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S2 Ch 2. Cost-Volume-Profit Analysis

Cost-volume-profit (CVP) analysis

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Cost-volume-profit (CVP) analysis examines the behavior of total

revenues, total costs, and operating income as changes occur in the units sold, the selling price, the variable cost per unit, or the fixed costs of a product.
Example: Emma Frost is considering selling GMAT Success, a test prep book and software package for the business school admission test, at a college fair in Chicago. Emma knows she can purchase this package from a wholesaler at $120 per package, with the privilege of returning all unsold packages and receiving a full $120 refund per package. She also knows that she must pay $2,000 to the organizers for the booth rental at the fair. She will incur no other costs. She must decide whether she should rent a booth.

Basic Formulae
Sales Less: Variable Costs
Contribution Margin

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Less: Fixed Costs

Operating Income

Sales: Variable Costs:

Selling price Per Unit * Quantity Variable Cost Per Unit * Quantity

Basic Formulae
Sales Less: Variable Costs Contribution Margin Less: Fixed Costs Operating Income
Contribution margin is the difference between total revenues and total variable costs. This is an indication of the reason operating income changes as the number of units sold changes.

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Selling Price Per Unit Less: Variable Costs Per Unit Contribution Margin Per Unit

Contribution margin per unit is the difference between selling price and variable cost per unit.

3-17 (1 a & b)
Unit Sales Less: Variable cost Contribution Margin Less: Fixed cost Operating Income 400000 Per unit ($) 60 50 10 Amt in $ 24,000,000 20,000,000

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4,000,000
1,600,000

2,400,000

3-17 (2 & 3)
Unit Sales Less: Variable cost Contribution Margin Less: Fixed cost Operating Income 400000 Per unit ($) 60 32 Amt in $ 24,000,000 12,800,000

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11,200,000
4,800,000

6,400,000

Wilsor should accept case 2 as it would increase contribution margin, operating income

Contribution Margin Percentage

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The contribution margin percentage (also called contribution margin ratio) equals contribution margin per unit divided by the selling price. This is an indication of the percent of each sales dollar that is available to pay fixed costs and return on profit.

Unit Sales Less: Variable cost Contribution Margin Less: Fixed cost Operating Income 400000

Per unit ($) 60 50 10

Amt in $ 24,000,000 20,000,000 4,000,000 1,600,000 2,400,000

Contribution margin percentage =

4,000,000 = 16.67% 24,000,000

3-16
Case Revenues
Variable Costs

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Contribution

Fixed Costs

Total Costs

Operating Income

Contribution Margin %

a b c d

2000
2000 1000 1500

500

1500 500 300 600

300
300

800

1200 200

75% 25% 30%

40%

1500
700

1800
1000

300
300

0 300

900

1200

Breakeven Point

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Breakeven Point (BEP) is that quantity of output sold at which total revenue equal total cost that is, the quantity of output sold that results in 0 of operating income Contribution Margin Less: Fixed Cost Operating Income 100 100 0

Breakeven Point No profit No Loss

Quantity of Units sold

Fixed Cost Contribution Margin Per Unit

Breakeven Point in Units Amount of BEP in Revenue = Fixed Cost Contribution Margin Percentage

Breakeven Point in Revenues

Example
Calculating Breakeven Point in units & amounts

Breakeven numbers of Units Breakeven numbers of Units Breakeven numbers of Units

Fixed Cost Contribution Margin Per Unit

1,600,000 10

Given Sales Variable cost Fixed cost

Unit Per unit ($) ???? 60 50

Amt in $

160,000

1,600,000

Sales Less: Variable cost Contribution Margin Less: Fixed cost Operating Income Contribution Margin Percentage

Per unit Unit ($) Amt in $ 160,000 60 9,600,000 50 8,000,000 10 1,600,000 1,600,000 0

BEP in Revenue

Fixed Cost = Contribution Margin

Percentage
= 1,600,000 16.67% 9,600,000

BEP in Revenue
BEP in Revenue

16.67%

Target Operating Income

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Target Operating Income analysis can help managers determine the level of sales needed to attain a specified dollar amount of operating income. In order to determine TOI, simply treat the desired operating income as a fixed cost in the breakeven calculation.
Quantity of units required to be sold

= Fixed Costs + Target Operating Income Contribution Margin Per Unit

Target Operating Income

Quantity of units required to be sold = Fixed Costs + Target Operating Income Contribution Margin Per Unit
Unit Sales Less: Variable cost Contribution Margin Less: Fixed cost Operating Income 400,000 ???? Per unit ($) 60 50 10 Amt in $ 24,000,000 20,000,000 4,000,000 1,600,000 2,400,000

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Quantity of units required to be sold Quantity of units required to be sold

= =

1,600,000 + 2,400,000 10 400,000

CVP, changing revenues and costs

Case1 a Canadian Air charges passengers 1000 8% Case 2 1000 8%

E.g. 3-18

Case 3

Case 4

b
c d e f g

Commission earned by Sunshine on airfare

Sunshine's revenue/ticket (a*b) Variable costs Contribution/ticket (c-d) Fixed costs Break-even quantity (FC/Contribution per ticket) (f/e)

48

53

80
35 45 22000 489 10000

80
29 51 22000 431 10000

48
29 19 22000 1158 10000

53
29 24 22000 917 10000

h
i

Operating Profit required

Sales in units {(f+h)/e}

711

627

1684

1333

CVP Exercises Delicious Donuts

15% incr. in CM 15% decr. in CM 8% incr. in FC

E.g. 3-19
8% decr. in FC

Budget Revenue 12,500,000 (-) Variable cost 10,000,000 Contribution 2,500,000 (-) Fixed cost 2,250,000 Operating Income 250,000 Contribution Margin % 20% (Contribution/revenues)

Given

Case1 12,500,000

Case 2 12,500,000

9,625,000
2,875,000 2,250,000 625,000

10,375,000
2,125,000 2,250,000 -125,000

Case 3 12,500,000 10,000,000 2,500,000 2,430,000 70,000

Case 4 12,500,000 10,000,000 2,500,000 2,070,000 430,000

23%
10% incr. in units sold

17%
10% decr. in units sold

20%
15% incr. in FC, 15% incr. in units sold

20%
15% incr. in FC, 8% decr. in VC

Budget Revenue 12,500,000 (-) Variable cost 10,000,000 Contribution 2,500,000 (-) Fixed cost 2,250,000 Operating Income 250,000 Contribution Margin % 20.00% (Contribution/revenues)

Given

Case 5
13,750,000 11,000,000 2,750,000 2,250,000 500,000

Case 6 11,250,000 9,000,000

2,250,000 2,250,000 0

Case 7 14,375,000 11,500,000

2,875,000 2,587,500 287,500

Case 8 12,500,000 9,200,000

3,300,000 2,430,000 870,000

20%

20%

20%

26.40%

E.g. 3-20, Pg 112 Contribution & Operating Income Break-even point in Revenues Break-even point in units

The Doral Company manufactures and sells pens. Sales: 5,000,000 units @ $0.50per unit. Fixed costs $900,000/yr Variable costs are $0.30/yr

Given Revenues (-) Variable Costs Contribution

(-) Fixed Costs Operating Income Contribution Margin % (=Contribution/ Sales Rev.) Contribution Margin per unit (=Contribution/Sales Qty) Break-even point in revenues (=Fixed Costs/cm%)

Units 5,000,000

US$/unit 0.5 0.3

Cost (US$) 2,500,000 1,500,000 1,000,000

900,000 100,000

0.40
0.20

2,250,000
4,500,000

Break-even point in Units (=FC/cm per unit)

E.g. 3-20, Pg 112

The Doral Company Given Revenues (-) Variable Costs Units US$/ unit 1. Current Cost (US$)

2. $0.04per unit incr in VC

3. 10% incr in FC, 10% incr in units sold

$/ unit Cost (US$)

Units

$/ Unit

Cost

5,000,000 0.5 0.3

2,500,000 1,500,000

0.5

2,500,000

5,500,000 0.5

2,750,000

0.34

1,700,000
800,000 900,000 -100,000 0.32 0.16 2,812,500 5,625,000

0.3

1,650,000
1,100,000 990,000 110,000 0.40 0.20 2,475,000 4,950,000

Contribution
(-) Fixed Costs Operating Income Contribution Margin % (=Contribution Margin/ Sales Rev.) Contribution Margin per unit (=CM/Sales Qty) Break-even point in revenues (=Fixed Costs/cm%) Break-even point in Units (=FC/cm per unit)

1,000,000
900,000 100,000 0.40 0.20

2,250,000
4,500,000

E.g. 3-20, Pg 112

4. 20% decr in FC, 10% decr in SP, 10% decr in VC, 40% in Qty Sold

The Doral Company

Given Revenues (-) Variable Costs Contribution (-) Fixed Costs Operating Income Contribution Margin % (=Contribution Margin/ Sales Rev.) Contribution Margin per unit (=CM/Sales Qty) Break-even point in revenues (=Fixed Costs/cm%) Break-even point in Units (=FC/cm per unit) Units 5,000,000 US$/unit 0.5 0.3 Cost (US$) 2,500,000 1,500,000 1,000,000 900,000 100,000 0.40 0.20 2,250,000 4,500,000 Units 7,000,000 Per Unit 0.4 0.27 0.1 Cost 2,800,000 1,890,000 910,000 720,000 190,000 0.33 0.13 2,215,385 5,538,462

Target Net Income & Income Taxes

Target Net Income Target Operating Income = (Target Operating Income)

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* (1 - Tax Rate)

Target Net Income 1 Tax Rate

Replace

Quantity of units required to be sold

= Fixed Costs + Target Operating Income Contribution Margin Per Unit

Quantity of units = required to be sold

Fixed Costs +

Target Net Income 1 - tax Rate Contribution Margin Per Unit

Target Net Income & Income Taxes

Target Net Income Fixed Costs + Quantity of units = 1 - tax Rate required to be sold Contribution Margin Per Unit
Sales Less: Variable cost Contribution Margin Less: Fixed cost Operating Income Less: Income Taxes @ 30% Net Income Unit Per unit ($) 400,000 ???? 60 50
10

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Amt in $
24,000,000 20,000,000 4,000,000

1,600,000
2,400,000 720,000

1,680,000

1,600,000 Quantity of units = required to be sold Quantity of units = 400,000 required to be sold

+ 10

1,680,000 1 30%

3.21 (1)
Revenues Variable cost Per car Salespeople commission Contribution Margin
Fixed Cost Rent Salaries Advertisement

Breakeven numbers of Units

Fixed Cost Contribution Margin Per Unit

152,000 3,400

$29,000
$25,000 $600 $25,600 $3,400 $65,000 $75,000 $12,000 $152,000

Breakeven numbers of Units Breakeven numbers of Units

45

3.21 (2)

Target Operating Income

Target Net Income 1 Tax Rate

Revenues Variable cost Per car Salespeople commission Contribution Margin

Fixed Cost Rent Salaries Advertisement

$29,000
$25,000 $600 $25,600 $3,400 $65,000 $75,000 $12,000 $152,000 Given: Target Net Income = $69,000 Tax rate = 25%

Target Operating Income Target Operating Income

= =

69,000 1 25% $92,000

3.21 (2)
Revenues Variable cost Per car Salespeople commission Contribution Margin
Fixed Cost Rent Salaries Advertisement

Quantity of units = required to be sold

$29,000
$25,000 $600 $25,600 $3,400 $65,000 $75,000 $12,000 $152,000

Fixed Costs +

Target Net Income 1 - tax Rate Contribution Margin Per Unit

Given: Target Net Income = $69,000 Tax rate = 25%

Quantity of units = required to be sold

152,000 + 3400

69,000 1 25%

Quantity of units = 72 units required to be sold

Using CVP Analysis for Decision Making

Decision to Advertise
40 Packages sold NO ADVERTISING Sales Less: Variable cost Contribution Margin Less: Fixed cost Operating Income Unit Per unit ($) 40 200 120 80 Amt in $ 8,000 4,800 3,200 2,000 1,200

Advertisement cost is 500. Advertising will increase sales by 10%

44 Packages sold WITH ADVERTISING Sales Less: Variable cost Contribution Margin Less: Fixed cost Operating Income

Unit Per unit ($) 44 200 120 80

Amt in $ 8,800 5,280 3,520 2,500 1,020

Using CVP Analysis for Decision Making

Decision to Reduce Selling Price
40 Packages sold NO ADVERTISING Sales Less: Variable cost Contribution Margin Less: Fixed cost Operating Income Unit Per unit ($) 40 200 120 80 Amt in $ 8,000 4,800 3,200 2,000 1,200

Having decided not to advertise, now whether to reduce the selling price to 175, due to which quantity sold will be 50 packages
50 Packages sold WITH REDUCING PRICES Sales Less: Variable cost Contribution Margin Less: Fixed cost Operating Income Unit Per unit ($) 50 175 120 55 Amt in $ 8,750 6,000 2,750 2,000 750

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