always assess whether the simplified CVP

CHAPTER
Cost-Volume-Profit relationships generate sufficiently accurate
3 Analysis predictions of how total revenues and total costs
behave. If decisions can be significantly
improved, managers should choose a more
Overview complex approach that, for example, uses
multiple cost drivers and nonlinear cost
This chapter explains a planning tool called functions.
cost-volume-profit (CVP) analysis. CVP
analysis examines the behavior of total 3. Because managers want to avoid
revenues, total costs, and operating income operating losses, they are interested in the
(profit) as changes occur in the output level, breakeven point calculated using CVP
selling price, variable cost per unit, and/or fixed analysis. The breakeven point is the quantity of
costs of a product or service. The reliability of output sold at which total revenues equal total
the results from CVP analysis depends on the costs. There is neither a profit nor a loss at the
reasonableness of the assumptions. The breakeven point. To illustrate, assume a
Appendix to the chapter gives additional company sells 2,000 units of its only product for
insights about CVP analysis; it illustrates $50 per unit, variable cost is $20 per unit, and
decision models and uncertainty. fixed costs are $60,000 per month. Given these
conditions, the company is operating at the
Review Points breakeven point:

1. CVP analysis is based on several Revenues, 2,000  $50 $100,000

assumptions including: Deduct:
a. Changes in the level of revenues and costs Variable costs, 2,000  $20 40,000
arise only because of changes in the number Fixed costs 60,000
of product (or service) units produced and Operating income $   -0-   
sold (that is, the number of output units is
the only driver of revenues and costs). The breakeven point can be expressed two ways:
b. Total costs can be separated into a fixed 2,000 units and $100,000 of revenues.
component that does not vary with the
output level and a component that is 4. Under CVP analysis, the income
variable with respect to the output level. statement above is reformatted to show a key
c. When represented graphically, the behaviors line item, contribution margin:
of both total revenues and total costs are
linear (straight lines) in relation to the Revenues, 2,000  $50 $100,000
output level within the relevant range (and Variable costs, 2,000  $20 40,000
Contribution margin 60,000
time period).
Fixed costs 60,000
d. The analysis either covers a single product Operating income $   -0-   
or assumes that the proportion of different
products when multiple products are sold This format, called the contribution income
will remain constant as the level of total statement, is used extensively in this chapter
units sold changes. and throughout the textbook.
2. Even though CVP assumptions simplify 5. Contribution margin can be expressed
real-world situations, many companies have three ways: in total, on a per unit basis, and as
found CVP relationships can be helpful in a percentage of revenues. In our example, total
making decisions about strategic and long-range contribution margin is $60,000. Contribution
planning, as well as decisions about product margin per unit is the difference between
features and pricing. Managers, however, must selling price and variable cost per unit:

COST-VOLUME-PROFIT ANALYSIS     23
$50 − $20 = $30. Contribution margin per unit
is also equal to contribution margin divided by To state a target net income figure in terms of
the number of units sold: $60,000  2,000 = operating income, divide target net income by 1
$30. Contribution margin percentage (also − tax rate: $30,000  (1 − .40) = $50,000. Note,
called contribution margin ratio) is the income-tax factor does not change the
contribution margin per unit divided by selling breakeven point because no income taxes arise if
price: $30  $50 = 60%; it is also equal to operating income is $0.
contribution margin divided by revenues:
$60,000  $100,000 = 60%. This contribution 8. Managers use CVP analysis to guide
margin percentage means that 60 cents in their decisions, many of which are strategic
contribution margin is gained for each $1 of decisions. For example, CVP analysis helps
revenues. managers decide how much to spend on
advertising, whether or not to expand into new
6. In our example, compute the breakeven markets, and which features to add to existing
point (BEP) in units and in revenues as follows: products. Of course, different choices can affect
fixed costs, variable cost per unit, selling prices,
Total fixed costs units sold, and operating income.
BEP units 
Contributi on margin per unit
9. Single-number “best estimates” of input
$60, 000
BEP units   2, 000 units data for CVP analysis are subject to varying
$30
degrees of uncertainty, the possibility that an
Total fixed costs actual amount will deviate from an expected
BEP revenues 
Contributi on margin percentag e amount. One approach to deal with uncertainty
$60, 000 is to use sensitivity analysis (discussed in
BEP revenues   $100, 000
0. 60 paragraphs 10 through 12). Another approach is
to compute expected values using probability
While the breakeven point is often of interest to distributions (discussed in paragraph 19).
managers, CVP analysis considers a broader
question: What amount of sales in units or in 10. Sensitivity analysis is a “what if”
revenues is needed to achieve a specified target technique that managers use to examine how an
operating income? The answer is easily obtained outcome will change if the original predicted
by adding target operating income to total fixed data are not achieved or if an underlying
costs in the numerator of the formulas above. assumption changes. In the context of CVP
Assuming target operating income (TOI) is analysis, sensitivity analysis examines how
$15,000: operating income (or the breakeven point)
changes if the predicted data for selling price,
Unit sales to  $60, 000  $15, 000  2, 500 units variable cost per unit, fixed costs, or units sold
achieve TOI are not achieved. The sensitivity to various
$30 possible outcomes broadens managers’
perspectives as to what might actually occur
Revenues to  $60, 000  $15, 000  $125, 000
achieve TOI before they make cost commitments. Electronic
0. 60 spreadsheets, such as Excel, enable managers to
7. Because for-profit organizations are conduct CVP-based sensitivity analyses in a
subject to income taxes, their CVP analyses systematic and efficient way.
must include this factor. For example, if a
company earns $50,000 before income taxes and 11. An aspect of sensitivity analysis is
the tax rate is 40%, then: margin of safety, the amount by which
budgeted (or actual) revenues exceed breakeven
Operating income $50,000 revenues. The margin of safety answers the
Deduct income taxes (40%) 20,000 “what-if” question: If budgeted revenues are
Net income $30,000

24     CHAPTER 3
above breakeven and drop, how far can they fall proportions of lower or higher contribution
below the budget before the breakeven point is margin products have shifted. Other things
reached? being equal, for any given total quantity of units
sold, the breakeven point decreases and
12. CVP-based sensitivity analysis operating income increases if the sales mix
highlights the risks and returns that an existing shifts toward products with higher contribution
cost structure holds for a company. This insight margins.
may lead managers to consider alternative cost
structures. For example, compensating a 15. Recall from paragraph 1d that, in
salesperson on the basis of a sales commission multiple product situations, CVP analysis
(a variable cost) rather than a salary (a fixed assumes a given sales mix of products remains
cost) decreases the company’s downside risk if constant as the level of total units sold changes.
demand is low but decreases its return if demand In this case, the breakeven point is some number
is high. The risk-return tradeoff across of units of each product, depending on the sales
alternative cost structures can be measured as mix. To illustrate, assume a company sells two
operating leverage. Operating leverage products, A and B. The sales mix is 4 units of A
describes the effects that fixed costs have on and 3 units of B. The contribution margins per
changes in operating income as changes occur in unit are $80 for A and $40 for B. Fixed costs are
units sold and hence in contribution margin. $308,000 per month. To compute the breakeven
Companies with a high proportion of fixed costs point:
in their cost structures have high operating
leverage. Consequently, small changes in units Let 4X  No. of units of A to break even
sold cause large changes in operating income. Then 3X  No. of units of B to break even
At any given level of sales: $308, 000
BEP in X units 
4($80)  3($40)
Contribution margin
Degree of operating leverage  $308, 000
Operating income BEP in X units   700 units
$440
Knowing the degree of operating leverage at a A units to break even  4  700  2,800 units
given level of sales helps managers calculate the
B units to break even  3  700  2,100 units
effect of changes in sales on operating income.
Proof of breakeven point:
13. The time horizon being considered for a A: 2,800  $80 $224,000
decision affects the classification of costs as B: 2,100  $40 84,000
variable or fixed. The shorter the time horizon, Total contribution margin 308,000
the greater the proportion of total costs that are Fixed costs 308,000
fixed. For example, virtually all the costs of an Operating income $   -0-    
airline flight are fixed one hour before takeoff.
When the time horizon is lengthened to one year 16. CVP analysis can be applied to service
and then five years, more and more costs organizations and nonprofit organizations. The
become variable. This example underscores the key is measuring their output. Unlike
point: which costs are fixed in a specific manufacturing and merchandising companies
decision situation depends on the length of the that measure their output in units of product, the
time horizon and the relevant range. measure of output differs from one service
industry (or nonprofit organization) to another.
14. Sales mix is the quantities of various For example, airlines measure output in
products (or services) that constitute total unit passenger-miles and hotels/motels use room-
sales of a company. If the sales mix changes and nights occupied. Government welfare agencies
the overall unit sales target is still achieved, measure output in number of clients served and
however, the effect on the breakeven point and universities use student credit-hours.
operating income depends on how the original

COST-VOLUME-PROFIT ANALYSIS     25
 17. Recall from paragraph 1a that CVP (but not contribution margin); it deducts sales
analysis assumes that the number of output units commissions from revenues in computing
is the only revenue and cost driver. By relaxing contribution margin (but not gross margin).
this assumption, CVP analysis can be adapted to
the more general case of multiple cost drivers 19. The Appendix to this chapter uses a
but the simple formulas in paragraph 6 can no probability distribution to incorporate
longer be used. Moreover, there is no unique uncertainty into a decision model. This approach
breakeven point. The example, text p. 77, has provides additional insights about CVP analysis.
two cost drivers—the number of software A decision model, a formal method for making a
packages sold and the number of customers. choice, usually includes five steps: (a) identify a
One breakeven point is selling 26 packages to 8 choice criterion such as maximize income, (b)
customers. Another breakeven point is selling identify the set of alternative actions (choices) to
27 packages to 16 customers. be considered, (c) identify the set of events
(possible occurrences) that can occur, (d) assign
18. Contribution margin, a key concept in a probability to each event that can occur, and
this chapter, contrasts with gross margin (e) identify the set of possible outcomes (the
discussed in Chapter 2. Gross margin is an predicted economic result of each action-event
important line item in the GAAP income combination). Uncertainty is present in a
statements of merchandising and manufacturing decision model because for each alternative
companies. Gross margin is total revenues action there are two or more possible events,
minus cost of goods sold, whereas contribution each with a probability of occurrence. The
margin is total revenues minus total variable correct decision is to choose the action with the
costs (from the entire value chain). Gross best expected value. Expected value is the
margin and contribution margin will be different weighted average of the outcomes, with the
amounts (except in the highly unlikely case that probability of each outcome serving as the
cost of goods sold and variable costs are equal). weight. Although the expected value criterion
For example, a manufacturing company deducts helps managers make good decisions, it does not
fixed manufacturing costs that become period prevent bad outcomes from occurring.
costs from revenues in computing gross margin

Featured Exercise

In its budget for next month, McGwire Company has revenues of $500,000, variable costs of $350,000,
and fixed costs of $135,000.

a. Compute contribution margin percentage.

b. Compute total revenues needed to break even.
c. Compute total revenues needed to achieve a target operating income of $45,000.
d. Compute total revenues needed to achieve a target net income of $48,000, assuming the income tax
rate is 40%.

26     CHAPTER 3
Solution

a. Contribution margin percentage = ($500,000 − $350,000)  $500,000

= $150,000  $500,000 = 30%
Note, variable costs as a percentage of revenues = $350,000  $500,000 = 70%

b. Breakeven point = $135,000  0.30 = $450,000

Proof of breakeven point:
Revenues $450,000
Variable costs, $450,000  0.70 315,000
Contribution margin 135,000
Fixed costs 135,000
Operating income $   -0-    

c. Let X = Total revenues needed to achieve target operating income of $45,000

$135, 000  $45, 000 $180, 000

X   $600, 000
0. 30 0. 30

d. Two steps are used to obtain the answer. First, compute operating income when net income is
$48,000:

$48, 000 $48, 000

  $80, 000
1  0. 40 0. 60

Second, compute total revenues needed to achieve a target operating income of $80,000 (that is, a
target net income of $48,000), which is denoted by Y:

$135, 000  $80, 000 $215, 000

Y   $716, 667
0. 30 0. 30

Review Questions and Exercises 4. ________________________ is a “what if”

technique that, when used in the context of
(All answers are at the end of the chapter.) CVP analysis, examines how an outcome
such as operating income will change if the
Completion Statements original predicted data are not achieved or if
an underlying assumption changes.
Fill in the blank(s) to complete each statement. 5. The quantities of various products (or
services) that constitute total unit sales of a
1. __________________________________ is company is called the ________________.
equal to selling price minus variable cost per 6. _________________ describes the effects
unit. that fixed costs have on changes in
2. The financial report that highlights the operating income as changes occur in units
contribution margin as a line item is called sold and hence in contribution margin.
the _______________________________. 7. (Appendix) In a decision model, the correct
3. The possibility that an actual amount will decision is to choose the action with the best
deviate from an expected amount is called ______________________, which is the
_______________. weighted average of the outcomes with the

COST-VOLUME-PROFIT ANALYSIS     27
 probability of each outcome serving as the True-False
weight.
Indicate whether each statement is true (T) or
false (F).

____1. Generally, the breakeven point in

revenues can be easily determined by
simply summing all costs in the
company’s contribution income
statement.
____2. At the breakeven point, total fixed costs
always equals contribution margin.
____3. The amount by which budgeted (or
actual) revenues exceed breakeven
revenues is called the margin of
forecasting error.
____4. An increase in the income tax rate
increases the breakeven point.
____5. Trading off fixed costs in a company’s
cost structure for higher variable cost
per unit decreases downside risk if
demand is low and decreases return if
demand is high.
____6. At any given level of sales, the degree
of operating leverage is equal to
contribution margin divided by
operating income.
____7. If the budget appropriation for a
government social welfare agency is
reduced by 15% and the cost-volume
relationships remain the same, the client
service level would decrease by 15%.
____8. The longer the time horizon in a
decision situation, the lower the
percentage of total costs that are
variable.
____9. Cost of goods sold in manufacturing
companies is a variable cost.
____10. (Appendix) The probability distribution
for the mutually exclusive and
collectively exhaustive set of events in a
decision model sums to 1.00.
____11. (Appendix) Even if a manager makes a
good decision, a bad outcome may still
occur.

Multiple Choice

28     CHAPTER 3
Select the best answer to each question. Space is ____1. (CPA) CVP analysis does not assume
provided for computations after the quantitative that:
questions. a. selling prices remain constant.
b. there is a single revenue and cost
driver.
c. total fixed costs vary inversely with
the output level.
d. total costs are linear within the
relevant range.
____2. Given for Winn Company in 2005:
revenues $530,000, manufacturing costs
$220,000 (one-half fixed), and
marketing and administrative costs
$270,000 (two-thirds variable). The
contribution margin is:
a. $40,000.
b. $240,000.
c. $310,000.
d. $330,000.

____3. Using the information in question 2 and

ignoring inventories, the gross margin
for Winn Company is:
a. $40,000.
b. $240,000.
c. $310,000.
d. $330,000.

____4. (CPA) Koby Company has revenues of

$200,000, variable costs of $150,000,
fixed costs of $60,000, and an operating
loss of $10,000. By how much would
Koby need to increase its revenues in
order to achieve a target operating
income of 10% of revenues?
a. $200,000
b. $231,000
c. $251,000
d. $400,000

COST-VOLUME-PROFIT ANALYSIS     29
____5. (CPA) The following information c. $66,000
pertains to Nova Co.’s CVP d. $170,000
relationships: ____8. The amount of total costs probably will
not vary significantly in decision
Breakeven point in units 1,000 situations in which:
Variable cost per unit $500 a. the time span is quite short and the
Total fixed costs $150,000 change in units of output is quite
large.
How much will be contributed to b. the time span is quite long and the
operating income by the 1,001st unit change in units of output is quite
sold? large.
a. $650 c. the time span is quite long and the
b. $500 change in units of output is quite
c. $150 small.
d. $0 d. the time span is quite short and the
change in units of output is quite
small.
____9. (CPA) Product Cott has revenues of
$200,000, a contribution margin of
20%, and a margin of safety of $80,000.
What are Cott’s fixed costs?
____6. (CPA) During 2005, Thor Lab supplied a. $16,000
hospitals with a comprehensive b. $24,000
diagnostic kit for $120. At a volume of c. $80,000
80,000 kits, Thor had fixed costs of d. $96,000
$1,000,000 and an operating income of
$200,000. Due to an adverse legal
decision, Thor’s liability insurance in
2006 will increase by $1,200,000.
Assuming the volume and other costs ____10. For a multiple-product company, a shift
are unchanged, what should the selling in sales mix from products with high
price be in 2006 if Thor is to earn the contribution-margin percentages toward
same operating income of $200,000? products with low contribution-margin
a. $120 percentages causes the breakeven point
b. $135 to be:
c. $150 a. lower.
d. $240 b. higher.
c. unchanged.
d. different but undeterminable.

____11. (Appendix, CMA) The College Honor

Society sells large pretzels at the home
____7. In the fiscal year just completed, Varsity football games. The following
Shop reported net income of $24,000 on information is available:
revenues of $300,000. The variable
costs as a percentage of revenues are Unit Sales Probability
70%. The income tax rate is 40%. What 2,000 pretzels .10
is the amount of fixed costs? 3,000 pretzels .15
a. $30,000 4,000 pretzels .20
b. $50,000 5,000 pretzels .35

30     CHAPTER 3
 6,000 pretzels .20 but only 3,000 of them are sold, the
operating income is:
The pretzels are sold for $2.00 each, and a. $5,600.
the cost per pretzel is $0.60. Any unsold b. $4,200.
pretzels are discarded because they will c. $3,600.
be stale before the next home game. If d. $900.
4,000 pretzels are on hand for a game e. none of the above.

Review Exercises

Solutions for these Review Exercises are at the end of the

chapter.
Check figures are given at the end of each of the exercises.

1. (CMA) The income statement for Davann Co. presented below shows the operating results for the
fiscal year just ended. Davann had sales of 1,800 tons of product during that year. The manufacturing
capacity of Davann’s facilities is 3,000 tons of product.

Revenues $900,000
Variable costs:
Manufacturing $315,000
Nonmanufacturing 180,000 495,000
Contribution margin 405,000
Fixed costs:
Manufacturing 90,000
Nonmanufacturing 157,500 247,500
Operating income 157,500
Income taxes (40%) 63,000
Net income $ 94,500

a. If the sales volume is estimated to be 2,100 tons for next year, and if the selling price and cost-
behavior patterns remain the same next year, how much net income does Davann expect to earn
next year?
b. Assume Davann estimates the selling price per ton will decline 10% next year, variable cost will
increase by $40 per ton, and total fixed costs will not change. Compute how many tons must be
sold next year to earn net income of $94,500.
(Check figures: (a) $135,000 (b) 3,000 tons)

COST-VOLUME-PROFIT ANALYSIS     31
2. Valdosta Manufacturing Co. produces and sells two products:

T U
Selling price $25 $16
Variable costs per unit 20 13

Total fixed costs are $40,500.

Compute the breakeven point in units, assuming the sales mix is five units of U for each unit of T.
(Check figures: 2,025 units of T; 10,125 units of U)

3. (CPA) Dallas Corporation wishes to market a new product at a selling price of $1.50 per unit. Fixed
costs for this product are $100,000 for less than 500,000 units of output and $150,000 for 500,000 or
more units of output. The contribution-margin percentage is 20%.

Compute how many units of this product must be sold to earn a target operating income of $100,000.
(Check figure: 833,334 units)

4. (Appendix, CMA) The ARC Radio Company is trying to decide whether to introduce a new product,
a wrist “radiowatch” designed for shortwave reception of the exact time as broadcast by the National
Bureau of Standards. The “radiowatch” would be priced at $60, which is exactly twice the variable
cost per unit to manufacture and sell it. The fixed costs to introduce the radiowatch are $240,000 per
year. The following probability distribution estimates the demand for the product:

Annual Demand Probability

6,000 units .20
8,000 units .20
10,000 units .20
12,000 units .20
14,000 units .10
16,000 units .10

a. Compute the expected value of demand for the radiowatch.

b. Compute the probability that the introduction of the radiowatch will not increase the company’s
operating income.
(Check figures: (a) 10,200 units (b) 0.40)

32     CHAPTER 3
Answers and Solutions to Chapter 3 Review Questions and Exercises

Completion Statements

1. Contribution margin per unit

2. contribution income statement
3. uncertainty
4. Sensitivity analysis
5. sales mix
6. Operating leverage
7. expected value

True-False

1. F The breakeven point in revenues is computed by dividing total fixed costs by contribution-
margin percentage. The computation described in the statement gives breakeven revenues only if
the company happened to be operating at the breakeven point.
2. T
3. F The amount by which budgeted revenues exceed breakeven revenues is called the margin of
safety.
4. F The breakeven point is unaffected by income taxes because operating income at the breakeven
point is $0 and hence no income taxes arise.
5. T
6. T
7. F If the budget appropriation for a government social welfare agency is reduced by 15% and the
cost-volume relationships remain the same, the client service level would decrease by more than
15% because of the existence of fixed costs. For example, the illustration, text p. 78, has a 21.4%
decrease in the service level when the budget appropriation is reduced by 15%.
8. F The longer the time horizon in a decision situation, the lower the percentage of total costs that are
fixed and the higher the percentage of total costs that are variable.
9. F Cost of goods sold in manufacturing companies includes both variable and fixed manufacturing
costs.
10. T
11. T

Multiple Choice

1. c One of the assumptions in CVP analysis is that total fixed costs remain the same within the
relevant range. In other words, fixed cost per unit varies inversely with the output level within
the relevant range.
2. b Contribution margin = $530,000 − $220,000(1/2 variable) − $270,000(2/3 variable)
= $530,000 − $110,000 − $180,000 = $240,000
3. c Gross margin = $530,000 − $220,000 = $310,000
4. a Let R = Revenues needed to earn a target operating income of 10% of revenues
R  ($150,000  $200, 000 )R  $60, 000  0. 10R
R  0. 75R  0. 10 R  $60, 000
0. 15R  $60, 000
R  $60, 000  0. 15  $400, 000
Because current revenues are $200,000, an increase in revenues of $200,000 is needed to earn a
target operating income of 10% of revenues.

COST-VOLUME-PROFIT ANALYSIS     33
5. c Total costs at breakeven = (1,000  $500) + $150,000 = $650,000
Selling price = $650,000  1,000 units = $650
Contribution margin per unit = $650 − $500 = $150
6. b The selling price in 2003 to earn the same operating income of $200,000 is the selling price in
2002, $120, increased by the amount of the higher liability insurance in 2003, $1,200,000, spread
over the 80,000-unit sales volume:
Selling price in 2003 = $120 + ($1,200,000  80,000) = $120 + $15 = $135
7. b Three steps are used to obtain the answer. First, compute the contribution margin.
Contribution margin percentage = 100% − Variable costs percentage of 70% = 30%.
Contribution margin = $300,000  0.30 = $90,000. Second, compute operating income:
$24, 000 $24, 000
  $40, 000
1  0. 40 0. 60
Third, the difference between contribution margin and operating income is fixed costs:
$90,000 − $40,000 = $50,000
8. d An example of this decision situation is deciding whether to add a passenger to an airline flight
that has empty seats and will depart in one hour. Variable cost for the passenger is negligible.
Virtually all the costs in this decision situation are fixed.
9. b Margin of safety answers the what-if question: If budgeted revenues exceed the breakeven point
and drop, how far can they fall below the budget before the breakeven point is reached?
Breakeven point  $200, 000  $80, 000  $120, 000
Variable costs  $120, 000  (1  0. 20)
 $120, 000  0. 80  $96, 000
Fixed costs  $120, 000  $96, 000  $24, 000
Proof of breakeven point: $24,000  0.20 = $120,000
10. b A shift in the sales mix from high contribution-margin percentage products toward low ones
decreases the overall contribution-margin percentage of the sales mix. This change increases the
breakeven point.
11. c Operating income = 3,000($2.00) − 4,000($0.60) = $6,000 − $2,400 = $3,600

Review Exercise 1
a. Three steps are used to obtain the answer. First, compute selling price: $900,000  1,800 = $500.
Second, compute variable cost per unit: $495,000  1,800 = $275. Third, prepare a contribution
income statement at the 2,100-ton level of output:
Revenues, 2,100  $500 $1,050,000
Variable costs, 2,100  $275 577,500
Contribution margin 472,500
Fixed costs 247,500
Operating income 225,000
Income taxes (40%) 90,000
Net income $ 135,000
b. Let Q = Number of tons to break even next year
$94, 500
$500Q(1  0. 10 )  ($275Q  $40Q )  $247, 500 
1  0. 40
$450Q  $315Q  $247, 500  $157, 500
$135Q  $405, 000
Q  3, 000 tons

34     CHAPTER 3
Review Exercise 2
Let T  Number of units of T to be sold to break even
Then 5T  Number of units of U to be sold to break even
$25T  $16(5T )  $20T  $13(5T )  $40, 500  $0
$25T  $80T  $20T  $65T  $40, 500
$20T  $40, 500; T  2, 025 units; 5T  2, 025  5  10,125 units
$25( 2, 025)  $16(10,125)  $20( 2, 025)  $13(10,125)  $40,500  $0
Proof:
$50, 625  $162, 000  $40, 500  $131,625  $40,500  $0
$0  $0
Review Exercise 3
Two steps are used to obtain the answer. First, determine if fixed costs will be $100,000 or $150,000.
If fixed costs are $100,000, the maximum operating income is attained at 499,999 units:
Revenues, 499,999  $1.50 $749,998.50
Variable costs, 80% of revenues 599,998.80
Contribution margin, 20% of revenues 149,999.70
Fixed costs 100,000.00
Operating income $ 49,999.70
Because this operating income is below the target of $100,000, the output level needs to be greater
than 499,999 units and, hence, fixed costs will be $150,000. Second, compute the required output
level:
Let Q = Number of units to be sold to earn a target operating income of $100,000
$1. 50Q  (1  0. 20)($1. 50)Q  $150, 000  $100, 000
$1. 50Q  $1. 20Q  $100, 000  $150, 000
$0. 30Q  $250, 000
Q  833,333. 33, rounded to 833,334 units
Review Exercise 4
a. 6,000  .20 = 1,200
8,000  .20 = 1,600
10,000  .20 = 2,000
12,000  .20 = 2,400
14,000  .10 = 1,400
16,000  .10 = 1,600
Expected value of
demand in units 10,200
b. If the number of units sold each year is equal to or less than the breakeven point, the radiowatch
will not increase the company’s operating income. At the breakeven point,
Revenues  Variable costs  Fixed costs  $0
Let Q  Number of units to be sold to break even
$60Q  ($60  2)Q  $240,000  $0
$60Q  $30Q  $240, 000
$30Q  $240, 000
Q  $240, 000  $30  8, 000 units

COST-VOLUME-PROFIT ANALYSIS     35
 Because the company’s operating income will not increase if 8,000 units or 6,000 units are sold,
the probability of either of these events occurring is equal to the sum of their individual
probabilities:
0.20 + 0.20 = 0.40.

36     CHAPTER 3