BAM6008 Financial Reporting to Management – CVP Analysis Answers

CVP Analysis Answers

1.3 Example 1.
Calculation of Variable Element
%Occupancy Cost of Gas
High point-July 80 550
Low point- Jan 20 250
Difference 60 300

Thus: 300 = $5
60
Thus, the variable element is:$5 for each 1% rise in occupancy

Calculation of the Fixed Element:

Jan: Variable cost = 20 x 5 = 100

Fixed cost = 250 – 100 = 150

July: Variable cost = 80 x 5 = 400

Fixed cost = 550 – 400 = 150

1.4 Example 2.
Sales Costs
July – Dec 2003 4,300,000 3,760,000
Jan – June 2003 3,900,000 3,480,000
Difference 400,000 280,000

Thus: 280,000 = 0.7 variable costs are 70% of sales

400,000
Sales T.C. V.C. F.C.
July – Dec 4,300,000 3,760,000 3,010,000 750,000
Jan – June 3,900,000 3,480,000 2,730,000 750,000

1.5 Example 3. Motel

a) Fixed: Salaries, Rent, Interest, Insurance
Variable: Wages, Supplies
Mixed: Employee benefits, Utilities, Other costs

b) High 3000 rooms $115,700

Low 2000 rooms 91,200
Difference 1,000 24,500

V.C. Per room = 24,500/1,000 = $24.50

c) Total variable costs for say 3,000 rooms = 3,000 x $24.50 = $73,500
Fixed costs = Total cost – variable cost = $115,700 - $73,500 = $42,200

d) Y = a + bx Thus: Total cost = 42,200 + 24.50x

e) Total Cost = $42,200 + ($24.50 x 3,500). Thus, Total Cost = $127,950

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BAM6008 Financial Reporting to Management – CVP Analysis Answers

1.6 Example 4. Pizza Bar

a) Mixed: Payroll, Supplies, Other operating costs

b) Variable: Materials, Utilities, Lease
c) Fixed: Insurance, Depreciation,
d) 3,500 20,250
2,000 12,700
Difference 1,500 7,550
VC per unit 7,200/1,500= $5.03333
e) FC = TC – VC = 20,250 – ($5.03333 x 3,500) = $2,633
f) Y = $2,633 + 5.03333x
g) TC = $2,633 + ($5.03333 x 4,000) = $22,766

2.1 Example 5 Doug Little

a) $2000 = $1,000 + 2% sales. Therefore $1,000/0.02 = $50,000
or
$2,000 = 4% = $2,000/0.04 = $50,000
b) Lease cost at sales of $80,000 per month
Lease: a) b) c)
Fixed cost $2,000 $1,000 -
Variable cost - $1,600 $3,200
Total cost $2,000 $2,600 $3,200

3.3 Example 6 The Clock Restaurant

Breakeven point in units = FC = $18,000 = 6,000 units per month

CM $3

8.2 Example 7 Target profit & income tax

Pre-tax profit = After-tax profit = $90,000 = $150,000

1-t 0.6

Sales to achieve a target profit = FC + Profit = $200,000 + $150,000 = $1million

CMR 0.35
9.1 Example 8
a) Rooms F&B Shop Total
Sales $100,000 50,000 50,000 200,000
Variable costs 23,000 25,000 12,000 60,000
Contribution 77,000 25,000 38,000 140,000
Fixed costs 98,000
Net profit 42,000

b) CMR 0.77 0.5 0.76

c) 200,000 – 60,000 = 0.7

200,000
d) BEP in revenue = 98,000 = $140,000
0.7
e) Sales mix CMR Factor
Rooms 0.7 0.77 0.539

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BAM6008 Financial Reporting to Management – CVP Analysis Answers

F&B 0.2 0.5 0.1

Shop 0.1 0.76 0.076
CMRw 0.715

f) BEP in revenue = 98,000 = $137,063

0.715
10.0 Example 9
ADR = $10 + ($5,000 + $4,000) = $46
(250)

Question 1. Eastpointe Café.

a. 12 – 8 = 0.333 b. 11 – 7.75 = 0.295 c. 200 = 62
12 11 11 – 7.75

Question 2. Pepper Inn

a. BEP = 100,000 = 1,539 rooms b. 1,539 = 26th day c. 106,000 = 1,559 x $80
80 – 15 60 68 = $124,706

Question 3. Matt Smith

a. CMR = 0.75 – 0.25 = 0.67
0.75
b. Total fixed costs = $750 + (3 months x 4 weeks x 5 days x $2) = $870

BEP = 870 = 1,740 glasses 1,740 = 18 days (25th June)

0.5 100

Question 4. The German Inn

a) BEP = Fixed cost = 550,000 = $687,500 p.a. or $57,292 per month
CMR 0.8

b) ROI = $1,500,000 x 20% = $300,000 after tax.

Pre-tax profit = 300,000 = 400,000

0.75

Revenue to make = Fixed cost + Profit = 550,000 + 400,000 = $1,187,500

specified profit CMR 0.8

Question 5 Lucas Inn

a) Sales – V.C. = CMR = 100 – 25 = 0.75
Sales 100
b) Sales – V.C. = CMR = 100 – 60 = 0.4
Sales 100
c)
Dept. Sales mix CMR Factor
Rooms 0.65 0.75 0.4875
Food 0.35 0.4 0.14
Total 1.0 0.6275

d) FC = $300,000 = $478,087.68

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BAM6008 Financial Reporting to Management – CVP Analysis Answers

CMR 0.6275

e) Pre-tax profit = after tax profit = $100,000 = $125,000

1-t 0.8
Revenue to achieve a target profit = FC + Pre-tax Profit/CMR =
$300,000 + $125,000/0.6275 = $677,291

Question 6. AA Inn
1a) Sales – VC = Contribution 1,000,000 – 320,000 = 680,000

CMR = CMR = 680,000 = 0.68

Sales 1,000,000

Breakeven point in revenue = Fixed costs = 410,000 = $602,941

CMR 0.68

$
1 b) Total Revenue 1,200,000
Less V.C. (32%) 384,000
Contribution 816,000
Less Fixed costs 410,000
N.I. before tax 406,000
Taxation (30%) 121,800
N.I. after tax 284,200

1 c) Pre-tax profit = After tax profit/(1-t) = 200,000/0.7 = $285,714

Revenue to make = Fixed cost + Profit = 410,000 + 285,714 = $1,023,109

specified profit CMR 0.68

2 New sales mix =

Rooms % Café Shop % Total %
Revenue $750,000 100 $250,000 100 $1,000,000 100
V.C. 150,000 20 125,000 50 275,000 27.5
Contribution 600,000 80 125,000 50 725,000 72.5

2 a) CMR = CMR = 725,000 = 0.725

Sales 1,000,000

Breakeven point in revenue = Fixed costs = 410,000 = $565,517

CMR 0.725
$
2 b) Total Revenue 1,200,000
Less V.C. (27.5%) 330,000
Contribution 870,000
Less Fixed costs 410,000
N.I. before tax 460,000

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BAM6008 Financial Reporting to Management – CVP Analysis Answers

Taxation (30%) 138,000

N.I. after tax 322,000

2 c) Pre-tax profit = After tax profit/(1-t) = 200,000/0.7 = $285,714

Revenue to make = Fixed cost + Profit = 410,000 + 285,714 = $959,606

specified profit CMR 0.725

Question 7. Rhoades Inn

a. BEP = Fixed cost = 20,000 = 1,000 rooms per month
Contribution per unit (30 – 10) or $30,000

b. MOS (Revenues) = Current Output – BEP = 450,000 – (30,000 x 12) = $90,000

MOS (Rooms) = = (450,000/30) – (1,000 x 12) = 3,000

c. Rooms to make = Fixed cost + Profit = 240,000 + 100,000 = 17,000

specified profit Contribution per unit 20

d. Total rooms available for 365 days = 50 x 365 = 18,250

Thus, occupancy at a pre-tax profit of $100,000 =

17,000 x 100 = 93%

18,250
Question 8. Iowa Inn
a. Income Statement Iowa Inn
Rooms Coffee Shop Restaurant Total
$ $ $ $
Revenue 2,500,000 750,000 1,200,000 4,450,000
V.C 750,000 300,000 750,000 1,800,000
Contribution 1,750,000 450,000 450,000 2,650,000

CMR = Total Contribution = 2,650,000 = 0.5955

Sales 4,450,000

b. Before tax Net Income = $500,000 = $714,286

0.7
Revenue to make = Fixed cost + Profit = 1,000,000 + 714,286 = $2,878,734
specified profit CMR 0.5955

Question 9. Toni Towers

Sales Mix CMR Sales Mix x CMR
Rooms 80% 0.76 60.8
F&B 20% 0.55 11.0
Totals 100% 71.8

ROI = 1,500,000 x 0.18 = $270,000 N.I. before tax = 270,000 = $385,714

0.7
Revenue to make = Fixed cost + Profit = 240,000 + 385,714 = $871,468

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BAM6008 Financial Reporting to Management – CVP Analysis Answers

specified profit CMR 0.718

Question 10. M & L Inn

a. CMR = 1,300,000 = 0.65
2,000,000

BEP = Fixed costs = 1,000,000 = $1,538,462

CMR 0.65

b. V.C. = 35% + 5% = 40%

CMR = 0.65 – 0.05 = 0.6

BEP = Fixed costs = 520,000 = $866,667

CMR 0.6

Question 11. Myer Motel

a. CMR = 60 – 20 = 0.6666
60

b. BEP = Fixed Costs = 20,000 = 500 Rooms per month or 6,000 per year
Contribution per unit 40

c. N.I. before tax = 10,000 = $12,500

0.8

Revenue to make = Fixed cost + Profit = 20,000 + 12,500 = $48,755 per month
specified profit CMR 0.6666

d. Rooms sold = 20,000 + 12,500 = 812.5 rooms per month

40
Rooms sold per day = 812.5/30 = 27
Day of breakeven = 500/27 =19th June

Question 12. Blue Moon Inn

a. Variable Mixed Fixed
BEP = F.C. 100,000 118,000 130,000
CMR 0.34 0.38 0.4

= $294,118 $310,526 $325,000

b. 700,000 x 0.34 700,000 x 0.38 700,000 x 0.4

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BAM6008 Financial Reporting to Management – CVP Analysis Answers

= Contribution 238,000 266,000 280,000

Less F.C. 100,000 118,000 130,000
Net Income 138,000 148,000 150,000

c. 400,000 x 0.06 400,000 x 0.02 2,500 x 12

24,000 8,000 + 18,000 30,000
Lease cost $24,000  $26,000 x $30,000 x

Question 13. Dick Turpin Inn

a) Students should calculate and explain the following measures:
1. The BEP in revenue. CMR = 1,050,000/1,500,000 = 0.7
BEP in sales revenue = FC/CMR = $560,000/0.7 = $800,000

2. The BEP is the point at which total sales equals total cost, it is also
the point where total contribution equals fixed costs.

3. Changing a fixed lease for a variable lease will reduce fixed costs but
increase variable costs. This will result in a lower CMR.
Thus, New FC = $560,000 – 105,000 = $455,000
New CMR = 0.7 – 0.2 = 0.5. New VC = 30% + 20% = 50%
CMR + VC will always equal 100%.
Thus, at the breakeven point total costs equals total sales.

4. The effect on the BEP in sales revenue = $455,000/0.5 = $910,000.

Thus, a higher BEP because the fixed lease is a cheaper option than
the variable lease. (See indifference point)
5. The indifference point = $105,000 = $1,050,000
0.1
Sales > than $1,050,000 should use a fixed lease, whereas,
Sales < than $1,050,000 should use a variable lease
Currently the total sales = $1.5m. Thus the fixed lease is the best option.

6. Margin of safety (MOS):

MOS with a fixed lease = 1,500,00 – $800,000 x 100 = 46.7%
1,500,000
MOS with a variable lease = 1,500,00 – $910,000 x 100 = 39.3%
1,500,000
A higher MOS indicates lower risk.
b) See part (b) in question 14 for CVP critical evaluation below.

Question 14
a) Students should identify measures that can be used to monitor the
business. The significance of each measure should also be explained.
1) Total fixed costs: $805,000 p.a. The FC represent costs that must be
paid whether the business is open or closed.
When the Total Sales – total VC > FC the company will make a profit.

2) Food contribution: = Selling price – VC = CM = $80 – 10 = 70

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BAM6008 Financial Reporting to Management – CVP Analysis Answers

This is the contribution per dinner/entertainment package that is used

to pay the fixed costs and contribute toward profit.

3) Food Contribution Margin Ratio (CMR) =

CM/Selling price per unit = $70/$80 = 0.875
A higher CMR equals higher profit potential
CMR + VC = Sales Thus, if the CMR = 0.875 the VC = 0.125
The sum of the CMR + VC must = Sales

4) Weighted average CMR: Because this company sells different products

with different contributions/VC, a weighted average CMR must be calculated
to compute the BEP, see below;

CMRw calculation
Dept. Sales mix CMR Factor
Food 0.4 0.875 0.35
Bev. 0.6 0.6 0.36
CMRw 0.71

5) BEP (revenue): FC = 805,000 = $1,133,803 per year

CMR 0.71
The BEP is calculated in dollars, it is not possible to calculate in units
because the company sells different products at different profit margins.

6) Revenue required for target profit = (805,000 + (150,000/0.8))/0.71 =

$1,397,887 or $5,592 per night

7) Indifference point = $200,000/0.1 = $2m

Sales > than $2,000,000 should use a fixed lease, whereas,
Sales < than $2,000,000 should use a variable lease
Thus, if the sales equals $1,397,887 the company should have a variable lease.

8) Margin of safety (MOS):

MOS at sales required to give the target profit sales =
$1,397,887 – $1,133,803 x 100 = 18.9%
1,397,887
A higher MOS indicates lower risk.

b) Limitations of CVP
1. It is assumed that fixed costs are the same in total and variable costs are the same
per unit at all levels of output. This assumption is a great simplification.

(i) Fixed costs will change if output falls or increases substantially, (most fixed
costs are stepped costs).

(ii) The variable cost per unit will decrease where economies of scale are
made at higher output volumes, but variable cost per unit will also eventually
rise when diseconomies of scale begin to appear at even higher volumes of
output, (for example the cost of labour in overtime working).

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BAM6008 Financial Reporting to Management – CVP Analysis Answers

The assumption is only correct within a normal range or relevant range of output. It is
generally assumed that both the budgeted output and breakeven point lie within this
relevant range.

2. It is assumed that sales prices will be constant at all levels of activity. This may not be
true, especially at higher volumes of output where prices may have to be reduced to
attract the extra sales.

3. Production and sales are assumed to be the same, so that the consequences of any
increase in inventory levels are ignored.

4. Uncertainty in the estimates of fixed costs and unit variable costs is often ignored.

5. Assumes all output will be sold. It may be that the product will not sell in sufficient
quantities. But it is a good guide for new businesses.

6. Costs & revenues are expressed as straight lines. However, selling prices may vary
with quantities sold. Variable costs may change as advantage is taken of lower prices
due to bulk buying, or more efficient production methods.
7. It is not possible to extrapolate the graph. At higher levels of output the method of
production may be different.

8. It concentrates too much on the breakeven point. While this is important, efficient
production and monitoring of costs is just as important.

9. The basic model that calculates a breakeven point in units is unrealistic in practice, as
it can only deal with a single products sales and production, unlikely in the modern
business environment.

10. CVP analysis depicts relationships that are essentially short-term. This makes them
inappropriate in the long-term.

Advantages of CVP
1. Graphical presentation of cost and revenue data is easier to understand for non-
financial managers.

2. A breakeven model enables profit or loss to be identified at any level of activity within
the range for which the model is valid.

3. The contribution margin ratio (CMR) can indicate the relative profitability of different
products.

4. The breakeven point and margin of safety give some indication of the level of risk
involved.

Question 15
a) Variable: Cost of food sold, Supplies, & Other operating costs.
Mixed: Payroll costs & Utilities. Fixed Building rent & Depreciation.
b) Y = 3,500 + (2.72x)
c) Y = 3,500 + (2.72 x 8000) = $25,260