Cost Volume Profit Analysis

What is CVP Analysis?

 CVP (Cost Volume Profit) analysis explores the
relationship between revenue, cost and volume and its
effect on profit.
Who uses CVP Analysis?
 Managers want to know how profits will change as units
sold of a product or service changes
 Managers like to use “what-if” analysis to examine the
possible outcomes of different decisions so they can make
the best one
Assumptions in CVP
 Changes in production/sales volume are the sole cause for cost
and revenue changes
 Total costs consist of fixed costs and variable costs
 Selling price, variable cost per unit and fixed costs are all known
and constant
 Revenue and costs behave and can be graphed as a linear function
(a straight line)
 In many cases only a single product will be analysed.
 If multiple products are studied, their relative sales proportions are
known and constant
 The time value of money (interest) is ignored
Basic Formula Derivation
Sales – Expenses = Operating income
Sales – Variable Cost – Fixed Cost = Operating Income
SP (Q) – VC (Q) – Fixed Cost = Operating Income
(SP – VC) Q – Fixed Cost = Operating Income
Contribution * Q – Fixed Cost = Operating Income
Contribution * Q = Operating Income + Fixed Cost
Q = Operating income + Fixed cost
Contribution
Where:
SP is selling price per unit
VC is variable cost per unit
Q is quantity or units
Formulas
 Total Contribution Margin equals Sales less Variable costs
CM = S – VC
 Contribution Margin per Unit equals unit selling price less variable cost per
unit
CMu = SPu – VCu
 Contribution Margin Ratio (percentage) or PV Ratio equals contribution
margin per unit divided by Selling Price
CMR = CMu ÷ SP * 100
 Breakeven point – by setting the operating income to zero we get
CMu * Q = FC or Q = FC ÷ CMu
 If per-unit values are not available, the Breakeven Point may be restated in
its alternate format
BE Sales = FC ÷ CMR
 Profit Planning
Q = (FC + OI)÷ CMu or Q = (FC + OI)÷ CMR
Example
Given:
SP = Rs. 10
VC = Rs. 6
Fixed cost = Rs. 4000
What is my Break even point?
How many units should I sell to have an operating income = Rs. 4000
Numerical
ABC Ltd manufacturing a single product, incurring variable cost of
Rs.300 per unit and fixed cost of Rs.2,00,000 per month. If the product
sells for Rs.500 per unit, the breakeven point is?
Solution:
Breakeven point is units = Fixed cost / Contribution per unit
= 200000/200 = 1000 units

Breakeven point in value = 1000 units * SP (500) = Rs. 500,000

Or Fixed cost / PV ratio

PV ratio = contribution/sales * 100 = 200/500*100 = 40%
Fixed cost / PV ratio = 200000/40% = Rs.500000
Breakeven Point – Graphical
Point of no profit no loss
Multi Product Breakeven Analysis
In a multi product environment, when more than one product
is manufactured by using common fixed cost. The breakeven
point is calculated by taking weighted average contribution
based on the sales mix.
Numerical
Arvind Ltd sells two products J and K. The sales mix is 4 units of J and 3
units of K. The contribution margins per unit are Rs. 40 for J and Rs.20
for K. Fixed costs are Rs. 6,16,000 per month. Find the breakeven
point.

Sales mix is 4:3

Weighted average contribution = [(4 * 40 )+ (3 * 20)]/7 = Rs. 31.43

Composite Breakeven point = Fixed cost / wt. avg contribution

= 616000/31.43 = 19600 units (rounded)

Breakeven units of Product J = 19600 * 4/7 = 11200 units

Breakeven units of Product K = 19600 * 3/7 = 8400 units

Margin of Safety
One indicator of risk, the Margin of Safety (MOS) measures
the distance between budgeted sales and breakeven sales:
 MOS = Budgeted Sales – BE Sales

The MOS Ratio removes the firm’s size from the output, and
expresses itself in the form of a percentage:
 MOS Ratio = MOS ÷ Budgeted Sales
Numerical
The following data for RICO Ltd is provided

Variable cost Rs. 60,000 60%

Fixed cost Rs. 30,000 30%
Net profit Rs. 10,000 10%
Sales Rs. 1,00,000 100%

Find out:
a) P/V ratio
b) Break even point
c) Margin of Safety
Solution
P/V ratio = Contribution / Sales = 40000/100000 = 40%

Breakeven point = FC / PV ratio = 30000/40% = Rs.75,000

Margin of safety = Actual sales – Breakeven sales

= Rs. 1,00,000 – Rs. 75,000 = Rs. 25,000
CVP & Income Tax
 From time to time it is necessary to move back and forth
between pre-tax profit (OI) and after-tax profit (NI),
depending on the facts presented

After-tax profit can be calculated by:

 Operating Income x (1-Tax Rate) = Net Income

or
 Operating Income = Net Income / (1-Tax Rate)
CVP & Income Tax

If we want a profit of Rs. 5000 after tax. Tax rate 30%

How much profit to be earned before tax?

5000 5000
= ----------- = ----------------- = Rs. 7143
(1 – tax rate) 0.7
Numerical
The following details are available: Actual sales = Rs. 20,000, break-
even sales = Rs.10,000 and fixed cost = Rs.5000. Find out the profit at
actual sales.

Solution
At break-even point, contribution = Fixed cost
At break-even point, sales is Rs.10,000 and contribution is Rs.5,000
Hence PV ratio = 5000/10000 * 100 = 50%

At actual sales of Rs.20,000, Contribution = 20000 * 50% = Rs.10,000

Profit = Contribution – Fixed cost = Rs.10,000 – Rs.5,000 = Rs.5000

Decision Making
Relevance
 Relevant Information has two characteristics:
 It occurs in the future
 It differs among the alternative courses of action
 Relevant Costs – expected future costs
 Relevant Revenues – expected future revenues

Irrelevance
 Historical costs are past costs that are irrelevant to decision
making
 Also called Sunk Costs
Terminology
 Incremental Cost – the additional total cost incurred for an
activity
 Differential Cost – the difference in total cost between two
alternatives
 Incremental Revenue – the additional total revenue from an
activity
 Differential Revenue – the difference in total revenue
between two alternatives
 Types of Decisions

 One-Time-Only Special Orders

 Insourcing vs. Outsourcing/ Make or Buy
 Local vs Export sale
 Product-Mix, product-mix under resource constraints
 Customer Profitability
 Branch / Segment: Adding or Discontinuing
 Equipment Replacement
 Sale or further processing
Sensitivity Analysis
CVP Provides structure to answer a variety of “what
if” scenarios
“What” happens to profit “if”:
 Selling price changes
 Volume changes
 Cost structure changes
Variable cost per unit changes
Fixed cost changes
Operating Leverage
Operating Leverage (OL) is the effect that fixed costs have on
changes in operating income as changes occur in units sold,
expressed as changes in contribution margin

OL = Contribution Margin / Operating Income

Operating leverage
Harisons Furnishings is holding a two-week carpet sale at Richi Rich, a
local warehouse store. Harisons plans to sell carpets for Rs.5000 each. The
company will purchase the carpets from a local distributor for Rs.3500
each with a privilege of returning any unsold units for a full refund. Richi
Rich has offered Harisons two payment alternatives for the use of space:
Option 1 : a fixed payment of Rs.50,000 for the sale period
Option 2 : 10 per cent of total revenues earned during the sale period.
Assume Harrison will incur no other costs.
1. Calculate the breakeven point in units for option 1 & 2
2. At what level will Harisons earn the same operating income under
either option?
3. For what range of unit sales will Harisons prefer option 1?
4. For what range of unit sales will Harisons prefer option 2?
Solution
Option 1: SP = Rs. 5000, VC = Rs. 3500, hence Contribution = Rs. 1500

BEP = FC/contribution pu, 50000/1500 = 34 carpets

Option 2: SP = Rs. 5000, VC = Rs. 3500 and VC = 10% of 5000 = Rs. 500
hence Contribution = Rs. 1000
BEP = FC/contribution pu, FC = 0, hence zero carpets
Option 1 Operating income = Option 2 Operating income
1500x – 50000 = 1000x
Solving for x = 50, i.e 100 carpets

Option 1 Is preferrable for sales greater than 100 carpets

Option 2 Is preferrable for sales less than 100 carpets

Effects of Sales Mix on CVP
 The formula presented to this point have assumed a single
product is produced and sold
 A more realistic scenario involves multiple products sold, in
different volumes, with different costs
 The same formula are used, but instead use average
contribution margins for bundles of products.
 Sales Mix… two products
Ambika condiments brings out two products, Ruchi and Suchi, which are
popular in the market. The management has the option to alter the sales mix of
the two products from the following combination
Option Suchi (units) Ruchi (units)
I 800 600
II 1600 -
III - 1300
IV 1100 500

The per unit cost data: Direct material: Suchi Rs.875 Ruchi Rs.1050
Direct labour (hrs): Suchi 10 hrs Ruchi 12 hrs
Variable factory overhead is 100% of the direct labour cost for both products.
The selling price of Suchi and Ruchi are Rs.2625 and Rs. 3150 respectively.
Labour rate is Rs. 70 per hour. Common fixed overhead for both products is
Rs.350,000.

a) Prepare a marginal cost statement for the two products

b) Evaluate the options and identify the most profitable sales-mix
 Marginal cost statement of two products
Particulars Products (Rs. per unit)
Suchi Ruchi
Selling price 2,625 3,150
Direct material 875 1,050
Direct labour @ Rs.70 per hour 700 840
Variable overhead (100% of direct labour) 700 840
Total variable cost 2,275 2,730
Contribution per unit 350 420

Evaluation of Options and identification of most profitable sales mix

Particulars Option I Option II Option III Option IV
Units (Rs.) Units (Rs.) Units (Rs.) Units (Rs.)
Contribution : Suchi 800 2,80,000 1600 5,60,000 - 1100 3,85,000
: Ruchi 600 2,52,000 - 1300 5,46,000 500 2,10,000
Total contribution 5,32,000 5,60,000 5,46,000 5,95,000
Less: Fixed Cost 3,50,000 3,50,000 3,50,000 3,50,000
Profit 1,82,000 2,10,000 1,96,000 2,45,000
Option IV gives the highest profit of Rs.245,000, hence option IV sales mix is recommended
Sales Mix… three products
The Lee company has three product lines of belts: X, Y and Z with
contribution margins of Rs.15, Rs.10 & Rs.5 respectively. The
president foresees sales of 1,00,000 units in the coming period,
consisting of 10,000 units of X, 50,000 units of Y and 40,000 units
of Z. The company’s fixed costs for the period are Rs.5,10,000.
• What is the company’s breakeven point in units, assuming that
the given sales mix is maintained?
• If the sales mix is maintained what is the total contribution when
1,00,000 units are sold? What is the operating income?
• What would operating income be if 10,000 units of X, 40,000 units
of Y and 50,000 units of Z were sold? What is the new breakeven
point in units if these relationships persist in the next period?
Solution
X Y Z Total
Contribution 15 10 5
Budgeted sales (units) 10000 50000 40000
Weight of sales 10% 50% 40%
Weighted contribution 1.5 5 2 8.5
Fixed cost 510000
Break even point (Units) 60000
BEP in the ratio of weight of sales (units) 6000 30000 24000
Check
Total contribution 90000 300000 120000 510000
Less: Fixed cost 510000
Profit/Loss 0
Product mix under resource constraint
ABC Limited produces and sells two products X and Y. The product is highly
demanded in the market. Following information relating to both the
products are given: Per Unit Rs.
X Y
Direct materials 140 180
Direct wages 60 100
Variable Overhead (Rs. 5 per 20 40
machine hour)
Selling price 300 450

The company is facing scarcity of machine hours for working. The availability
of machine hours are limited to 60,000 hours in a month. At present, the
monthly demand of product X and product Y is 8000 units and 6000 units
respectively. The fixed expenses of the company are Rs.2,25,000 per month.
You are required to:
Determine the product mix that generates maximum profit to the company
in the given situation and also calculate the profit of the company.
Contribution per unit Rs.
X Y
Selling price 300 450
Variable cost: Direct material 140 180
Direct wages 60 100
Variable Overhead 20 40
Total Variable cost 220 320
Contribution per unit 80 130
Machine hours 4 8
Contribution per machine hour 20 16.25
Panking I II
Product mix to maximise the profit:
Product X = 8,000 units
Hours required = 32,000 hrs (8000 * 4 hrs)
Balance hours available = 28,000 hrs (60000 – 32000 hrs)
Product Y = 3,500 units (28,000 hrs/8hrs)

Profitability of the best Product mix

X (Rs) Y (Rs.) Total (Rs.)
Sales (in units) 8,000 units 3,500 units
Contribution 80 130
per unit
Contribution 6,40,000 4,55,000 10,95,000
Less: Fixed cost 2,25,000
Profit 8,70,000
One time Special Order
RD Enterprises manufactures medals for winners of athletic events and other
contest. Its manufacturing plant has the capacity to produce 10,000 medals each
month. The company has current production and sales level of 7,500 medals per
month. The current domestic market price of medal is Rs. 150.
The cost data for the month of August is as under:

Rs.
Variable costs:
- Direct materials 2,62,500
- Direct labour cost 3,00,000
- Overhead 75,000
Fixed manufacturing costs 2,75,000
Fixed marketing costs 1,75,000
Total 10,87,500
RD Enterprises has received a special one-time only order for 2,500 medals at Rs.
120 per medal.
a) Should RD Enterprises accept the special order? Explain
b) Suppose the plant capacity was 9,000 medals instead of 10,000 medals each
month. The special order must be taken either in full or rejected totally. Analyse
whether RD Enterprises should accept the special order or not.
Currently there is idle capacity for 2500 medals in a month. Hence any
additional order could increase the existing profit, provided offer price
is more than the marginal cost.
Particulars Amount (Rs.) Amount Rs.

Selling price per unit 150

Variable cost per unit

Direct material (262500 / 7500) 35

Direct labour (300000/7500) 40

Overhead (75000/7500) 10 85

Contribution 65

Total contribution 7500 * 65 4,87,500

Fixed cost

Fixed manufacturing costs 2,75,000

Fixed marketing costs 1,75,000 4,50,000

Profit 37,500
Since the offered price for the additional 2500 medals is more than the
variable cost per unit, any additional demand will contribute towards
fixed costs and profit

Particulars Amount (Rs.) Amount Rs.

Sales (150 * 7500)+(120 * 2500) 14,25,000

Variable (85 * 10000) 8,50,000

Contribution 5,75,000

Fixed cost

Fixed manufacturing costs 2,75,000

Fixed marketing costs 1,75,000 4,50,000

Profit 1,25,000

The offer for 2,500 unit be accepted as it increases the profit by

Rs.87,500 (125000-37500)
III) If the capacity is reduced by 1000 units per month and existing
demand for medals is 7,500 units, the space capacity is only 1500
medals. If the special order of 2500 medals is accepted, the company will
lose contribution on 1000 medals from existing customers. The offer
should be accepted only if the gain from the new offer supersedes the
loss from existing customers

Particulars Amount (Rs.) Amount Rs.

Sales (150 * 6500)+(120 * 2500) 12,75,000

Variable (85 * 9000) 7,65,000

Contribution 5,10,000

Fixed cost

Fixed manufacturing costs 2,75,000

Fixed marketing costs 1,75,000 4,50,000

Profit 60,000

The offer for 2,500 unit be accepted as it increases the profit by

Rs.22,500 (60000-37500). Other qualitative factors must be taken care
of
Make or Buy
NM Ltd manufactures automobile accessories and parts. The following are
the total cost of processing 2,00,000 units:
Direct material cost Rs.375 per unit
Direct labour cost Rs. 80 per unit
Variable factory overhead Rs.16 per unit
Fixed factory overhead Rs. 500 lacs

The purchase price of the component is Rs. 485. The fixed overhead
would continue to be incurred even when the component is bought from
outside.
Required:
a) Should the part be made or bought from outside considering that the
present facility when released following a buying decision would
remain idle?
b) In case the capacity can be rented out to another manufacturer for
Rs.32,00,000 having good demand. What should be the decision?
The present cost structure is as follows:
Variable cost per unit is:
Direct materials cost Rs.375
Direct labour cost Rs. 80
Variable factory overhead Rs. 16
Total variable cost Rs. 471
The fixed cost of Rs.500 lacs is irrelevant for decision making as it
would be incurred in either case.
a) Variable cost of making the component is Rs.471, as compared to
buying cost of Rs.485. Making the component in own production
facility would save the company Rs.14 per unit.
b) When an additional income of Rs.32 lacs can be earned, compared
additional income with additional cost of buying
Rental income = 32 lacs
Additional cost of buying (14 * 200000) = 28 lacs
Additional income = 4 lacs
The component should be bought from outside as it would save the
company Rs. 4,00,000 in fixed cost.
Multiple Cost Drivers
Variable costs may arise from multiple cost drivers or
activities. A separate variable cost needs to be calculated for
each driver. Examples include:
 Customer or patient count
 Passenger miles
 Patient days
 Student credit-hours
 Multiple Cost Drivers
Ritu is a distributor of brass picture frames. For the current year, she plans to
purchase frames for Rs.60 each and sell them for Rs.90 each. Ritu’s fixed cost for
current year are expected to be Rs.4,80,000. Ritu’s only other cost will be
variable cost of Rs.120 per shipment for preparing the invoice and delivery
documents, organizing the delivery, and following up for collection accounts
receivable. The Rs.120 cost will be incurred each time Ritu ships an order of
picture frames, regardless of the number of frames in the order.
Suppose Ritu sells 40,000 picture frames in 1000 shipments in current year.
Calculate Ritu’s current operating income.
Suppose Ritu anticipates making 500 shipments in current year. How many
picture frames must Ritu sell to breakeven in current year?
Calculate another breakeven point for current year different from the one
described in requirement 2.

41
Given Rs.
Selling price 90
Variable cost per brass frame 60
Contribution per brass frame 30
Varibale cost per shipment 120
Fixed cost 480000

Option I
40000 picture frame & 1000 shipments

Contribution from brass frames 40000* 30 12.00,000

Less: Variable cost of shipment 1000 * 120 -120,000
Net contribution 10,80,000
Less Fixed cost 480000
Profit 6,00,000

42
Option II
Breakeven if 500 shipments are made

(x*30) - (500*120) - 480000 = 0

30x - 60000 - 480000 = 0
x= 18000frames
With 500 shipments Ritu will breakeven at 18000 frames

Option III
Breakeven if 700 shipments are made

(x*30) - (700*120) - 480000 = 0

30x - 84000 - 480000 = 0
x= 18800frames

With 700 shipments Ritu will breakeven at 18800 frames

43
Equipment Replacement
Maruthi Agencies has received an order from a valuable client for supplying
3,00,000 pieces of a component at Rs. 550 per unit at a uniform rate of 25,000
units a month.
Variable manufacturing costs amount to Rs.404.70 per unit, of which direct
materials is Rs. 355 per unit. Fixed production overheads amount to Rs. 30 lacs per
annum, including depreciation. There is a penalty/reward clause of Rs. 30 per unit
for supplying less/more than 25,000 units per month. To adhere to the schedule of
supply, the company procured a machine worth Rs. 14.20 lacs which will wear out
by the end of the year and will fetch Rs. 3.55 lacs at the year end. After this supply
of machine, the supplier offers another advanced machine which will cost Rs.10.65
lacs, will wear out by the year end and not have any resale value. If the advanced
machine is purchased immediately, the purchaser will exchange the earlier
machine supplied at the price of the new machine. Fixed costs of maintaining the
advanced machine will increase by Rs.14,200/- per month for the whole year.
While the old machine had the capacity to complete the production in 1 year, the
new machine can complete the entire job in 10 months. The new machine will
have material wastage of 0.5% . Assume uniform production throughout the year
for both the machines.

Required Using incremental cost/revenue approach, decide whether the company

should opt for the advanced version.
 Old (Rs.) New (Rs.) Incremental
Depreciation (14.20 – 3.55) lacs 10,65,000 10,65,000 -
Fixed cost increase (12months x - 1,70,400 (1,70,400)
Rs.14200)
Resale value 3,55,000 - (3,55,000)
Material (Rs.355 x 0.5% x 300000 pieces) - 5,32,500 (5,32,500)
Increase in costs in New Machine (10,57,900)
Purchased
Penalty Rs. 30 per unit - - -
Reward Rs. 30 per unit (5000 units x 10 - 15,00,000 15,00,000
months x Rs. 30)
New Gain 4,42,100

Decision: Buy the advanced version.

Working Note Old Machine’s Production is 25,000 units per month. Hence, no penalty
and no reward. New Machine’s Production is 30,000 units (3,00,000units/10months) per
month. Hence, there is reward for 5,000 units (30,000 units – 25,000 units) per month.
CVP Analysis – Changing revenues & Cost

Cox and Kings Travel Agency specializes in flight between India and
Malaysia. It books passengers on Malaysian Air. Cox & Kings fixed costs are
Rs.10,00,000 per month. Malaysian Air charges a passenger Rs.20,000 per
round trip ticket.
Calculate the number of tickets Cox & Kings must sell each month to (a)
breakeven & (b) make a target operating income of Rs.4,00,000 per
month in each of the following independent cases.
1. Cox & Kings variable costs are Rs.400 per ticket. Malaysian Air pays
Cox & Kings 10 percent commission on ticket price.
2. Cox & Kings variable costs are Rs.200 per ticket. Malaysian Air pays
Cox & Kings 10 percent commission on ticket price.
3. Cox & Kings variable costs are Rs.200 per ticket. It receives Rs.500
commission per ticket from Malaysian Air. It charges its customer a
delivery fee of Rs.50 per ticket.
Solution
Given: Rs.
Commission 2,000 10% commission
VC 400
Contribution 1,600
Fixed cost 10,00,000 per month
Using the formula Sales - VC - FC = Operating Income
a) No. of tickets to be sold to breakeven
1600*x - 1000000 = 0 or x = 625.0tickets
b) To make a target operating income of Rs. 4,00,000 per month
1600*x - 1000000 = 400000 or x = 875.0tickets
Given: Rs.
Commission 2,000 10% commission
VC 200
Contribution 1,800
Fixed cost 10,00,000 per month
Using the formula Sales - VC - FC = Operating Income
a) No. of tickets to be sold to breakeven
1800*x - 1000000 = 0 or x = 555.6tickets or 556 tickets
b) To make a target operating income of Rs. 4,00,000 per month
1800*x - 1000000 = 400000 or x = 777.8tickets or 778 tickets
Given: Rs.
Commission 500
Delivery fee 50
VC 200
Contribution 350
Fixed cost 10,00,000 per month
Using the formula Sales - VC - FC = Operating Income
a) No. of tickets to be sold to breakeven
350*x - 1000000 = 0 or x = 2857.1tickets or 2858 tickets
b) To make a target operating income of Rs. 4,00,000 per month
350*x - 1000000 = 400000 or x = 4000.0tickets
Special Order
Suppose Nike produces and sells 5,00,000 units of a basketball
shirt. The selling price is $35 and there is excess capacity to
produce an additional 300,000 shirts. The costs are as follows
for the 500,000 shirts currently being produced and sold. The
absorption cost is $20 per shirt, consisting of variable
manufacturing cost of $14 per shirt and fixed manufacturing
cost of $6 per shirt. Variable selling and administrative costs
are $3 per shirt and fixed selling and administrative costs are
$2,000,000.
1. Suppose Nike receives a special order for 100,000 shirts
from the Sports Authority that had the following terms:
Selling price would be $18 per shirt, and if Nike accepts
the order it would not incur any additional variable selling
and administrative cost, but will have to pay a flat fee of
$80,000 to a manufacturer’s agent who had obtained the
potential order. Should Nike accept the order?
2. What if the order was for 250,000 units at a selling price of
$13.00 and there was no $80,000 agent fee? One manager
argued for acceptance of such an order as follows:
“Of course we will lose $1.00 each on the variable
manufacturing costs ($13 - $14), but we will gain $2.00 per
unit by spreading our fixed manufacturing costs over 750,000
shirts instead of 500,000 shirts. Consequently, we should take
the offer because it represents an advantage of $1.00 per
shirt.” The manager’s analysis follows:
Old fixed manufacturing cost per unit $3000,000 / 500,000 $6.00
New fixed manufacturing cost per unit $3000,000 / 750,000 4.00
“Savings” in fixed manufacturing cost per unit $2.00
Loss on variable manufacturing cost per unit, $13 - $14 1.00
Net saving per unit in manufacturing cost $1.00

Do you agree with the argument given by the manager?

Solution
1. Focus on relevant information – the difference in revenues and
costs. In addition to difference in variable costs, there is a difference in
fixed costs between two alternatives.
Additional revenue, 100,000 units @ 18.00 per shirt $1,800,000
Less: additional costs
Variable costs, 100,000 units @14 per unit 1,400,000
Fixed costs, agent’s fee 80,000
Increase in operating income from special order $3,20,000

From a financial perspective Nike should accept the order

2. The faulty thinking comes from attributing a “savings” to the
decrease in unit fixed costs. Regardless of how we spread the fixed cost
over the units produced, the special order will not change the total of
$3 million. We have a negative contribution margin of $1 per unit on
this special order. There is no way we can cover any amount of fixed
costs. Fixed costs are not relevant to this decision.
End of Session