A Cost-Volume-Profit Example
The textbook publishing business provides a good illustration of the effective use of cost-
volume profit analysis for new product decisions. Consider the hypothetical cost-volume-
profit analysis data shown in Table. Fixed costs of $100,000 can be estimated quite
accurately.
Variable costs are linear and set by contract. List prices are variable, but competition keeps
prices within a sufficiently narrow range to make a linear total revenue curve reasonable.
Variable costs for the proposed book are $92 a copy, and the price is $100. This means that
each copy sold provides $8 in profit contribution. Applying the breakeven formula from
Equation, the breakeven sales volume is 12,500 units, calculated as
Q = $100,000/$8
= 12,500 units
Publishers evaluate the size of the total market for a given book, competition, and other
factors. With these data in mind, they estimate the probability that a given book will reach or
exceed the breakeven point. If the publisher estimates that the book will neither meet nor
exceed the breakeven point, they may consider cutting production costs by reducing the
number of illustrations, doing only light copyediting, using a lower grade of paper,
negotiating with the author to reduce the royalty rate, and so on.
Assume now that the publisher is interested in determining how many copies must sell to
earn a $20,000 profit. Because profit contribution is the amount available to cover fixed
costs and provide profit, the answer is found by adding the profit requirement to the book’s
fixed costs and then dividing by the per-unit profit contribution. The sales volume required in
this case is 15,000 books, found as follows:
Q = Fixed Costs + Profit Requirement/Profit Contribution
= $100,000 + $20,000/$8
= 15,000 units
Consider yet another decision problem that might confront the publisher. Assume that a
book club has offered to buy 3,000 copies at a price of $77 per copy. Cost-volume-profit
analysis can be used to determine the incremental effect of such a sale on the publisher’s
profits.
Because fixed costs do not vary with respect to changes in the number of textbooks sold,
they should be ignored. Variable costs per copy are $92, but note that $25 of this cost
represents bookstore discounts. Because the 3,000 copies are being sold directly to the
club, this cost will not be incurred. Hence, the relevant variable cost is only $67 (= $92 –
$25). Profit contribution per book sold to the book club is $10 (= $77 – $67), and $10 times
the 3,000 copies sold indicates that the order will result in a total profit contribution of
$30,000. Assuming that these 3,000 copies would not have been sold through normal sales
channels, the $30,000 profit contribution indicates the increase in profits to the publisher
from accepting this order.