries $30,000
Lease payments 48,000
Total fixed costs 78,000

Guest performers $1,500
Fixed costs
Salaries ($30,000 + $28,000) $58,000
Lease payments ($4,000 × 12) 48,000
Less donations 29,000
Net fixed costs $ 77,000

3-14
Check
Donations $ 29,000
Revenue ($4,500 × 55) 247,500
Less variable costs

Less fixed costs

Salaries $58,000
Operating Income if 53 concerts are held

Donations $ 29,000
Revenue ($4,500 × 53) 238,500
Less variable costs

Less fixed costs

Salaries $58,000
Operating income (loss) $ (2,800)
The Music Society would not be able to afford the new marketing director if the number of
concerts were to increase to only 53 events. The addition of the new marketing director would
require the Music Society to hold at least 55 concerts in order to breakeven. If only 53 concerts
were held, the organization would lose $2,800 annually. The Music Society could look for other
contributions to support the new marketing director’s salary or perhaps increase the number of
attendees per concert if the number of concerts could not be increased beyond 53.

3-15
Guest performers $ 1,500
Fixed costs
Salaries ($30,000 + $28,000) $58,000
Lease payments ($4,000 × 12) 48,000
Deduct donations ($29,000 + $14,000) 43,000
Net fixed costs $ 63,000

Check
Donations $ 43,000
Revenue ($4,500 × 45) 202,500
Less variable costs

Less fixed costs

Salaries $58,000

3-16
3-21 (15 min.) Contribution margin, decision making.
1. Revenues $500,000
Deduct variable costs:
Cost of goods sold $200,000
Sales commissions 55,000
Other operating costs 25,000 280,000
$220,000
2. Contribution margin percentage = = 44%
$500,000
3. Incremental revenue (25% × $500,000) = $125,000

Incremental contribution margin
(44% × $125,000) $55,000
Incremental fixed costs (advertising) 15,000
Incremental operating income $40,000
If Mr. Wharton spends $15,000 more on advertising, the operating income will increase
by $40,000, decreasing the operating loss from $54,000 to an operating loss of $14,000.
Proof (Optional):
Revenues (125% × $500,000) $625,000
Cost of goods sold (40% of sales) 250,000
Gross margin 375,000
Operating costs:
Salaries $190,000
Sales commissions (11% of sales) 68,750
Depreciation of equipment and fixtures 14,000
Store rent 60,000
Advertising 15,000
Other operating costs:
 $25,000 
Variable   $625,000  31,250
 $500,000 
Fixed 10,000 389,000
Operating income $(14,000)
4. To improve operating income, Mr Wharton must find ways to decrease variable costs,
decrease fixed costs, or increase selling prices.

3-17
3-22 (25min.) Contribution margin, gross margin and margin of safety.
1.
Sweet Aroma
Operating Income Statement, November 2012
Units sold 8,000
Revenues $64,000
Variable costs
Variable manufacturing costs $ 43,200
Variable marketing costs 1,600
Contribution margin 19,200
Fixed costs
Fixed manufacturing costs $12,000
Fixed marketing & administration costs 3,000
Operating income $ 4,200
$19,200
2. Contribution margin per unit =  $2.40 per unit
8,000 units
Fixed costs $15,000
Breakeven quantity =   6,250 units
Contribution margin per unit $2.40 per unit
Revenues $64,000
Selling price =   $8 per unit
Units sold 8,000 units
Breakeven revenues = 6,250 units  $8 per unit = $50,000
Alternatively,
Contribution margin percentage =   30%
Revenues $64,000
Fixed costs $15,000

Breakeven revenues =   $50,000
Contribution margin percentage 0.30
3. Margin of safety (in units) = Units sold – Breakeven quantity

= 8,000 units – 6,250 units = 1,750 units
4. Units sold 7,500

Revenues (Units sold  Selling price = 7,500  $8) $60,000
Contribution margin (Revenues  CM percentage = $60,000  30%) $18,000
Fixed costs 15,000
Operating income 3,000
Taxes (30%  $3,000) 900
Net income $ 2,100

3-18
3-23 (30 min.) Uncertainty and expected costs.
1. Monthly Number of Orders Cost of Current System

400,000 $1,000,000 + $45(400,000) = $19,000,000
500,000 $1,000,000 + $45(500,000) = $23,500,000
600,000 $1,000,000 + $45(600,000) = $28,000,000
700,000 $1,000,000 + $45(700,000) = $32,500,000
800,000 $1,000,000 + $45(800,000) = $37,000,000
Monthly Number of Orders Cost of Partially Automated System

400,000 $11,000,000 + $25(400,000) = $21,000,000
500,000 $11,000,000 + $25(500,000) = $23,500,000
600,000 $11,000,000 + $25(600,000) = $26,000,000
700,000 $11,000,000 + $25(700,000) = $28,500,000
800,000 $11,000,000 + $25(800,000) = $31,000,000
Monthly Number of Orders Cost of Fully Automated System

400,000 $19,000,000 + $10(400,000) = $23,000,000
500,000 $19,000,000 + $10(500,000) = $24,000,000
600,000 $19,000,000 + $10(600,000) = $25,000,000
700,000 $19,000,000 + $10(700,000) = $26,000,000
800,000 $19,000,000 + $10(800,000) = $27,000,000
2. Current System Expected Cost:

$19,000,000 × 0.10 = $ 1,900,000
23,500,000 × 0.25 = 5,875,000
28,000,000 × 0.45 = 12,600,000
32,500,000 × 0.15 = 4,875,000
37,000,000 × 0.05 = 1,850,000
$27,100,000
Partially Automated System Expected Cost:

$21,000,000 × 0.10 = $ 2,100,000
23,500,000 × 0.25 = 5,875,000
26,000,000 × 0.45 = 11,700,000
28,500,000 × 0.15 = 4,275,000
31,000,000 × 0.05 = 1,550,000
$25,500,000
Fully Automated System Expected Cost:

$23,000,000 × 0.10 = $ 2,300,000
24,000,000 × 0.25 = 6,000,000
25,000,000 × 0.45 = 11,250,000
26,000,000 × 0.15 = 3,900,000
27,000,000 × 0.05 = 1,350,000
$24,800,000

3-19
The fully automated system has the lowest expected cost. It has high costs for low numbers of
orders and low costs if the numbers of orders are high. Given the probabilities that Dawnmart
assesses, it should implement the fully automated system.
3. Dawmart should consider the impact of the different systems on its relationship with
suppliers. The interface with Dawmart’s system may require that suppliers also update their
systems. This could cause some suppliers to raise the cost of their merchandise. It could force
other suppliers to drop out of Dawmart’s supply chain because the cost of the system change
would be prohibitive. Dawmart may also want to consider other factors such as the reliability of
different systems and the effect on employee morale if employees have to be laid off as it
automates its systems.
3-24 (15–20 min.) CVP analysis, service firm.
1. Revenue per package $7,500

Variable cost per package 6,300
Contribution margin per package $1,200
Breakeven (packages) = Fixed costs ÷ Contribution margin per package

$570,000
= = 475 tour packages
$1,200 per package
Contribution margin per package $1, 200

2. Contribution margin ratio = = = 16%
Selling price $7,500
Revenue to achieve target income = (Fixed costs + target OI) ÷ Contribution margin ratio
$570,000  $102,000
= = $4,200,000, or
0.16
Number of tour packages to earn $570,000  $102,000
  560 tour packages
$102,000 operating income $1, 200
Revenues to earn $102,000 OI = 560 tour packages × $7,500 = $4,200,000.
3. Fixed costs = $570,000 + $19,000 = $589,000

Fixed costs
Breakeven (packages) =
Contribution margin per package
Fixed costs
Contribution margin per package =
Breakeven (packages)
$589,000
= = $1,240 per tour package
475 tour packages
Desired variable cost per tour package = $7,500 – $1,240 = $6,260

Because the current variable cost per unit is $6,300, the unit variable cost will need to be reduced
by $40 to achieve the breakeven point calculated in requirement 1.
3-20
Alternate Method: If fixed cost increases by $19,000, then total variable costs must be reduced
by $19,000 to keep the breakeven point of 475 tour packages.
Therefore, the variable cost per unit reduction = $19,000 ÷ 475 = $40 per tour package.
Contribution margin per package = $8,200 − $6,300 = $1,900
4. Breakeven (packages) = Fixed costs ÷ Contribution margin per package

= $570,000 ÷ $1,900 per tour package = 300 tour packages
The key question for the general manager is: Can Outback Escapes sell enough packages at
$8,200 per package to earn more total operating income than when selling packages at $7,500.
Lowering the breakeven point per se is not the objective.
3-25 (20 min.) CVP analysis, margin of safety.
1. Selling price $320

Variable costs per unit:
Production costs $100
Shipping and handling 20 120
Contribution margin per unit (CMU) $200
Fixed costs $2,000,000
Breakeven point in units = = = 10,000 units
Contribution margin per unit $200
Margin of safety (units) = 12,000 – 10,000 = 2,000 units
2. Selling price per unit $320

Variable costs:
Production costs $100 × 120% $120
Shipping and handling ($20  90%) 18 138
(Total) contribution margin = $182  12,000 units = $2,184,000
Operating income = Contribution margin – Fixed costs = $2,184,000 – $2,000,000 = $184,000
$2,000,000
3. Breakeven point in units = = 10,990 units
$182
Margin of safety = 12,000 – 10,990 = 1,010 units
The change in variable costs decreases the margin of safety from 2,000 units to 1,010.
This means that the company’s sales units can drop by only 1,010 before the company
begins reporting an operating loss.
Margin of safety is smaller, so there is some concern of losses if sales drop. To reduce
risk, the manager should try to reduce fixed costs and variable costs or increase price.
FC  TOI $2,000,000  $400,000
4. Target sales in units = = = 13,187 units
CMU $182
Target sales in dollars = $320 × 13,187 = $4,219,840

3-21
3-26 (30–40 min.) CVP analysis, income taxes.
Target net income
1. Revenues – Variable costs – Fixed costs =
1  Tax rate
Let X = Net income for 2012
X
20,000($24.00) – 20,000($13.50) – $147,000 =
1  0.40
X
$480,000 – $270,000 – $147,000 =
0.60
X = $63,000  0.6 = $37,800
Alternatively,
Operating income = Revenues – Variable costs – Fixed costs
= $480,000 – $270,000 – $147,000 = $63,000
Income taxes = 0.40 × $63,000 = $25,200
Net income = Operating income – Income taxes
= $63,000 – $25,200 = $37,800
2. Let Q = Number of units to break even

$24.00Q – $13.50Q – $147,000 = 0
Q = $147,000  $10.50 = 14,000 units
3. Let X = Net income for 2013

X
22,500($24.00) – 22,500($13.50) – ($147,000 + $10,500) =
1  0.40
X
$540,000 – $303,750 – $157,500 =
0.60
X
$78,750 =
0.60
X = $47,250
4. Let Q = Number of units to break even with new fixed costs of $157,500
$24.00Q – $13.50Q – $157,500 = 0
Q = $157,500  $10.50 = 15,000 units
Breakeven revenues = 15,000  $24.00 = $360,000
5. Let S = Required sales units to equal 2012 net income

$37,800
$24.00S – $13.50S – $157,500 =
0.60
$10.50S = $63,000 + $157,500 = $220,500
S = 21,000 units
Revenues = 21,000 units  $24 = $504,000

3-22
6. Let A = Amount spent for advertising in 2012
$47,100
$24  = 22,500 – $13.50  22,500 – ($147,000 + A) =
0.60
$540,000 – $303,750 – $147,000 – A = 78,500
$89,200 – A = $78,500
A = $89,250 – $78,500 = $10,750
3-27 (25 min.) CVP, sensitivity analysis.
Contribution margin per pair of shoes = $70 – $30 = $40

Fixed costs = $80,000
Units sold = Total sales ÷ Selling price = $280,000 ÷ $70 per pair= 4,000 pairs of shoes
1. Variable costs decrease by 15%; Fixed costs increase by 10%

Sales revenues 4,000  $70 $280,000
Variable costs 4,000  $30  (1 – 0.15) 102,000
Fixed costs $80,000  1.10 88,000
2. Increase advertising (fixed costs) by $20,000; Increase sales 40%

Sales revenues 4,000  1.40  $70.00 $392,000
 
Variable costs 4,000 1.40 $30.00 168,000
Fixed costs ($80,000 + $20,000) 100,000
3. Increase selling price by $10.00; Sales decrease 15%; Variable costs increase by $8
Sales revenues 4,000  0.85  ($70 + $10) $272,000
 
Variable costs 4,000 0.85 ($30 + $8) 129,200
Fixed costs 80,000
4. Double fixed costs; Increase sales by 60%

Sales revenues 4,000  1.60  $70 $448,000
Variable costs 4,000  1.60  $30 192,000
Fixed costs $80,000  2 160,000
Alternative 2 yields the highest operating income. Choosing alternative 2 will give Derby
a 55% increase in operating income [($124,000 – $80,000) ÷ $80,000 = 55%], which is greater
than the company’s 25% targeted increase. Alternatives 1 and 4 also generate more operating
income for Derby, but they too do not meet Derby’s target of 25% increase in operating income.
Alternative 3 actually results in lower operating income than under Derby’s current cost
structure. There is no reason, however, for Derby to think of these alternatives as being mutually

3-23
exclusive. For example, Derby can combine actions 1 and 2, automate the machining process
and advertise. This will result in an even greater increase in operating income.
The point of this problem is that managers always need to consider broader rather than
narrower alternatives to meet ambitious or stretch goals.
3-28 (30 min.) CVP analysis, clothing store.
1. CMU (SP – VCU = $160 – $128) $ 32.00

a. Breakeven units (FC  CMU = $320,000  $32 per unit) 10,000
b. Breakeven revenues
(Breakeven units  SP = 10,000 units  $160 per unit) $1,600,000
2. Suits sold 8,000

Revenues, 8,000  $160 $1,280,000
Total cost of suit, 8,000  $120 960,000
Total sales commissions, 8,000  $8 64,000
Total variable costs 1,024,000
Fixed costs 320,000
Operating income (loss) $ (64,000)
3. Unit variable data (per suit)

Selling price $ 160.00
Cost of suits 120.00
Sales commissions 0
Variable cost per unit $ 120.00
Annual fixed costs
Rent $ 45,000
Salaries, $200,000 + $90,000 290,000
Advertising 50,000
Other fixed costs 25,000
Total fixed costs $ 410,000
CMU, $160 – $120 $ 40.00

a. Breakeven units, $410,000  $40 per unit 10,250
b. Breakeven revenues, 10,250 units  $160 per unit $1,640,000

3-24
4. Unit variable data (per suit)
Selling price $ 160.00
Cost of suits 120.00
Sales commissions 8.75
Variable cost per unit $ 128.75
Total fixed costs $ 320,000
CMU, $160 – $128.75 $ 31.25

a. Break even units = $320,000  $31.25 per unit 10,240 (rounded up)
b. Break even revenues = 10,240 units  $160 per unit $1,638,400
5. Suits sold 15,000

Revenues (15,000 suits  $160 per suit) $2,400,000
Total cost of suits (15,000 suits  $120 per suit) $1,800,000
Sales commissions on first 10,000 suits (10,000 suits  $8.00 per suit) 80,000
Sales commissions on additional 5,000 suits
[5,000 pairs  ($8.00 + $0.75 per suit)] 43,750
Total variable costs $1,923,750
Contribution margin $ 476,250
Fixed costs 320,000
Alternative approach:
Breakeven point in units = 10,000 suits

Store manager receives commission of $0.75 on 5,000 (15,000 – 10,000) suits.
Contribution margin per suit beyond breakeven point of 10,000 suits =
$31.25 ($160 – $120 – $8.75) per suit.
Operating income = 5,000 suits  $31.25 contribution margin per suit = $156,250.
3-29 (25 min.) CVP analysis, clothing store.
1. The new store will have the same operating income under either compensation plan when
the volume of sales is 11,250 suits. This can be calculated as the unit sales level at which both
compensation plans result in the same total costs:
Let Q = unit sales level at which total costs are same for both plans
$120Q + $320,000 + $90,000 = $128Q + $320,000

$8 Q = $90,000
Q = 11,250 suits
2. When sales volume is above 11,250 suits, the higher-fixed-salaries plan results in lower
costs and higher operating incomes than the salary-plus-commission plan. So, for an expected
volume of 12,000 suits, the owner would be inclined to choose the higher-fixed-salaries-only
plan.
Operating income with no sales commission = $40  12,000 − $410,000 = $70,000
Operating income with sales commission = $32  12,000 − $320,000 = $64,000

3-25
But it is likely that sales volume itself is determined by the nature of the compensation plan. The
salary-plus-commission plan provides a greater motivation to the salespeople, and it may well be
that for the same amount of money paid to salespeople, the salary-plus-commission plan
generates a higher volume of sales than the fixed-salary plan.
3. Let Q = Target number of units
For the salary-only plan,

$160Q – $120Q – $410,000 = $180,000
$40Q = $590,000
Q = $590,000 ÷ $40
Q = 14,750 units
For the salary-plus-commission plan,
$160Q – $128Q – $320,000 = $180,000
$32Q = $500,000
Q = $500,000 ÷ $32
Q = 15,625 units
4. Dress4Less Company
Operating Income Statement, 2013
Revenues (18,000 suits  $160) + (2,000 suits  $100) $3,080,000

Cost of suits, 20,000 suits  $120 2,400,000
Commissions = Revenues  5% = $3,080,000  0.05 154,000
Fixed costs 320,000
3-30 (40 min.) Alternative cost structures, uncertainty, and sensitivity analysis.
1. Contribution margin per

page assuming current = $0.15 – $0.04 – $0.05 = $0.06 per page
fixed leasing agreement
Fixed costs $1,200
Breakeven point =   20,000 pages
Contribution margin per page $0.06 per page
Contribution margin per page

assuming $20 per 500 page = $0.15–$0.04a – $0.04 – $.05 = $0.02 per page
commission agreement
Fixed costs = $0

3-26
Fixed costs $0
Breakeven point =   0 pages
Contribution margin per page $0.02 per page
(i.e., Integral makes a profit no matter how few pages it sells)
a
$20  500 pages = $0.04 per page
2. Let x denote the number of pages Integral must sell for it to be indifferent between the
fixed leasing agreement and commission based agreement.
To calculate x we solve the following equation.
$0.15 x – $0.04 x – $0.05 x – $1,200 = $0.15 x – $0.04 x – $0.04 x – $.05 x
$0.06 x – $1,200 = $0.02 x
$0.04 x = $1,200
x = $1,200 ÷ $0.04 = 30,000 pages
For sales between 0 to 30,000 pages, Integral prefers the commission-based agreement
because in this range, $0.02 x > $0.06 x – $1,200. For sales greater than 30,000 pages,
Integral prefers the fixed leasing agreement because in this range, $0.06 x – $1,200 >
$.02 x .
3. Fixed leasing agreement

Operating Expected
Pages Variable Fixed Income Operating
Sold Revenue Costs Costs (Loss) Probability Income
(1) (2) (3) (4) (5)=(2)–(3)–(4) (6) (7)=(5)  (6)
20,000 20,000  $.15=$ 3,000 20,000  $.09=$1,800 $1,200 $ 0 0.20 $ 0
30,000 30,000  $.15=$ 4,500 30,000  $.09=$2,700 $1,200 $ 600 0.20 120
40,000 40,000  $.15=$ 6,000 40,000  $.09=$3,600 $1,200 $1,200 0.20 240
40,000 50,000  $.15=$ 7,500 50,000  $.09=$4,500 $1,200 $1,800 0.20 360
60,000 60,000  $.15=$ 9,000 60,000  $.09=$5,400 $1,200 $2,400 0.20 480
Expected value of fixed leasing agreement $1,200
Commission-based leasing agreement:
Pages Variable Operating Expected

Sold Revenue Costs Income Probability Operating Income
(1) (2) (3) (4)=(2)–(3) (5) (6)=(4)  (5)
20,000 20,000  $.15=$ 3,000 20,000  $.13=$2,600 $400 0.20 $ 80
30,000 30,000  $.15=$ 4,500 30,000  $.13=$3,900 $600 0.20 120
40,000 40,000  $.15=$ 6,000 40,000  $.13=$5,200 $800 0.20 160
50,000 50,000  $.15=$ 7,500 50,000  $.13=$6,500 $1,000 0.20 200
60,000 60,000  $.15=$ 9,000 60,000  $.13=$7,800 $1,200 0.20 240
Expected value of commission based agreement $800
Integral should choose the fixed cost leasing agreement because the expected value is higher than
under the commission-based leasing agreement. The range of sales is high enough to make the
fixed leasing agreement more attractive.

3-27
3-31 (25 min.) CVP, alternative cost structures.
1. Contribution margin per phone = Selling price –Variable cost per phone
= $150 – $55 – $45= $50
Breakeven point = Fixed costs ÷ Contribution margin per phone
= $5,000 ÷ $50 = 100 phones (per month)
Fixed costs + Target operating income

2. Target number of phones =
Contribution margin per phone
$5,000 + $4,000
=  180 phones
$50
3. Contribution margin per phone = Selling price – Variable cost per phone
= $150 – $77.50 – $10 = $62.50
Fixed costs
Breakeven point =
Contribution margin per phone
$5, 000
  80 phones
$62.50
4. Let x be the number of phones for which Crabapple is indifferent between paying a
monthly rental fee for the retail space and paying a 20% commission on sales.
Crabapple will be indifferent when the profits under the two alternatives are equal.
$150 x – $100 x – $5,000 = $150 x – $100 x – $150 (0.20) x

$50 x – $5,000 = $20 x
$30 x = $5,000
x = 167 phones (rounded up)
For sales between 0 and 166 phones, Crabapple prefers to pay the 20% commission because in
this range, $20 x > $50 x –$5,000. For sales greater than 167 phones, the company prefers to pay
the monthly fixed rent of $5,000 because $50 x –$5,000 > $20 x
5. The company would need to consider the forecasted sales since this will determine
cost under each alternative. The company would also need to consider any potential
price increases, as this would affect the rent cost under the commission alternative.

3-28
3-32 (25 min.) CVP analysis, income taxes, sensitivity.
1a. To breakeven, Skudder Inc must sell 1,875 units. This amount represents the point where
revenues equal total costs.
Let Q denote the quantity of engines sold.
Revenue = Variable costs + Fixed costs
$750Q = $350Q + $750,000
$400Q = $750,000
Q = 1,875 units
Breakeven can also be calculated using contribution margin per unit.
Contribution margin per unit = Selling price – Variable cost per unit = $750 – $350 = $400
Breakeven = Fixed Costs  Contribution margin per unit
= $750,000  $400
= 1,875 units
1b. To achieve its net income objective, Skudder Inc must sell 2,375 units. This amount
represents the point where revenues equal total costs plus the corresponding operating income
objective to achieve net income of $150,000.
Revenue = Variable costs + Fixed costs + [Net income ÷ (1 – Tax rate)]

$750Q = $350Q + $750,000 + [$150,000  (1  0.25)]
$750Q = $350Q + $750,000 + $200,000
$400Q = $950,000
Q = 2,375 units
2. To achieve its net income objective, Skudder should select alternative c, where fixed
costs are reduced by 20% and selling price is reduced by 10% resulting in 2,100 additional units
being sold through the end of the year. This alternative results in the highest net income and is
the only alternative that equals or exceeds the company’s net income objective of $150,000.
Calculations for the three alternatives are shown below.
Alternative a
Revenues = ($750  500) + ($750  0.80  2,800) = $2,055,000
Variable costs = $350  (500 + 2,800) = $1,155,000
Operating income = $2,055,000  $1,155,000  $750,000 = $ 150,000
Net income = $150,000  (1  0.25) = $ 112,500

3-29
Alternative b
Revenues = ($750  500) + [($750  $100)  2,300)] = $1,870,000
Variable costs = ($350  500) + [($350  $15)  2,300) = $ 945,500
Operating income= $1,870,000  $945,500  $750,000 = $ 174,500
Net income = $174,500  (1  0.25) = $ 130,875
Alternative c
Revenues = ($750  500) + ($750  0.90  2,100 = $1,792,500
Variable costs = $350  (500 + 2,100) = $ 910,000
Fixed costs = $750,000  0.80 = $ 600,000
Operating income = $1,792,500  $910,000  $600,000 = $ 282,500
Net income = $282,500  (1  0.25) = $211,875
3-33 (30  40 min.) Choosing between compensation plans, operating leverage.
1. Recast Diem’s income statement to emphasize contribution margin, and then use it to compute
the required CVP parameters.
Diem Corporation
Income Statement
For the Year Ended December 31, 2012
Using Sales Agents Using Own Sales Force

Revenues $35,000,000 $35,000,000
Variable Costs
Cost of goods sold—variable $19,250,000 $19,250,000
Marketing commissions 7,000,000 26,250,000 5,250,000 24,500,000
Contribution margin 8,750,000 10,500,000
Fixed Costs
Cost of goods sold—fixed 4,750,000 4,750,000
Marketing—fixed 1,450,000 6,200,000 3,200,000 7,950,000
Operating income $ 2,550,000 $ 2,550,000

($8,750,000  35,000,000;
$10,500,000  $35,000,000) 25% 30%
Breakeven revenues
($6,200,000  0.25;
$7,950,000  0.30) $24,800,000 $26,500,000
Degree of operating leverage
($8,750,000  $2,550,000;
$10,500,000  $2,550,000) 3.43 4.12
2. The calculations indicate that at sales of $35,000,000, a percentage change in sales and
contribution margin will result in 3.43 times that percentage change in operating income if Diem
continues to use sales agents and 4.12 times that percentage change in operating income if Diem
employs its own sales force. The higher contribution margin per dollar of sales and higher fixed
costs by using own sales force gives Diem more operating leverage, that is, greater benefits

3-30
(increases in operating income) if revenues increase but greater risks (decreases in operating
income) if revenues decrease. Diem also needs to consider the skill levels and incentives under
the two alternatives. Sales agents have more incentive compensation and hence may be more
motivated to increase sales. On the other hand, Diem’s own sales force may be more
knowledgeable and skilled in selling the company’s products. Using its own sales force gives
Diem direct access to its customers and better information about their needs. That is, the sales
volume itself will be affected by who sells and by the nature of the compensation plan.
3. Variable costs of marketing = 18% of Revenues

Fixed marketing costs = $3,200,000
Variable manufacturing costs per dollar of revenue = $19,250,000  $35,000,000 = 0.55
Variable Fixed
Operating income = Revenues  Variable  Fixed  marketing  marketing
manuf. costs manuf. costs
costs costs
Denote the revenues required to earn $2,550,000 of operating income by R, then

R  0.55R  $4,750,000  0.18R  $3,200,000 = $2,550,000
R  0.55R  0.18R = $2,550,000 + $4,750,000 + $3,200,000

0.27R = $10,500,000
R = $10,500,000  0.27 = $38,888,889
3-34 (45 min.) Multi-product CVP and decision making.
1. Small trampoline:
Selling price $200
Variable cost per unit 120
Contribution margin per unit $ 80
Large trampoline:
Selling price $600
Each bundle contains 4 small trampolines and 1 larger trampoline.
So contribution margin of a bundle = 4  $80 + 1  $180 = $500

Breakeven Fixed costs $1,250,000
point in =   2,500 bundles
bundles Contribution margin per bundle $500
Breakeven point in units of small trampolines and large trampolines is:

Small trampolines: 2,500 bundles  4 units per bundle = 10,000 units
Large trampolines: 2,500 bundles  1 units per bundle = 2,500 units

3-31
Breakeven point in dollars for small trampolines and large trampolines is:
Small trampolines: 10,000 units  $200 per unit = $2,000,000
Large trampolines: 2,500 units  $600 per unit = 1,500,000
Breakeven revenues $3,500,000
(4  $80) + (1 $180)

Alternatively, weighted average contribution margin per unit = = $100
5
$1,250,000
Breakeven point =  12,500 units
$100
4
Small:  12,500 units = 10,000 units
5
1
Large: 12,500 units  2,500 units
5
Breakeven point in dollars

Large trampolines: 2,500 units  $600 per unit = $1,500,000
2. Small trampolines:
Selling price $200
Contribution margin per unit $ 95
Large trampolines:
Selling price $600
Each bundle contains 4 small trampolines and 1 large trampoline.

So contribution margin of a bundle = 4  $95 + 1  $225 = $605
Breakeven Fixed costs $1,250,000  $202,000

point in =   2,400 bundles
bundles Contribution margin per bundle $605
Breakeven point in units of small trampolines and large trampolines is:

Small trampolines: 2,400 bundles  4 units per bundle = 9,600 units
Large trampolines: 2,400 bundles  1 units per bundle = 2,400 units
Breakeven point in dollars for small trampolines and large trampolines is:
Large trampolines: 2,400 units  $600 per unit = 1,440,000
Breakeven revenues $3,360,000

3-32
(4  $95) + (1 $225)
Alternatively, weighted average contribution margin per unit = = $121
5
$1,250,000 + $202,000
Breakeven point =  12,000 units
$121
4
Small:  12,000 units = 9,600 units
5
1
Large: 12,000 units  2,400 units
5
3. Let x be the number of bundles for JumpUP to be indifferent between the old and
new production equipment.
Operating income using old equipment = $500 x – $1,250,000

Operating income using new equipment = $605 x – $1,250,000 – $202,000
At point of indifference:
$500 x – $1,250,000 = $605 x – $1,452,000
$605 x – $500 x = $1,452,000 – $1,250,000
$105 x = $202,000
x = $202,000 ÷ $105 = 1,924 bundles (rounded up)
Small trampolines = 1,924 bundles  4 units per bundle = 7,696 units

Large trampolines = 1,924 bundles  1 units per bundle = 1,924 units
Total number of units 9,620 units
Note that at sales of 9,620 units, JumpUP will make a loss ($288,000) whether it uses
old or new production equipment, because 9,620 units is lower than the breakeven
points calculated in requirements 1 and 2.
Let x be the number of bundles,
When total sales are less than 9,620 units (1,924 bundles), $500x  $1,250,000 >
$605x  $1,452,000 so JumpUP is better off with the old equipment.
When total sales are greater than 9,620 units (1,924 bundles), $605x  $1,452,000 >
$500x  $1,250,000, so JumpUP is better off buying the new equipment.
At total sales of 13,000 units (2,600 bundles), JumpUP should buy the new
production equipment.
Proof:
With old equipment,

Operating income = $500  2,600 − $250,000 = $50,000
With new equipment,
Operating income = $605  2,600 − $1,452,000 = $121,000

3-33
3-35 (20–25 min.) Sales mix, two products.
1. Sales of standard and deluxe carriers are in the ratio of 180,000 : 60,000. So for every 1
unit of deluxe, 3 (180,000 ÷ 60,000) units of standard are sold.

$1,050,000
$28
Standard carrier: 37,500 bundles × 3 units per bundle 112,500 units
Deluxe carrier: 37,500 bundles × 1 unit per bundle 37,500 units
Alternatively,
Let Q = Number of units of Deluxe carrier to break even
3Q = Number of units of Standard carrier to break even
Revenues – Variable costs – Fixed costs = Zero operating income
$30(3Q) + $28Q – $24(3Q) – $28Q – $1,050,000 = 0

$90Q + $38Q – $72Q – $28Q = $1,050,000
$28Q = $1,050,000
Q = 37,500 units of Deluxe
3Q = 112,500 units of Standard
The breakeven point is 112,500 Standard units plus 37,500 Deluxe units, a total of 150,000
units.
2a. Unit contribution margins are: Standard: $30 – $24 = $6; Deluxe: $38 – $28 = $10
If only Standard carriers were sold, the breakeven point would be:
$1,050,000  $6 = 175,000 units.
2b. If only Deluxe carriers were sold, the breakeven point would be:
$1,050,000  $10 = 105,000 units
3. Operating income = Contribution margin of Standard + Contribution margin of Deluxe – Fixed costs
= 200,000($6) + 40,000($10) – $1,050,000
= $1,200,000 + $400,000 – $1,050,000
= $550,000
Sales of standard and deluxe carriers are in the ratio of 200,000 : 40,000. So for every 1
unit of deluxe, 5 (200,000 ÷ 40,000) units of standard are sold.

$1,050,000
$40

3-34
Standard carrier: 26,250 bundles × 5 units per bundle 131,250 units
Deluxe carrier: 26,250 bundles × 1 unit per bundle 26,250 units
Alternatively,
Let Q = Number of units of Deluxe product to break even
5Q = Number of units of Standard product to break even
$30(5Q) + $38Q – $24(5Q) – $28Q – $1,050,000 = 0

$150Q + $38Q – $120Q – $28Q = $1,050,000
$40Q = $1,050,000
Q = 26,250 units of Deluxe
5Q = 131,250 units of Standard
The breakeven point is 131,250 Standard +26,250 Deluxe, a total of 157,500 units.
The major lesson of this problem is that changes in the sales mix change breakeven points
and operating incomes. In this example, the budgeted and actual total sales in number of units
were identical, but the proportion of the product having the higher contribution margin declined.
Operating income suffered, falling from $630,000 to $550,000. Moreover, the breakeven point
rose from 150,000 to 157,500 units.
3-36 (30 min.) Ethics, CVP analysis.
Revenues  Variable costs

1. Contribution margin percentage =
Revenues
$3,000,000  $2,100,000
=
$3,000,000
$900,000
= = 30%
$3,000,000
Fixed costs
Breakeven revenues =
$1,050,000
= = $3,500,000
0.30
2. If variable costs are 58% of revenues, contribution margin percentage equals 42%
(100%  58%)
Fixed costs
Breakeven revenues =
$1,050,000
= = $2,500,000
0.42

3-35
3. Revenues $3,000,000
Variable costs (0.58  $3,000,000) 1,740,000
4. Incorrect reporting of environmental costs with the goal of continuing operations is

unethical. In assessing the situation, the specific “Standards of Ethical Conduct for Management
Accountants” (described in Exhibit 1-7) that the management accountant should consider are
listed below.
Competence
Clear reports using relevant and reliable information should be prepared. Preparing reports on
the basis of incorrect environmental costs to make the company’s performance look better than it
is violates competence standards. It is unethical for Madden not to report environmental costs to
make the plant’s performance look good.
Integrity
The management accountant has a responsibility to avoid actual or apparent conflicts of interest
and advise all appropriate parties of any potential conflict. Madden may be tempted to report
lower environmental costs to please Foreman and Vang and save the jobs of his colleagues. This
action, however, violates the responsibility for integrity. The Standards of Ethical Conduct
require the management accountant to communicate favorable as well as unfavorable
information.
Credibility
The management accountant’s Standards of Ethical Conduct require that information should be
fairly and objectively communicated and that all relevant information should be disclosed. From
a management accountant’s standpoint, underreporting environmental costs to make
performance look good would violate the standard of objectivity.
Madden should indicate to Vang that estimates of environmental costs and liabilities should
be included in the analysis. If Vang still insists on modifying the numbers and reporting lower
environmental costs, Madden should raise the matter with one of Vang’s superiors. If after
taking all these steps, there is continued pressure to understate environmental costs, Madden
should consider resigning from the company and not engage in unethical behavior.

3-36
3-37 (30-40 min.) Deciding where to produce.
Ogden Sandy
Selling price $ 320.00 $320.00
Variable cost per unit
Manufacturing $ 95.00 $ 110.00
Marketing and distribution 15.00 110.00 15.00 125.00

Contribution margin per unit (CMU) 210.00 195.00
Fixed costs per unit
Manufacturing 48.00 24.00
Marketing and distribution 22.00 70.00 15.00 39.00

Operating income per unit $ 140.00 $156.00
CMU of normal production (as shown above) $210 $195

CMU of overtime production
($210 – $5; $195 – $10) 205 185
1.
Annual fixed costs = Fixed cost per unit  Daily
production rate  Normal annual capacity
($70  250 units  240 days;
$39  200 units  240 days) $ 4,200,000 $1,872,000
Breakeven volume = FC  CMU of normal
production ($4,200,000  $210; $1,872,000  195) 20,000 units 9,600 units
2.
Units produced and sold 60,000 60,000
Normal annual volume (units)
(250 × 240; 200 × 240) 60,000 48,000
Units over normal volume (needing overtime) 0 12,000
CM from normal production units (normal annual
volume  CMU normal production)
(60,000 × $210; 48,000 × 195) $12,600,000 $9,360,000
CM from overtime production units
(0; 12,000  $185) 0 2,220,000
Total contribution margin 12,600,000 11,580,000
Total fixed costs 4,200,000 1,872,000

Operating income $ 8,400,000 $9,708,000
Total operating income $18,108,000
3. The optimal production plan is to produce 75,000 units at the Ogden plant and 45,000
units at the Sandy plant. The full capacity of the Ogden plant, 75,000 units (250 units × 300
days), should be used because the contribution from these units is higher at all levels of
production than is the contribution from units produced at the Sandy plant.

3-37
Contribution margin per plant:
Ogden, 60,000 × $210 $12,600,000
Ogden 15,000 × $205 3,075,000
Sandy, 45,000 × $195 8,775,000
Total contribution margin 24,450,000
Deduct total fixed costs 6,072,000
Operating income $18,378,000
The contribution margin is higher when 75,000 units are produced at the Ogden plant and 45,000
units at the Sandy plant. As a result, operating income will also be higher in this case since total
fixed costs for the division remain unchanged regardless of the quantity produced at each plant.

3-38
CHAPTER 3 TEACHING NOTE
ON-THE-GO: Cost-Volume-Profit Analysis
1a. Contribution margin per unit for money orders:
Selling price: 79.0 cents

Deduct:
Processing fee 6.0 cents
Contribution margin 73.0 cents per unit
The instructor should ask students why costs of the counter clerks are not included in variable
costs since counter clerks are paid by the hour. The reason is that the costs of the counter clerks
will not change since new clerks would not be hired and existing clerks would not be asked to
work longer hours as a result of introducing the service. The service time needed to process the
money orders is expected to simply reduce the time that counter clerks are idle waiting for
customers to check out.
All other costs such as the cost of renting the machine of $30 per month and the lease rent of the
store of $5,000 per month are fixed costs and not variable costs and hence not included when
calculating the contribution margin per unit.
1b. Break even calculation using the equation method:
Revenues – Variable costs – Fixed costs (FC) = Operating income (OI)

Where
(Unit selling price × quantity (Q)) – (Unit variable costs × Q) – Fixed costs = OI
$0.79Q – $0.06Q – $30.00 = $0

$0.73Q – $30.00 = $0
$0.73Q = $30.00
Q = $30.00/$0.73 = 41.10 money orders (approximately 1 per day)
Break even calculation using the contribution margin method:

$30.00/$0.73 per unit = 41.10 units per month
The instructor may want to ask students why the fixed cost of lease rent of the store of $5,000 is
excluded from the break even calculations. The answer is that the question only asks about the
break even number of money orders should the service be introduced and so only the fixed costs
of providing the money order service should be included.
1c. Revenues – Variable costs – Fixed costs (FC) = Operating income (OI)
$0.79Q – $0.06Q – $30.00 = $140

$0.73Q – $30.00 = $140
$0.73Q = $140 + $30.00 = $170

3-39
Q = $170.00/$0.73 = 232.88 money orders per month (approximately 8 per day)
2.
Incremental operating income per 2-hour period each day if On-the-Go buys and sells 24
sandwiches from an outside vendor (12 sandwiches per hour × 2 hours):
Sales ($4.50 × 24 sandwiches) $108
Variable costs ($3.50 × 24 sandwiches) 84
Incremental operating income per 2-hour period each day if On-the-Go makes 24 sandwiches in-
house
Sales ($4.50 × 24 sandwiches) $108
Variable costs of ingredients ($2.50 × 24 sandwiches) 60
Cost of temporary worker ($10 per hour × 2 hours) 20
Total operating cost 80


3-40
The instructor may wish to ask students why the cost of labor used in the calculation is the $10
per hour paid to the temporary worker rather than the $15 per hour paid to the senior
employee who is actually making the sandwiches. The reason is that the cost of the senior
employee is a fixed cost that would be incurred regardless of whether On-the-Go sells deli
sandwiches or not. The additional cost of making the deli sandwiches is the cost of the
temporary worker hired so that On-the-Go can make Deli sandwiches. It is not relevant
that the temporary worker is not the one actually making the sandwiches.
On-the-Go should sell deli sandwiches. It is more profitable for On-the-Go to hire a temporary
worker for the 2-hour lunch period to allow the senior employee to make the sandwiches
rather than purchase the sandwiches from an outside vendor.
Students should discuss other factors that Peter Kankel may want to consider before deciding to
sell deli sandwiches. Can the deli sandwich station be set up in a way that does not affect
the flow of traffic in the store? Selling deli sandwiches should not disrupt the shopping of
customers looking for other products. Will selling deli sandwiches reduce sales of other
products? Can the temporary worker provide the same service as the senior employee for
the other activities?
If the deli sandwiches are made in-house, can they be produced at the same level of quality as the
sandwiches purchased from outside? An argument for making the sandwiches in-house is
that they are likely to be fresher than if the sandwiches were purchased from outside.
3.
Incr. optg. income from selling 300 money orders per month ($0.73 × 300) – $30 $ 189
Incr. optg. income per 30-day month from selling 24 deli sandwiches per day ($28×30) 840
Total increase in operating income from selling money orders and deli sandwiches $1,029
From a financial viewpoint, selling money orders and deli sandwiches increases
On-the-Go’s operating income. In making his final recommendation, however, Peter
Kankel needs to take into account the comments made by John Lefarge and Susan
Polk. From Lefarge’s point of view, adding these products is profitable in its own right

3-41
but On-the-Go might earn additional operating income from sales of other products
when customers come in for money orders or deli sandwiches. For example, customers
who might be attracted to money order services include those new to the location who
don’t have a bank checking account, or those who do not wish to establish a
relationship with a bank for financial services. In the Northeast, On-the-Go operates in
neighborhoods with large immigrant populations whose members have yet to open
bank checking accounts. These customers are also likely to buy On-the-Go’s other
products once they are in the store, for example a drink to go with the sandwich.
Some students will raise the concerns suggested by Susan Polk’s comments. For
example, since it takes three times as long for a clerk to complete a money order
transaction versus a typical product sale (90 seconds versus 30 seconds), customers
who are not purchasing money orders will have to wait three times longer while the
money order transaction is being completed. Some customers may choose not to wait,
thereby costing the store those sales. It is difficult to calculate the exact cost since the
number of customers who might leave and the contribution margin for the average
$3.00 sale is not known. Students may try to calculate the cost using the gross margin
percentage of 30%, and an estimate of the variable operating costs such as the labor of
the store clerk. Some reports about the convenience store industry indicate that 40% of
shoppers walk out of a convenience store due to long checkout lines costing the
industry over a billion dollars a year. On-the-Go may want to track customers coming
to the store each hour to determine peak traffic times that could be used to justify
additional staffing to cover those busy hours. If the stores have security cameras the
video could be used to track customers to identify the busy periods.
Instructors may also want to have students discuss Polk’s arguments that the cost of
making deli sandwiches should be calculated using the wage rate of the senior employee of $15
per hour rather than the wage rate of the temporary worker at $10 per hour used in the
calculation in question 2. The arguments why this is not correct has already been discussed in
question 2. The only additional point that can be made here is that if the temporary worker were
not hired the senior employee would have been stocking shelves and been paid $15 per hour for
doing so.
Copyright: Srikant M. Datar

3-42

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CHAPTER 3

NOTATIONS USED IN CHAPTER 3 SOLUTIONS

SP: Selling price

© 2014 Pearson Education. All rights reserved.

3-7 Examples include:

3-11 (10 min.) CVP computations.

Variable Fixed Total Operating Contribution Contribution

© 2014 Pearson Education. All rights reserved.

3-13 (20 min.) CVP exercises.

1b. Fixed costs ÷ Contribution margin per unit = Breakeven units

2. 5,400,000 ($0.60 – $0.46) – $860,000 = $ (104,000)

© 2014 Pearson Education. All rights reserved.

3-14 (10 min.) CVP analysis, income taxes.

1. Monthly fixed costs = $55,000 + $75,000 + $14,000 = $144,000

2. Tax rate 40%

3-15 (30 min.) CVP analysis, sensitivity analysis.

1. SP = $35.00  (1 – 0.30 margin to bookstore)

VCU = $4.50 variable production and marketing cost

CMU = $24.50 – $6.95 = $17.55 per copy

© 2014 Pearson Education. All rights reserved.

SOLUTION EXHIBIT 3-15A

= 175,214 copies sold (rounded up)

© 2014 Pearson Education. All rights reserved.

CMU = $24.50 – $7.44 = $17.06 per copy

CMU= $28.00 – $7.30 = $20.70 per copy

© 2014 Pearson Education. All rights reserved.

Revenues, 85,000 units  $25 $2,125,000

3-17 (25 min.) Operating leverage.

1a. Let Q denote the quantity of carpets sold

Breakeven point under Option 1

1b. Breakeven point under Option 2

2. Operating income under Option 1 = $510Q  $18,870

Find Q such that $510Q  $18,870 = $340Q

© 2014 Pearson Education. All rights reserved.

For Q > 111, say, 115 carpets,

For Q < 111, say, 105 carpets,

© 2014 Pearson Education. All rights reserved.

Contribution margin of the bundle = 3  $130 + 2  $80 = $390 + $160 = $550

© 2014 Pearson Education. All rights reserved.

Units sold to new customers (60%  220,000) 132,000

[$195S + $115 (1.5S)] – [$65S + $35 (1.5S)] – $16,500,000 = OI

© 2014 Pearson Education. All rights reserved.

New Upgrade Breakeven

© 2014 Pearson Education. All rights reserved.

Contribution margin of the bundle = 1  $5 + 4  $4 + 2  $3 = $5 + $16 + $6 = $27

Contribution margin – Fixed costs = Zero operating income

$5Q + $4(4Q) + $3(2Q) – $405,000 = 0

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Contribution margin of the bundle = 1  $5 + 2  $4 + 4  $3 = $5 + $8 + $12 = $25

Contribution margin – Fixed costs = Breakeven point

$5Q + $4(2Q) + $3(4Q) – $405,000 = 0

© 2014 Pearson Education. All rights reserved.

1. Ticket sales per concert $ 4,500

Net fixed costs $49,000

Less variable costs

Less fixed costs

2. Ticket sales per concert $ 4,500

© 2014 Pearson Education. All rights reserved.

Less variable costs

Less fixed costs

Operating Income if 53 concerts are held

Less variable costs

Less fixed costs