Hilton 13e SM Ch07
Hilton 13e SM Ch07
Cost-Volume-Profit Analysis
fixed
expense
s
This equation is solved for the sales volume in units.
c. In the graphical approach, sales revenue and total expenses are graphed. The
break-even point occurs at the intersection of the total revenue and total expense
lines.
7-2 The term unit contribution margin refers to the contribution that each unit of sales
makes toward covering fixed expenses and earning a profit. The unit contribution
margin is defined as the sales price minus the unit variable expense.
7-3 In addition to the break-even point, a CVP graph shows the impact on total expenses,
total revenue, and profit when sales volume changes. The graph shows the sales
volume required to earn a particular target net profit. The firm's profit and loss areas
are also indicated on a CVP graph.
7-4 The safety margin is the amount by which budgeted sales revenue exceeds break-
even sales revenue.
7-5 An increase in the fixed expenses of any enterprise will increase its break-even
point. In a travel agency, more clients must be served before the fixed expenses are
covered by the agency's service fees.
7-6 A decrease in the variable expense per pound of oysters results in an increase in the
contribution margin per pound. This will reduce the company's break-even sales
volume.
7-7 The president is correct. A price increase results in a higher unit contribution
margin. An increase in the unit contribution margin causes the break-even point to
decline.
Sales revenue:
350 units at $10 $3,500
100 units at $20 $2,000
Variable expenses:
350 units at $6 2,100
100 units at $6 600
Contribution margin $1,400 $1,400
Fixed expenses 1,000 1,000
Profit $ 400 $ 400
7-21 The statement makes three assertions, but only two of them are true. Thus, the
statement is false. A company with an advanced manufacturing environment
typically will have a larger proportion of fixed costs in its cost structure. This will
result in a higher break-even point and greater operating leverage. However, the
firm's higher break-even point will result in a reduced safety margin.
7-22 Activity-based costing (ABC) results in a richer description of an organization's cost
behavior and CVP relationships. Costs that are fixed with respect to sales volume
may not be fixed with respect to other important cost drivers. An ABC system
recognizes these nonvolume cost drivers, whereas a traditional costing system does
not.
Total Break-Even
Sales Variable Contribution Fixed Net Sales
Revenue Expenses Margin Expenses Income Revenue
1 $160,000a $40,000 $120,000 $30,000 $90,000 $40,000
2 80,000 65,000 15,000 15,000b -0- 80,000
3 120,000 40,000 80,000 30,000 50,000 45,000c
4 110,000 22,000 88,000 50,000 38,000 62,500d
d
$62,500 = $50,000/.80, where .80 is the contribution-margin ratio.
= = 8,000 pizzas
2. Contribution-margin ratio =
= = .5
= = $80,000
4. Let X denote the sales volume of pizzas required to earn a target net profit of
$65,000.
$10X – $5X – $40,000= $65,000
$5X = $105,000
X = 21,000 pizzas
= = 4,000 components
p denotes Argentina’s peso
= = 4,400 components
3. Sales revenue (5,000 × 3,000p) 15,000,000p
Variable costs (5,000 × 2,000p) 10,000,000p
Contribution margin 5,000,000p
Fixed costs 4,000,000p
Net income 1,000,000p
4,000,000p
1,000,000p
The price cut should not be made, since projected net income will decline.
1. Cost-volume-profit graph:
Break-even point:
$250,000 20,000 tickets
Total expenses
Profit
area Variable
$200,000 expense
(at 30,000
tickets)
$150,000
$50,000
Tickets
sold per
5,000 10,000 15,000 20,000 25,000 30,000 year
1. Profit-volume graph:
$150,000
$100,000
$50,000
Break-even point:
20,000 tickets
0 Tickets sold
5,000 10,000 15,000 20,000 25,000 per year
Profit
area
Loss
area
$(50,000)
$(100,000)
Annual fixed
expenses
$(150,000)
$(180,000)
2. Safety margin:
3. Let P denote the break-even ticket price, assuming a 12-game season and 50 percent
attendance:
2.
3.
= 10% × 4.35
= 43.5%
4. Most operating managers prefer the contribution income statement for answering this
type of question. The contribution format highlights the contribution margin and
separates fixed and variable expenses.
1.
Sales Unit Unit
Bicycle Type Price Variable Cost Contribution Margin
High-quality $500 $300 ($275 + $25) $200
Medium-quality 300 150 ($135 + $15) 150
2. Sales mix:
3. Weighted-average unit
contribution margin = ($200 × 25%) + ($150 × 75%)
= $162.50
4.
Break-Even Sales
Bicycle Type Sales Volume Sales Price Revenue
High-quality bicycles 100 (400 × .25) $500 $ 50,000
Medium-quality bicycles 300 (400 × .75) 300 90,000
Total $140,000
This means that the shop will need to sell the following volume of each type of
bicycle to earn the target net income:
High-quality 175 (700 × .25)
Medium-quality 525 (700 × .75)
Amount Percent
Revenue $500,000 100
Variable expenses 300,000 60
Contribution margin $200,000 40
Fixed expenses 150,000 30
Net income $ 50,000 10
2.
Decrease in Contribution Margin Decrease in
Revenue Percentage Net Income
$75,000* × 40%† = $30,000
3.
4.
1.
4. A change in the tax rate will have no effect on the firm's break-even point. At the break-
even point, the firm has no profit and does not have to pay any income taxes.
X =
= 150,000 units
= (220,000)($4) – $600,000
4. Let P denote the selling price that will yield the same contribution-margin ratio:
5. The Build a Spreadsheet Excel file can be downloaded from the Connect Instructor
Library: Build a Spreadsheet 07-34.xls
4. Let P denote the selling price that will yield the same contribution-margin ratio:
2. Model no. 4399 is more profitable when sales and production average 46,000 units.
Model Model
No. 6754 No. 4399
3. Annual fixed costs will increase by $90,000 ($450,000 ÷ 5 years) because of straight-
line depreciation associated with the new equipment, to $1,203,600 ($1,113,600 +
$90,000). The unit contribution margin is $48 ($2,208,000 ÷ 46,000 units). Thus:
Required sales = (fixed costs + target net profit) ÷ unit contribution margin
= ($1,203,600 + $956,400) ÷ $48
= 45,000 units
Required sales = (fixed costs + target net profit) ÷ unit contribution margin
= ($2,280,000 + $480,000) ÷ $60
= 46,000 sets, or $3,680,000 (46,000 sets x $80)
2. If operations are shifted to Mexico, the new unit contribution margin will be $62 ($80 -
$18). Thus:
(b) No effect
(c) Increase
(d) No effect
1. Sales mix refers to the relative proportion of each product sold when a company
sells more than one product.
2. (a) Yes. Plan A sales are expected to total 65,000 units (45,500 + 19,500), which
compares favorably against current sales of 60,000 units.
(b) Yes. Sales personnel earn a commission based on gross dollar sales. As the
following figures show, Deluxe sales will comprise a greater proportion of
total sales under Plan A. This is not surprising in light of the fact that Deluxe
has a higher selling price than Basic ($86 vs. $74).
Current Plan A
Sales Sales
Units Mix Units Mix
(c) Yes. Commissions will total $535,600 ($5,356,000 x 10%), which compares
favorably against the current flat salaries of $400,000.
(d) No. The company would be less profitable under the new plan.
Current Plan A
3. (a) The total units sold under both plans are the same; however, the sales mix
has shifted under Plan B in favor of the more profitable product as judged by
the contribution margin. Deluxe has a contribution margin of $21 ($86 - $65),
and Basic has a contribution margin of $33 ($74 - $41).
Plan A Plan B
Sales Sales
Units Mix Units Mix
(b) Plan B is more attractive both to the sales force and to the company.
Salespeople earn more money under this arrangement ($549,900 vs. $400,000)
and the company is more profitable ($1,283,100 vs. $1,112,000).
Current Plan B
Sales revenue:
Deluxe: 39,000 units x $86; 26,000 units x $86… $3,354,000 $2,236,000
Basic: 21,000 units x $74; 39,000 units x $74….. 1,554,000 2,886,000
Total revenue……………………………………. $4,908,000 $5,122,000
Less variable cost:
Deluxe: 39,000 units x $65; 26,000 units x $65… $2,535,000 $1,690,000
Basic: 21,000 units x $41; 39,000 units x $41….. 861,000 1,599,000
Total variable cost……………………………… $3,396,000 $3,289,000
Contribution margin…………………………………….. $1,512,000 $1,833,000
2. Operating leverage refers to the use of fixed costs in an organization’s overall cost
structure. An organization that has a relatively high proportion of fixed costs and
low proportion of variable costs has a high degree of operating leverage.
Plan A Plan B
1.
2.
Break-even point
Let P denote sales price required to maintain a contribution-margin ratio of .208. Then
P is determined as follows:
1. CVP graph:
10
9 Profit
Break-even point: area
8 80,000 units or
$4,000,000 of sales
7
Total expenses
6
5
4
3
Loss
2 area
Fixed expenses
1
Units sold per year
50 100 150 200 (in thousands)
2. Break-even point:
6. Cost structure:
Amount Percent
Sales revenue $8,000,000 100.0
Variable expenses 2,000,000 25.0
Contribution margin $6,000,000 75.0
Fixed expenses 3,000,000 37.5
Net income $3,000,000 37.5
1. (a)
(b)
4. Profit-volume graph:
$750,000
$500,000
Profit
area
$250,000
Break-even point: Units sold
70,000 units per year
0
Loss 25,000 50,000 75,000 100,000
area
$(250,000)
$(500,000)
$(750,000)
6. The Build a Spreadsheet Excel file can be downloaded from the Connect Instructor
Library: Build a Spreadsheet 07-42.xls
1. In order to break even, during the first year of operations, 10,220 clients must visit the
new law office as the following calculations show.
Fixed expenses:
Advertising $ 490,000
Rent (6,000 × $28) 168,000
Property insurance 27,000
Utilities 37,000
Malpractice insurance 180,000
Depreciation ($60,000/4) 15,000
Wages and fringe benefits:
Regular wages
($25 + $20 + $15 + $10) × 16 hours × 360 days $403,200
Overtime wages
(200 × $15 × 1.5) + (200 × $10 × 1.5) 7,500
Total wages $410,700
Fringe benefits at 40% 164,280 574,980
Total fixed expenses $1,491,980
Break-even point:
0 = revenue – variable cost – fixed cost
0 = $30X + ($2,000 × .2X × .3)* – $4X – $1,491,980
0 = $30X + $120X – $4X – $1,491,980
$146X = $1,491,980
X = 10,220 clients (rounded)
$30X represents the $30 consultation fee per client. ($2,000 × .2X × .30) represents the
predicted average settlement of $2,000, multiplied by the 20% of the clients whose
judgments are expected to be favorable, multiplied by the 30% of the judgment that
goes to the firm.
2. Safety margin:
Computer-Assisted Labor-Intensive
Manufacturing System Production System
Selling price $30.00
$30.00
Variable costs:
Direct material $5.00 $5.60
Direct labor 6.00 7.20
Variable overhead 3.00 4.80
Variable selling cost 2.00 16.00 2.00
19.60
Contribution margin per unit $14.00
$10.40
$3.60X = $1,120,000
3. Operating leverage is the extent to which a firm's operations employ fixed operating
costs. The greater the proportion of fixed costs used to produce a product, the
greater the degree of operating leverage. Thus, the computer-assisted
manufacturing method utilizes a greater degree of operating leverage.
The greater the degree of operating leverage, the greater the change in
operating income (loss) relative to a small fluctuation in sales volume. Thus, there
is a higher degree of variability in operating income if operating leverage is high.
● The ability to discontinue production and marketing of the new product while
incurring the least amount of loss.
2. Profit-volume graph:
$20
Pro
fit
Break-even point:
40,816 tubs
$10
Tubs sold
0 10 20 30 40 50 per year
(in thousands)
Loss Profit
area area
Lo
($10)
ss
3. The sales price per tub is the same regardless of the type of machine selected.
Therefore, the same profit (or loss) will be achieved with the Economy and Regular
models at the sales volume, X, where the total costs are the same.
Variable Cost Total
Model per Tub Fixed Cost
Economy $1.43 $ 8,000
Regular 1.35 11,000
This reasoning leads to the following equation: 8,000 + 1.43X = 11,000 + 1.35X
Check: the total cost is the same with either model if 37,500 tubs are sold.
Economy Regular
Variable cost:
Economy, 37,500 × $1.43 $53,625
Regular, 37,500 × $1.35 $50,625
Fixed cost:
Economy, $8,000 8,000
Regular, $11,000 11,000
Total cost $61,625 $61,625
Since the sales price for popcorn does not depend on the popper model, the sales
revenue will be the same under either alternative.
1.
3.
5.
*Given in problem.
Let P denote the price required to cover increased direct-material cost and maintain
the same contribution margin ratio:
Check:
1. Memorandum
Date: Today
The $150,000 cost that has been characterized as fixed is fixed with respect to sales
volume. This cost will not increase with increases in sales volume. However, as the activity-
based costing analysis demonstrates, these costs are not fixed with respect to other
important cost drivers. This is the difference between a traditional costing system and an
ABC system. The latter recognizes that costs vary with respect to a variety of cost drivers,
not just sales volume.
(a) Its break-even point will be higher (17,000 units instead of 15,000 units).
(b) The number of sales units required to show a profit of $140,000 will be lower
(27,000 units instead of 29,000 units).
(c) These results are typical of situations where firms adopt advanced manufacturing
equipment and practices. The break-even point increases because of the
increased fixed costs due to the large investment in equipment. However, at
higher levels of sales after fixed costs have been covered, the larger unit
contribution margin ($14 instead of $10) earns a profit at a faster rate. This results
in the firm needing to sell fewer units to reach a given target profit level.
5. The controller should include the break-even analysis in the report. The Board of
Directors needs a complete picture of the financial implications of the proposed
equipment acquisition. The break-even point is a relevant piece of information. The
controller should accompany the break-even analysis with an explanation as to
why the break-even point will increase. It would also be appropriate for the
controller to point out in the report that the advanced manufacturing equipment
would require fewer sales units at higher volumes in order to achieve a given
target profit, as in requirement (3) of this problem.
(a) Competence: Provide decision support information and recommendations that are
accurate, clear, concise, and timely.
(b) Integrity: Refrain from engaging in any conduct that would prejudice carrying out
duties ethically.
(c) Credibility: Communicate information fairly and objectively. Disclose all relevant
information that could reasonably be expected to influence an intended user's
understanding of the reports, analyses, and recommendations.
2. Promotional campaign:
We can restate the November 20x1 data for the Downtown Store as follows:
Downtown Store
Items Sold at
Their
Variable Cost Other Items
Sales $60,000* $60,000*
Less: variable expenses 60,000
24,000
Contribution margin $ -0- $
36,000
*$60,000 is one half of the Downtown Store's dollar sales for November 20x1.
1.
CINCINNATI TOOL COMPANY
BUDGETED INCOME STATEMENT
FOR THE YEAR ENDED DECEMBER 31, 20X2
Hedge
Weeders Clippers Leaf Blowers Total
Unit selling price $28 $36 $48
Variable manufacturing cost $13 $12 $25
Variable selling cost 5
4 6
Total variable cost $18
$16 $31
Contribution margin per unit $10 $20 $17
Unit sales × 50,000 × 50,000 × 100,000
Total contribution margin $500,000
$1,000,000 $1,700,000 $3,200,000
2.
(a) (b)
Unit Sales
Contribution Proportion (a) × (b)
Weeders $10 .25 $ 2.50
Hedge Clippers 20 .25 5.00
Leaf Blowers 17 .50 8.50
Weighted-average unit
contribution margin $16.00
Sales proportions:
3.
(a) (b)
Unit Sales
Contribution Proportion (a) × (b)
Weeders $10 .20 $ 2.00
Hedge Clippers* 19 .20 3.80
Leaf Blowers† 12 .60 7.20
Weighted-average unit contribution margin $13.00
Sales proportions:
1.
Sales price per ton for regular orders = $900,000/1,800 = $500 per ton
Foreign Regular
Order Sales
Sales in tons 1,500 1,500
Contribution margin per ton:
Foreign order ($450 – $275) × $175
Regular sales ($500 – $275) × $225
Total contribution margin $262,500 $337,500
To maintain its current net income, Ohio Limestone Company just needs to break
even on sales in the new territory.
1.
Let Y denote the variable cost of the touring model such that the break-even point
for the touring model is 10,500 units.
Then we have:
Thus, the variable cost per unit would have to decrease by $2.97 ($52.80 – $49.83).
5. Weighted-average unit
contribution margin
Break-even point
1. SUMMARY OF EXPENSES
(a)
(b)
$ 10,800
Contribution marginratio=1− =1−.675=.325 Required sales dollars ¿ earn same net income=
$ 16,000
3. The volume in sales dollars (X) that would result in equal net income is the volume
of sales dollars where total expenses are equal.
Break-even point
in patient-days
Increase in revenue
(20 additional beds × 90 days × $300 charge per day) $
540,000
Increase in expenses:
Variable charges by medical center
(20 additional beds × 90 days × $100 per day) $
180,000
Salaries
(20,000 patient-days before additional 20 beds + 20 additional
beds × 90 days = 21,800, which does not exceed 22,000 patient-days;
therefore, no additional personnel are required) -0-
Total increase in expenses
$1,146,660
Net change in earnings from rental of additional 20 beds $
(606,660)
1. a. In order to break even, Oakley must sell 500 units. This amount represents the
point where revenue equals total costs.
b. In order to achieve its after-tax profit objective, Oakley must sell 2,500 units. This
amount represents the point where revenue equals total costs plus the before-tax
profit objective.
Revenue=variable costs+ ¿ costs+before−tax profit $ 400 X=$ 200 X + $ 100,000+[$ 300,000÷ (1−. 2
2. To achieve its annual after-tax profit objective, Oakley should select the first
alternative, where the sales price is reduced by $40 and 2,700 units are sold during
the remainder of the year. This alternative results in the highest profit and is the
only alternative that equals or exceeds the company’s profit objective. Calculations
for the three alternatives follow.
Alternative (1):
Revenue=($ 400)(350)+($ 360)(2,700)=$ 1,112,000 Variable cost =$ 200× 3,050=$ 610,000 Before−ta
Alternative (2):
Revenue=($ 400)(350)+($ 370)(2,200)=$ 954,000 Variable cost =($ 200)(350)+($ 175)(2,200)=$ 455,
Alternative (3):
Revenue=($ 400)(350)+($ 380)(2,000)=$ 900,000 Variable cost =$ 200 × 2,350=$ 470,000 Before−tax
Sales $10,000,000
Cost of goods sold 6,000,000
Gross margin $ 4,000,000
Commissions (at 5%) 500,000
Contribution margin $ 3,500,000
Sales $10,000,000
Cost of goods sold 6,000,000
Gross margin $ 4,000,000
Commissions (at 25%) 2,500,000
Contribution margin $ 1,500,000
Sales $ 13,333,333
Cost of goods sold (60% of sales)
8,000,000
Gross margin $ 5,333,333
Selling and administrative expenses:
Commissions $ 3,333,333
All other expenses (fixed) 100,000
3,433,333
Income before taxes $
1,900,000
Income tax expense (30%)
570,000
Net income $ 1,330,000
4. Sales dollar volume at which Niagara Falls Sporting Goods Company is indifferent:
Since the tax rate is the same regardless of which approach management chooses,
we can find X so that the company’s before-tax income is the same under the two
alternatives. (In the following equations, the contribution-margin ratios of .35
and .15, respectively, were computed in the preceding two requirements.)
.
.35X – $350,000 = .15X – $100,000
.20X = $250,000
X = $250,000/.20
X = $1,250,000
Thus, the company will have the same before-tax income under the two alternatives
if the sales volume is $1,250,000.
Check:
Alternatives
Employ
Sales Pay 25%
Personnel Commission
Sales $1,250,000 $1,250,000
Cost of goods sold (60% of sales) 750,000 750,000
Gross margin $ 500,000 $500,000
Selling and administrative expenses:
Commissions 62,500* 312,500†
All other expenses (fixed) 350,000 100,000
Income before taxes $ 87,500 $87,500
Income tax expense (30%) 26,250 26,250
Net income $ 61,250 $61,250
*$1,250,000 × 5% = $62,500
†
$1,250,000 × 25% = $312,500