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CHAPTER 4

COST-VOLUME-PROFIT ANALYSIS:
A MANAGERIAL PLANNING TOOL
DISCUSSION QUESTIONS
1. CVP analysis allows managers to focus on
selling prices, volume, costs, profits, and
sales mix. Many different what-if questions
can be asked to assess the effect of
changes in key variables on profits.

8. Packages of products, based on the


expected sales mix, are defined as a single
product. Selling price and cost information
for this package can then be used to carry
out CVP analysis.

2. The units sold approach defines sales


volume in terms of units of product and
gives answers in these same terms. The unit
contribution margin is needed to solve for
the break-even units. The sales revenue
approach defines sales volume in terms of
revenues and provides answers in these
same terms. The overall contribution margin
ratio can be used to solve for the break-even
sales dollars.

9. This statement is wrong; break-even


analysis can be easily adjusted to focus on
targeted profit.
10.

The basic break-even equation is adjusted


for targeted profit by adding the desired
targeted profit to the total fixed costs in the
numerator. The denominator remains the
contribution margin per unit.

11.

A change in sales mix will change the


contribution margin of the package (defined
by the sales mix), and thus will change the
units needed to break even.

12.

Margin of safety is the sales activity in excess


of that needed to break even. The higher the
margin of safety, the lower the risk.

3. Break-even point is the level of sales activity


where total revenues equal total costs, or
where zero profits are earned.
4. At the break-even point, all fixed costs are
covered. Above the break-even point, only
variable costs need to be covered. Thus,
contribution margin per unit is profit per unit,
provided that the unit selling price is greater
than the unit variable cost (which it must be
for break even to be achieved).

13. Operating leverage is the use of fixed costs


to extract higher percentage changes in
profits as sales activity changes. It is
achieved by increasing fixed costs while
lowering variable costs. Therefore, increased
leverage implies increased risk, and vice
versa.

5. Variable cost ratio = Variable costs/Sales


Contribution margin ratio
= Contribution margin/Sales

14. Sensitivity analysis is a what-if technique


that examines the impact of changes in
underlying assumptions on an answer. A
company can input data on selling prices,
variable costs, fixed costs, and sales mix
and set up formulas to calculate break-even
points and expected profits. Then, the data
can be varied as desired to see what impact
changes have on the expected profit.

Contribution margin ratio


= 1 Variable cost ratio
6. No. The increase in contribution is $9,000
(0.3 $30,000), and the increase in
advertising is $10,000. If the contribution
margin ratio is 0.40, then the increased
contribution margin is $12,000 (0.4
$30,000). This is $2,000 above the increased
advertising expense, so the increased
advertising would be a good decision.

15. A declining margin of safety means that


sales are moving closer to the breakeven point. Profit is going down, and the
possibility of loss is greater. Managers
should analyze the reasons for the
decreasing margin of safety and look for

7. Sales mix is the relative proportion sold of


each product. For example, a sales mix of
3:2 means that three units of one product
are sold for every two of the second product.

4-1
4-1

ways to increase
decrease costs.

revenue

and/or

4-2

MULTIPLE-CHOICE EXERCISES
41

42

43

44

45

46

47

48

49

Break-even units =

410

Variable cost ratio =

$9,000
= 3,000
$15 - $12
$12
= 0.80, or 80%
$15

Contribution margin ratio =


411

412

Units to be sold =

$15 - $12
= 0.20, or 20%
$15

($15,000 + $3,600)
= 6,200
($8 - $5)

4-1
4-1

CORNERSTONE EXERCISES
Cornerstone Exercise 413
1. Variable cost per unit = Direct materials + Direct labor
+ Variable factory overhead + Variable selling expense
= $30 + $5 + $12 + $2
= $49
2. Total fixed expense = $14,000 + $15,400 = $29,400
3.

Head-First Company
Contribution Margin Income Statement
For the Coming Year
Sales ($70 5,000 helmets)..................................
Total variable expense ($49 5,000)....................
Total contribution margin.....................................
Total fixed expense................................................
Operating income .................................................

Total

Per Unit

$350,000
245,000
$105,000
29,400
$ 75,600

$70
49
$21

Cornerstone Exercise 414


1. Break-even units =

Total fixed cost


(Price - Unit variable cost)
$29,400
($70 - $49)

= 1,400 helmets
2.

Head-First Company
Contribution Margin Income Statement
At Break-Even
Sales ($70 1,400 helmets)........................................................
Total variable expense ($49 1,400).........................................
Total contribution margin...........................................................
Total fixed expense.....................................................................
Operating income........................................................................

4-2
4-2

Total
$98,000
68,600
$29,400
29,400
$
0

Cornerstone Exercise 415


1. Variable cost ratio =
=

Variable cost per unit


Price
$49
$70

= 0.70, or 70%
(Price - Variable cost per unit)
Price

2. Contribution margin ratio =


=

Contribution margin per unit


Price

($70 - $49)
$70

= 0.30, or 30%
3.

Head-First Company
Contribution Margin Income Statement
For the Coming Year
Percent
of Sales
Sales ($70 5,000 helmets)..................................
Total variable expense ($49 5,000)....................
Total contribution margin.....................................
Total fixed expense................................................
Operating income .................................................

Cornerstone Exercise 416


Total fixed cost

1. Break-even sales dollars = Contributi on margin ratio


=

$29,400
0.30

= $98,000

4-3
4-3

$350,000
245,000
$105,000
29,400
$ 75,600

100%
70
30

Cornerstone Exercise 416


2.

(Concluded)

Head-First Company
Contribution Margin Income Statement
At Break-Even
Sales..............................................................................................
Total variable expense ($98,000 0.70)....................................
Total contribution margin...........................................................
Total fixed expense.....................................................................
Operating income........................................................................

Total
$98,000
68,600
$29,400
29,400
$
0

Cornerstone Exercise 417


1.

Break-even units =

(Total fixed cost + Target income)


(Price - Unit variable cost
($29,400 + $81,900)
($70 - $49)

= 5,300 helmets
2.

Head-First Company
Contribution Margin Income Statement
At 5,300 Helmets Sold
Sales ($70 5,300 helmets)........................................................
Total variable expense ($49 5,300).........................................
Total contribution margin...........................................................
Total fixed expense.....................................................................
Operating income........................................................................

Cornerstone Exercise 418


1. Sales for target income =

(Total fixed cost + Target income)


Contribution margin ratio
($29,400 + $81,900)
0.30

= $371,000

4-4
4-4

Total
$371,000
259,700
$111,300
29,400
$ 81,900

Cornerstone Exercise 418


2.

(Concluded)

Head-First Company
Contribution Margin Income Statement
At 5,300 Helmets Sold
Sales..............................................................................................
Total variable expense ($371,000 0.70)..................................
Total contribution margin...........................................................
Total fixed expense.....................................................................
Operating income........................................................................

Total
$371,000
259,700
$111,300
29,400
$ 81,900

Cornerstone Exercise 419


1. Any package with 5 bicycle helmets for every 1 motorcycle helmet is fine. For
example, 5:1, or 10:2, or 30:6. Throughout the rest of this exercise, we will use
5:1.

Product
Bicycle helmet
Motorcycle helmet
Package total
2. Break-even packages

Price
$ 70
220

Unit
Variable
Cost

Unit
Contribution
Margin

Sales
Mix

$21
77

5
1

$ 49
143

Package Unit
Contribution
Margin
$105
77
$182

Fixed cost

= Package contributi on margin


=

$54,600
$182

= 300 packages
Break-even bicycle helmets = Number of packages Sales mix amount
= 300 5
= 1,500
Break-even motorcycle helmets = Number of packages Sales mix amount
= 300 1
= 300

4-5
4-5

Cornerstone Exercise 419


3.

(Concluded)

Head-First Company
Contribution Margin Income Statement
At Break-Even
Sales [($70 1,500) + ($220 300)]............................................
Total variable expense [($49 1,500) + ($143 300)]..............
Total contribution margin...........................................................
Total fixed expense.....................................................................
Operating income........................................................................

Total
$171,000
116,400
$ 54,600
54,600
$
0

Cornerstone Exercise 420


1. Contribution margin ratio =

($570,000 - $388,000)
$570,000

= 0.3193
Break-even sales dollars

Total fixed cost

= Contributi on margin ratio


=

$54,600
0.3193

= $170,999
2.

Head-First Company
Contribution Margin Income Statement
At Break-Even Sales Dollars
Sales..............................................................................................
Total variable expense ($170,999 0.6807)..............................
Total contribution margin...........................................................
Total fixed expense.....................................................................
Operating income........................................................................

4-6
4-6

Total
$170,999
116,399
$ 54,600
54,600
$
0

Cornerstone Exercise 421


1. Margin of safety in units = Budgeted units Break-even units
= 5,000 1,400
= 3,600
2. Margin of safety in sales revenue = Budgeted sales Break-even sales
= $350,000 $98,000
= $252,000

Cornerstone Exercise 422


Degree of operating leverage =

Total contributi on margin


Operating income
$105,000

= $75,600
= 1.4

Cornerstone Exercise 423


1. Percent change in operating income = DOL % Change in sales
= 1.4 15%
= 21%
2. Expected operating income = Original income + (% Change Original income)
= $75,600 + (0.21 $75,600)
= $91,476

4-7
4-7

EXERCISES
Exercise 424
1. Direct materials............................................................................
Direct labor...................................................................................
Variable overhead........................................................................
Variable selling and administrative expense............................
Unit variable cost.........................................................................

$3.90
1.40
2.10
1.60
$9.00

Unit contribution margin = Price Unit variable cost


= $16 $9
= $7
2. Contribution margin ratio =
Variable cost ratio =

3. Break-even units =

$7
= 0.4375, or 43.75%
$16

$9
= 0.5625, or 56.25%
$16

($52,000 + $37,950)
= 12,850
($16 - $9)

4. Sales ($16 12,850).....................................................................


Variable cost ($9 12,850)..........................................................
Total contribution margin......................................................
Less: Fixed expenses ($52,000 + $37,950)................................
Operating income...................................................................

Exercise 425
1. Unit variable cost = $7.60 0.60 = $4.56
Unit contribution margin = $7.60 $4.56 = $3.04
2. Break-even units =

$349,600
$3.04

= 115,000

4-8
4-8

$205,600
115,650
$ 89,950
89,950
$
0

Exercise 425

(Concluded)

3. Break-even sales revenue = $7.60 115,000 = $874,000


OR
Break-even sales revenue =

$349,600
= $874,000
0.40

4. Sales..............................................................................................
Less: Variable costs....................................................................
Contribution margin....................................................................
Less: Fixed costs.........................................................................
Operating income........................................................................

$874,000
524,400
$349,600
349,600
$
0

Exercise 426
1. Contribution margin ratio =

Contribution margin
Sales
$18,000

= $90,000 = 0.20, or 20%

2. Variable cost ratio =

$72,000
= 0.80, or 80%
$90,000

OR
Variable cost ratio = 1 Contribution margin ratio = 1.00 0.20 = 0.80
Fixed cost

3. Break-even revenue = Contributi on margin ratio


=

$6,900
= $34,500
0.20

4-9
4-9

Exercise 427
1. Sales ($14 27,000).....................................................................
Variable cost ($9.50 27,000).....................................................
Total contribution margin......................................................
Less: Fixed expenses..................................................................
Operating income........................................................................
2. Break-even units =

$378,000
256,500
$121,500
126,000
$ (4,500)

$126,000
= 28,000
($14 - $9.50)

3. Units to earn target income =

($126,000 + $9,900)
= 30,200
($14 - $9.50)

Exercise 428
1. Break-even units =
=

($131,650 + $18,350)
($2.45 - $1.65)
$150,000
$0.80

= 187,500
2. Unit variable cost includes all variable costs on a unit basis:
Direct materials......................................................................
Direct labor.............................................................................
Variable overhead..................................................................
Variable selling.......................................................................
Unit variable cost...................................................................

$0.27
0.58
0.63
0.17
$1.65

Unit variable manufacturing cost includes the variable costs of production on


a unit basis:
Direct materials......................................................................
Direct labor.............................................................................
Variable overhead..................................................................
Unit variable manufacturing cost.........................................

$0.27
0.58
0.63
$1.48

Unit variable cost is used in CVP because it includes all variable costs, not
just manufacturing costs.

4-10
4-10

Exercise 428

(Concluded)

3. Units to earn $12,600 =

($131,650 + $18,350 + $12,600)


($2.45 - $1.65)

= 203,250
4. Sales revenue to earn $12,600 = 203,250 $2.45 = $497,962.50

Exercise 429
1. Break-even units =

($231,650 + $315,390)
= 208,000
($6.28 - $3.65)

2. Expected sales in units...............................................................


Break-even units..........................................................................
Margin of safety (in units)...........................................................

380,000
(208,000)
172,000

3. Expected sales revenue ($6.28 380,000)................................ $2,386,400


Break-even sales revenue*.........................................................
1,306,240
Margin of safety (in dollars)........................................................ $1,080,160
*Break-even revenue = Price Break-even units = $6.28 208,000 units

Exercise 430
Sales
Total variable costs
Total contribution margin
Total fixed costs
Operating income (loss)

A
$15,000
5,000
$10,000
9,500*
$ 500

Units sold
Price per unit
Variable cost per unit
Contribution margin per unit
Contribution margin ratio
Break even in units

3,000*
$5.00
$1.67*
$3.33*
67%*
2,853*

B
$15,600*
11,700
$ 3,900
4,000
$ (100)*
1,300
$12*
$9
$3
25%*
1,333*

C
$16,250*
9,750
$ 6,500*
6,136*
$ 364

D
$10,600
5,300*
$ 5,300*
4,452
$ 848

125
$130
$78*
$52*
40%
118*

1,000
$10.60*
$5.30*
$5.30*
50%*
840*

*Designates calculated amount.


(Note: Calculated break-even units that include a fractional amount have been
rounded to the nearest whole unit.)

4-11
4-11

Exercise 431
$141,750

1. Variable cost ratio = $315,000 = 0.45, or 45%


$173,250

Contribution margin ratio = $315,000 = 0.55, or 55%


2. Because all fixed costs are covered by break even, any revenue above break
even contributes directly to operating income.
Sales Contribution margin ratio = Increased operating income
$30,000 0.55 = $16,500
Therefore, operating income will be $16,500 higher.

3. Break-even sales revenue =

$63,000
= $114,545 (rounded to the nearest
0.55

dollar)
Sales..............................................................................................
Less: Variable cost ($114,545 0.45)........................................
Contribution margin...............................................................
Less: Fixed cost...........................................................................
Operating income...................................................................

$114,545
51,545
$ 63,000
63,000
$
0

4. Expected sales.............................................................................
Break-even sales.........................................................................
Margin of safety......................................................................

$315,000
114,545
$200,455

5. Sales revenue...............................................................................
Break-even sales.........................................................................
Margin of safety......................................................................

$280,000
114,545
$165,455

4-12
4-12

Exercise 432
1. Sales mix is 2:1 (twice as many DVDs are sold as equipment sets).
2.
Product

Price

DVDs
Equipment sets
Total

$12
15

Break-even packages =

Variable
Cost
=

CM

$4
6

$8
9

Sales
Mix

2
1

Total
CM
$16
9
$25

$70,000
= 2,800
$25

Break-even DVDs = 2 2,800 = 5,600


Break-even equipment sets = 1 2,800 = 2,800

Exercise 433
1. Sales mix is 2:1:4 (twice as many DVDs will be sold as equipment sets, and
four times as many yoga mats will be sold as equipment sets).
2.
Product

Price

DVDs
Equipment sets
Yoga mats
Total

$12
15
18

Break-even packages =

Variable
Cost
=

CM

$4
6
13
$118,350
$45

$8
9
5

= 2,630

Break-even DVDs = 2 2,630 = 5,260


Break-even equipment sets = 1 2,630 = 2,630
Break-even yoga mats = 4 2,630 = 10,520

4-13
4-13

Sales
Mix
2
1
4

Total
CM
$16
9
20
$45

Exercise 433

(Concluded)

3.

Switzer Company
Income Statement
For the Coming Year
Sales..............................................................................................
Less: Total variable costs...........................................................
Contribution margin...............................................................
Less: Total fixed costs................................................................
Operating income...................................................................

$555,000
330,000
$225,000
118,350
$106,650

$225,000

Contribution margin ratio = $555,000 = 0.405, or 40.5%


Break-even revenue =

$118,350
= $292,222
0.405

4. Margin of safety = $555,000 $292,222 = $262,778

Exercise 434
1. Sales mix is 3:5:1 (three times as many small basics will be sold as carved
models, and five times as many large basics will be sold as carved models).
2.
Product

Price

Small basic
Large basic
Carved model
Total

$120
200
350

Break-even packages =

Variable
Cost
=
$ 70
150
275

CM
$50
50
75

$446,500
= 940
$475

Break-even small basic models = 3 940 = 2,820


Break-even large basic models = 5 940 = 4,700
Break-even carved models = 1 940 = 940

4-14
4-14

Sales
Mix
3
5
1

Total
CM
$150
250
75
$475

Exercise 434

(Concluded)

3.

Sonora Company
Income Statement
For the Coming Year
Sales..............................................................................................
Less: Total variable costs...........................................................
Contribution margin...............................................................
Less: Total fixed costs................................................................
Operating income...................................................................

$17,100,000
12,350,000
$ 4,750,000
446,500
$ 4,303,500

$4,750,000

Contribution margin ratio = $17,100,00 0 = 0.2778, or 27.78%


Break-even revenue =

$446,500
= $1,607,271
0.2778

4. Margin of safety = $17,100,000 $1,607,271 = $15,492,729

Exercise 435
$35,000
$30,000

$ Profit

$25,000

$20,000
$15,000
$10,000 X
$5,000
$0
0

500

1,000

1,500

2,000

2,500

3,000

3,500

Units Sold

Break-even point = 2,500 units; + line is total revenue, and x line is total
cost.

4-15
4-15

Exercise 435

a. Fixed costs increase by $5,000:


$40,000

X
$35,000
$30,000
$25,000

$ Profit

2.

(Continued)

$20,000
$15,000X
$10,000
$5,000
$0
0

500

1,000

1,500

2,000

2,500

Units Sold

Break-even point = 3,750 units

4-16
4-16

3,000

3,500

4,000

Exercise 435

b. Unit variable cost increases to $7:

$50,000

$40,000

$ Profit

2.

(Continued)

$30,000

$20,000

$10,000

$0
0

500

1,000

1,500

2,000

Units Sold
Break-even point = 3,333 units

4-17
4-17

2,500

3,000

3,500

4,000

Exercise 435

c. Selling price increases to $12:


$60,000

$50,000

$40,000

$ Profit

2.

(Continued)

$30,000

$20,000

$10,000

$0
0

500

1,000

1,500

2,000

Units Sold

Break-even point = 1,667 units

4-18
4-18

2,500

3,000

3,500

4,000

Exercise 435
2.

(Concluded)

d. Both fixed costs and unit variable cost increase:


$70,000
$60,000

$ Profit

$50,000
$40,000
$30,000
$20,000 X
$10,000
$0
0

1,000

2,000

3,000

4,000

Units Sold

Break-even point = 5,000 units

Exercise 436
1. Unit contribution margin =
Break-even units =

$486,000
18,000

$540,000
$27

= $27

= 20,000 units

2. Operating income = 30,000 $27 = $810,000


3. Contribution margin ratio =
Break-even sales revenue =

$27
= 0.45, or 45%
$60

$540,000
= $1,200,000
0.45

Profit = ($200,000 0.45) $54,000 = $36,000

4-19
4-19

5,000

6,000

7,000

Exercise 437
1. Break-even sales dollars =

$916,650
= $1,580,431
0.58 *
$1,305,000

*Contribution margin ratio = $2,250,000

= 0.58, or 58%

2. Margin of safety = $2,250,000 $1,580,431 = $669,569


Contributi on margin

3. Degree of operating leverage = Operating income


$1,305,000

= $388,350
= 3.36

4. Percent change in operating income = 3.36 0.20 = 0.67


New operating income = $388,350 + (0.67 $388,350) = $648,545

4-20
4-20

Exercise 438
1.
Product
Vases
Figurines
Total

Price

$40
70

Break-even packages =

Variable
Cost
=
$30
42

CM

$10
28

Sales
Mix
2
1

Package
=
CM
$20
28
$48

$30,000
= 625
$48

Break-even vases = 2 625 = 1,250


Break-even figurines = 1 625 = 625
2. The new sales mix is 3 vases to 2 figurines.
Product
Vases
Figurines
Total

Price
$40
70

Break-even packages =

Variable
Cost
=
$30
42

CM
$10
28

$35,260
= 410
$86

Break-even vases = 3 410 = 1,230


Break-even figurines = 2 410 = 820

4-21
4-21

Sales
Mix
3
2

Package
=
CM
$30
56
$86

Exercise 439
1.

a. Variable cost per unit =

$6,720,000
350,000

= $19.20

b. Contribution margin per unit =


c. Contribution margin ratio =
d. Break-even units =

$4.80
$24.00

$1,512,000
$4.80

e. Break-even sales dollars =

$1,680,000
350,000

= $4.80

= 0.20, or 20%

= 315,000

$1,512,000
= $7,560,000
0.20

OR
Break-even sales dollars = 315,000 $24 = $7,560,000
2. Units for target income =

($1,512,000 + $300,000)
= 377,500
$4.80

3. Additional operating income = $50,000 0.20 = $10,000


4. Margin of safety in units = 350,000 315,000 = 35,000 units
Margin of safety in sales dollars = $8,400,000 $7,560,000 = $840,000
$1,680,000

5. Degree of operating leverage = $168,000

= 10.0

6. New operating income = $168,000 + [(10 0.10) ($168,000)] = $336,000

4-22
4-22

PROBLEMS
Problem 440
1. Break-even units =

Fixed cost
(Price - Unit variable cost)

$716,800
($20 - $12)

$716,800
$8

= 89,600 units
2. Units for target profit =
=

($716,800 + $640,000)
$8
$1,356,800
$8

= 169,600 units
3. Contribution margin ratio =

$8
= 0.40
$20

With additional sales of $50,000, the additional profit would be 0.40 $50,000 =
$20,000.
4. Current units =

$2,480,000

= 124,000 units

$20
Margin of safety in units = 124,000 89,600 = 34,400 units

4-23
4-23

Problem 441
1. Break-even units =

Fixed cost
(Price - Unit variable cost)
$96,000
($10 - $5)

= 19,200 units

2. Break-even units =

($96,000 - $13,500)
($10 - $5)

= 16,500 units
3. The reduction in fixed costs reduces the break-even point because less
contribution margin is needed to cover the new, lower fixed costs. Operating
income goes up, and the margin of safety also goes up.

Problem 442
1. Unit contribution margin =
Break-even point =

$1,920,000
128,000

$1,000,000
$15

Contribution margin ratio =


Break-even sales =

= $15

= 66,667 units

$15
= 0.3
$50

$1,000,000
= $3,333,333
0.3

OR
= $50 66,667 = $3,333,350 (rounded)
Note: Difference in break-even sales due to rounding.
2. Increased contribution margin ($1,000,000 0.3)....................
Less: Increased advertising expense........................................
Increased profit......................................................................

4-24
4-24

$300,000
100,000
$200,000

Problem 442

(Concluded)

3. $315,000 0.3 = $94,500


4. Margin of safety = $6,400,000 $3,333,333 = $3,066,667
Or
= $6,400,000 $3,333,350 = $3,066,650 (rounded)
Note: Difference in margin of safety due to rounding in break-even sales.
5.

$1,920,000
$920,000

= 2.09 (operating leverage)

20% 2.09 = 41.8% (profit increase)

Problem 443
1. Sales mix:
Squares:

$300,000
$30

Circles:

$2,500,000
$50

Product

Price

Squares
Circles
Package

$30
50

$100,000

* 10,000

$500,000
50,000

= 10,000 units
= 50,000 units

Variable
Cost* =
$10
10

Contribution
Margin
$20
40

= $10
= $10

Break-even packages =

$1,628,000
$220

= 7,400 packages

Break-even squares = 7,400 1 = 7,400


Break-even circles = 7,400 5 = 37,000

4-25
4-25

Sales
Mix =
1
5

Total
CM
$ 20
200
$220

Problem 443

(Concluded)

2. New mix:
Product

Price

Squares
Circles
Package

$30
50

Break-even packages =

Variable
Cost* =

Contribution
Margin

$10
10
$1,628,000
$260

$20
40

Sales
Mix =
3
5

Total
CM
$ 60
200
$260

= 6,262 packages

Break-even squares = 6,262 3 = 18,786


Break-even circles = 6,262 5 = 31,310
3. Increase in contribution margin for squares (25,000 $20)...
Decrease in contribution margin for circles (5,000 $40)......
Increase in total contribution margin...................................
Less: Additional fixed expenses................................................
Increase in income.................................................................

$ 500,000
(200,000)
$ 300,000
245,000
$ 55,000

Gosnell would gain $55,000 by increasing advertising for the squares. This
is a good strategy.

Problem 444
1. Break-even units =

$58,500
= 650,000
($0.36 - $0.27)

Margin of safety in units = 830,000 650,000 = 180,000


2. Sales revenue ($0.36 830,000).................................................
Total variable cost ($0.27 830,000).........................................
Total contribution margin......................................................
Total fixed expense.....................................................................
Operating income...................................................................
3. Units for target profit

($58,500 + $36,000)
($0.36 - $0.27)

= 1,050,000

4-26
4-26

$298,800
224,100
$ 74,700
58,500
$ 16,200

Problem 444

(Concluded)

4. Operating income = Sales (Variable cost ratio Sales) Fixed cost


0.20 Sales = Sales (0.75 Sales) $58,500
0.20 Sales = 0.25 Sales $58,500
$58,500 = (0.25 Sales 0.20 Sales)
$58,500 = 0.05 Sales
Sales = $1,170,000

Problem 445
$302,616

1. Contribution margin ratio = $560,400 = 0.54, or 54%


2. Revenue =

$150,000
= $277,778
0.54

3. $560,400 110% = $616,440


$257,784 110% =

283,562
$332,878
$332,878

Contribution Margin Ratio = $616,440 = 0.54


The contribution margin ratio remains at 0.54.
4. Additional variable expense: $560,400 0.03 = $16,812
New contribution margin = $302,616 $16,812 = $285,804
$285,804

New contribution margin ratio = $560,400 = 0.51


Break-even point =

$150,000
= $294,118
0.51

The effect is to increase the break-even point.

4-27
4-27

Problem 445

(Concluded)

5. Present contribution margin......................................................


Projected contribution margin*..................................................
Increase in contribution margin/profit......................................

$302,616
326,604
$ 23,988

*($560,400 + $80,000) 0.51 = $326,604


Operating leverage will decrease because the increase in variable costs (the
sales commission) causes a decrease in the contribution margin.
Doerhing should pay the commission because profit would increase by
$23,988.

Problem 446
1. Revenue =
=

Fixed cost
(1 - Variable rate)
$150,000
(1/3)

= $450,000
2. Of total sales revenue, 60 percent is produced by floor lamps and 40 percent
by desk lamps.
$360,000
$30

= 12,000 units

$240,000
$20

= 12,000 units

Thus, the sales mix is 1:1.

4-28
4-28

Problem 446

(Concluded)

Product

Price

Floor lamps
Desk lamps
Package

$30
20

Variable
Cost
=

Contribution
Margin

Sales
Mix =

Total
CM

$10.00
6.67

1
1

$10.00
6.67
$16.67

$20.00
13.33

Number of packages =
=

Fixed cost
(Price - Variable cost)
$150,000
$16.67

= 8,998 packages
Floor lamps: 1 8,998 = 8,998
Desk lamps: 1 8,998 = 8,998
3. Operating leverage =

Contribution margin
Operating income
$200,000

= $50,000
= 4.0

Percentage change in profits = 4.0 40% = 160%

Problem 447
1.
CM
CM ratio

Door Handles

Trim Kits

$12 $9 = $3
$3/$12 = 0.25

$8 $5 = $3
$3/$8 = 0.375

2. Contribution margin:
($3 20,000) + ($3 40,000)
Less: Fixed costs
Operating income

$180,000
146,000
$ 34,000

4-29
4-29

Problem 447

(Concluded)

3. Sales mix (from Requirement 2): 1 door handle to 2 trim kits


Price
Door handle
Trim kit
Package

$12
8

$9
5

Break-even packages

CM

$3
3

Sales Mix
1
2

Total CM
$3.00
6.00
$9.00

$146,000
= 16,222
$9

Door handles = 1 16,222 = 16,222


Trim kits = 2 16,222 = 32,444
4. Revenue (70,000 $8).................................................................
Variable cost (70,000 $5)..........................................................
Contribution margin...............................................................
Fixed cost.....................................................................................
Operating income...................................................................

$560,000
350,000
$210,000
111,000
$ 99,000

Yes, operating income is $65,000 higher than when both door handles and trim
kits are sold.

Problem 448
1. Break-even units =
$406,000

* 29,000

$300,000
= 21,429
$14*

= $14

Break-even in dollars = 21,429 $42** = $900,018


OR
=

$300,000
(1/3)

= $900,000

The difference is due to rounding.


**

$1,218,000
29,000

= $42

4-30
4-30

Problem 448

(Concluded)

2. Margin of safety = $1,218,000 $900,000 = $318,000


3. Sales.............................................................................................. $1,218,000
Variable cost (0.45 $1,218,000)................................................
548,100
Contribution margin............................................................... $ 669,900
Fixed costs...................................................................................
550,000
Operating income................................................................... $ 119,900
Break-even in units =

$550,000
= 23,810
$23.10*

Break-even in sales dollars =


$669,900

* 29,000

$669,900

** $1,218,000

$550,000
= $1,000,000
0.55**

= $23.10
= 55%

Problem 449
1. Variable cost ratio

Variable costs
Sales
$353,400

= $930,000 = 0.38, or 38%


Contribution margin ratio =
=

(Sales - Variable costs)


Sales
($930,000 - $353,400)
$930,000

= 0.62, or 62%
2. Break-even sales revenue =
3. Margin of safety

$310,000
= $500,000
0.62

= Sales Break-even sales


= $930,000 $500,000 = $430,000

4-31
4-31

Problem 449

(Concluded)

4. Contribution margin from increased sales = ($7,500)(0.62) = $4,650


Cost of advertising = $5,000
No, the advertising campaign is not a good idea, because the companys
operating income will decrease by $350 ($4,650 $5,000).

Problem 450
1.

Income = Revenue Variable cost Fixed cost


$0 = 1,500P $300(1,500) $120,000
$0 = 1,500P $450,000 $120,000
$570,000 = 1,500P
P = $380

2.

$160,000
= 128,000
($3.50 - Unit variable cost)

Unit variable cost = $2.25

Problem 451
1. Contribution margin per unit = $5.60 $4.20*
= $1.40
*Variable costs per unit:
$0.70 + $0.35 + $1.85 + $0.34 + $0.76 + $0.20 = $4.20
Contribution margin ratio =

2. Break-even in units =

$1.40
$5.60

= 0.25

($32,300 + $12,500)
= 32,000 boxes
$1.40

Break-even in sales = 32,000 $5.60 = $179,200


OR
=

($32,300 + $12,500)
= $179,200
0.25

4-32
4-32

Problem 451

(Concluded)

3. Sales ($5.60 35,000)..................................................................


Variable cost ($4.20 35,000).....................................................
Contribution margin...............................................................
Fixed cost.....................................................................................
Operating income...................................................................

$196,000
147,000
$ 49,000
44,800
$ 4,200

4. Margin of safety = $196,000 $179,200 = $16,800


5. Break-even in units =

$44,800
= 22,400 boxes
($6.20 - $4.20)

New operating income = $6.20(31,500) $4.20(31,500) $44,800


= $195,300 $132,300 $44,800 = $18,200
Yes, operating income will increase by $14,000 ($18,200 $4,200).

Problem 452
1. Company A:

$100,000
$50,000

=2

Company B:

$300,000
$50,000

=6

2.

Company A

Company B

X=

$50,000
(1 - 0.8)

X=

$250,000
(1 - 0.4)

X=

$50,000
0.2

X=

$250,000
0.6

X = $250,000

X = $416,667

Company B must sell more than Company A to break even because it must
cover $200,000 more in fixed costs (it is more highly leveraged).

4-33
4-33

Problem 452

(Concluded)

3. Company A:

2 50% = 100%

Company B:

6 50% = 300%

The percentage increase in profits for Company B is much higher than


Company As increase because Company B has a higher degree of operating
leverage (i.e., it has a larger amount of fixed costs in proportion to variable
costs as compared to Company A). Once fixed costs are covered, additional
revenue must cover only variable costs, and 60 percent of Company Bs
revenue above break even is profit, whereas only 20 percent of Company As
revenue above break even is profit.

Problem 453
1. Contribution margin ratios:
$23,910

May of current year = $43,560 = 0.549, or 54.9%


$23,400

May of prior year = $41,700 = 0.561, or 56.1%


2. Break-even point in sales dollars:
May of current year =
May of prior year =

$20,330
= $37,031
0.549

$13,800
= $24,599
0.561

3. Margin of safety:
May of current year = $43,560 $37,031 = $6,529
May of prior year = $41,700 $24,599 = $17,101
4. Clearly, the sharp rise in fixed costs from the prior year to the current year has
had a strong impact on the break-even point and the margin of safety. Kicker
will need to ensure that tight cost control is exercised since the margin of
safety is much slimmer. Still, the decision to go with the OEM investment
program could pay large dividends in the future. Note that the margin of safety
and break-even point give the company important information on the potential
risk of the venture but do not tell it the upside potential.

4-34
4-34

CASES
Case 454
1. Let X be a package of 3 Grade I cabinets and 7 Grade II cabinets.
0.3X($3,400) + 0.7X($1,600) = $1,600,000
X = 748 packages
Grade I: 0.3 748 = 224 units
Grade II: 0.7 748 = 524 units
2.
Product
I
II
Package

Price

Variable
Cost =

$ 3,400
1,600
21,400

$ 2,686
1,328
17,354

Direct fixed costs I


Direct fixed costs II
Common fixed costs
Total fixed costs

$ 95,000
95,000
35,000
$225,000

$225,000
$4,046

Contribution
Margin
$714
272

= 56 packages

Grade I: 3 56 = 168
Grade II: 7 56 = 392

4-35
4-35

Sales
Mix =

Total
CM

3
7

$2,142
1,904
$4,046

Case 454

(Continued)

3.
Product
I
II
Package

Price
$ 3,400
1,600
21,400

Variable
Cost =

Contribution
Margin

$ 2,444
1,208
15,788

$956
392

Sales
Mix =
3
7

Total
CM
$2,868
2,744
$5,612

$21,400X = $1,600,000 $600,000


X = 47 packages remaining
Grade I: 3 47 = 141
Grade II: 7 47 = 329
Additional contribution margin:
141($956 $714) + 329($392 $272)
Increase in fixed expenses
Increase in income
Break-even:

$73,602
44,000
$29,602

($225,000 + $44,000)
= 48 packages
$5,612

Grade I: 3 48 = 144
Grade II: 7 48 = 336
If the new break-even point is interpreted as a revised break-even point for the
current year, then total fixed costs must be reduced by the contribution
margin already earned (through the first five months) to obtain the units that
must be sold for the last seven months. These units would then be added to
those sold during the first five months:
Contribution margin earned = $600,000 (83* $2,686) (195* $1,328)
= $118,102
*224 141 = 83; 524 329 = 195
X=

($225,000 + $44,000 - $118,102)


= 27 packages
$5,612

From the first five months, 28 packages were sold (83/3 or 195/7). Thus, the
revised break-even point is 55 packages (27 + 28)in units, 165 of I and 385 of
II.

4-36
4-36

Case 454

(Concluded)

4.
Product
I
II
Package

Price
$3,400
1,600

New sales revenue


$5,000X
X

Variable
Cost =

Contribution
Margin

$2,686
1,328

$714
272

Sales
Mix =
1
1

Total
CM
$714
272
$986

$1,000,000 130% = $1,300,000

= $1,300,000
= 260 packages

Thus, 260 units of each cabinet will be sold during the rest of the year.
Effect on profits:
Change in contribution margin:
$714(260 141) $272(329 260)

$66,198

Increase in fixed costs:


$70,000(7/12)
Increase in operating income

40,833
$25,365

X =
=

Fixed cost
(Price - Variable cost)
$295,000
$986

= 299 packages (or 299 of each cabinet)


The break-even point is computed as follows:
X =
=

($295,000 - $118,102)
$986
$176,898
$986

= 179 packages (179 of each)


To this, add the units already sold, yielding the revised break-even point:
I: 83 + 179 = 262
II: 195 + 179 = 374

4-37
4-37

Case 455
1. Break-even point =

2.

Fixed expense
(Price - Varible cost)

First process:

$100,000
= 5,000 cases
($30 - $10)

Second process:

$200,000
= 8,333 cases
($30 - $6)

Income
X($30 $10) $100,000
$20X $100,000
$100,000
X

=
=
=
=
=

X(Price Variable cost) Fixed cost


X($30 $6) $200,000
$24X $200,000
$4X
25,000 cases

The manual process is more profitable if sales are less than 25,000 cases; the
automated process is more profitable at a level greater than 25,000 cases. It is
important for the manager to have a sales forecast to help in deciding which
process should be chosen.
3. The right to decide which process should be chosen belongs to the divisional
manager. Danna has an ethical obligation to report the correct information to
her superior. By altering the sales forecast, Danna unfairly and unethically
influenced the decision-making process. Managers certainly have a moral
obligation to assess the impact of their decisions on employees, and every
effort should be taken to be fair and honest with employees. Dannas behavior,
however, is not justified by the fact that it helped a number of employees
retain their employment. First, Danna had no right to make that decision.
Danna certainly has the right to voice her concerns about the impact of
automation on the employees well-being. In so doing, perhaps the divisional
manager would come to the same conclusion even though the automated
system appears to be more profitable. Second, the choice to select the manual
system may not be the best for the employees anyway. The divisional
manager may possess more information, making the selection of the
automated system the best alternative for all concerned, provided the sales
volume justifies its selection. For example, if the automated system is viable,
the divisional manager may have plans to retrain and relocate the displaced
workers in better jobs within the company. Third, her motivation for altering
the forecast seems more driven by her friendship with Jerry Johnson than any
legitimate concerns for the layoff of other employees. Danna should examine
her reasoning carefully to assess the real reasons for her behavior. Perhaps in
so doing, the conflict of interest that underlies her decision will become
apparent.

4-38
4-38

4-39
4-39