Example-1

The Deli-Sub Shop owns and operates six stores in and around Minneapolis. You are given
the following corporate budget data for next year:

Revenues $11,000,000
Fixed costs $ 3,000,000
Variable costs $ 7,500,000

Variable costs change based on the number of subs sold.

Compute the budgeted operating income for each of the following deviations from the
original budget data. (Consider each case independently.)

Required:
1. A 10% increase in contribution margin, holding revenues constant
2. A 10% decrease in contribution margin, holding revenues constant
3. A 5% increase in fixed costs
4. A 5% decrease in fixed costs
5. A 5% increase in units sold
6. A 5% decrease in units sold
7. A 10% increase in fixed costs and a 10% increase in units sold
8. A 5% increase in fixed costs and a 5% decrease in variable costs

Solution : 1

Budgeted
Variable Contribution Fixed Operating
Revenues Costs Margin Costs Income
Orig. $11,000,000G $7,500,000G $3,500,000 $3,000,000G $500,000
1. 11,000,000 7,150,000 3,850,000a 3,000,000 850,000
2. 11,000,000 7,850,000 3,150,000b 3,000,000 150,000
3. 11,000,000 7,500,000 3,500,000 3,150,000c 350,000
4. 11,000,000 7,500,000 3,500,000 2,850,000d 650,000
5. 11,550,000e 7,875,000f 3,675,000 3,000,000 675,000
6. 10,450,000g 7,125,000h 3,325,000 3,000,000 325,000
7. 12,100,000i 8,250,000j 3,850,000 3,300,000k 550,000
8. 11,000,000 7,125,000l 3,875,000 3,150,000m 725,000
Example -2

The Doral Company manufactures and sells pens. Currently, 5,000,000 units are sold per
year at $0.50 per unit. Fixed costs are $900,000 per year. Variable costs are $0.30 per unit.

Consider each case separately:

Required:
1. a. What is the current annual operating income?
b. What is the current breakeven point in revenues?

Compute the new operating income for each of the following changes:
2. A $0.04 per unit increase in variable costs
3. A 10% increase in fixed costs and a 10% increase in units sold
4. A 20% decrease in fixed costs, a 20% decrease in selling price, a 10% decrease in
variable cost per unit, and a 40% increase in units sold

Compute the new breakeven point in units for each of the following changes:
5. A 10% increase in fixed costs
6. A 10% increase in selling price and a $20,000 increase in fixed costs

Solution-2
1a. [Units sold (Selling price – Variable costs)] – Fixed costs = Operating income
[5,000,000 ($0.50 – $0.30)] – $900,000 = $100,000

1b. Fixed costs ÷ Contribution margin per unit = Breakeven units

$900,000 ÷ [($0.50 – $0.30)] = 4,500,000 units
Breakeven units × Selling price = Breakeven revenues
4,500,000 units × $0.50 per unit = $2,250,000
or,
Selling price −Variable costs
Contribution margin ratio = Selling price
$0.50 - $0.30
= $0.50 = 0.40
Fixed costs ÷ Contribution margin ratio = Breakeven revenues
$900,000 ÷ 0.40 = $2,250,000

2. 5,000,000 ($0.50 – $0.34) – $900,000 = $ (100,000)

3. [5,000,000 (1.1) ($0.50 – $0.30)] – [$900,000 (1.1)] = $ 110,000

4. [5,000,000 (1.4) ($0.40 – $0.27)] – [$900,000 (0.8)] = $ 190,000

5. $900,000 (1.1) ÷ ($0.50 – $0.30) = 4,950,000 units

6. ($900,000 + $20,000) ÷ ($0.55 – $0.30) = 3,680,000 units

Example -3

Westover Motors is a small car dealership. On average, it sells a car for $32,000, which it
purchases from the manufacturer for $28,000. Each month, Westover Motors pays $53,700 in
rent and utilities and $69,000 for salespeople’s salaries. In addition to their salaries,
salespeople are paid a commission of $400 for each car they sell. Westover Motors also
spends $10,500 each month for local advertisements. Its tax rate is 40%.

Required:
1. How many cars must Westover Motors sell each month to break even?
2. Westover Motors has a target monthly net income of $69,120. What is its target
monthly operating income? How many cars must be sold each month to reach the
target monthly net income of $69,120?

Solution:3

CVP analysis, income taxes.

1. Monthly fixed costs = $53,700 + $69,000 + $10,500 = $133,200

Contribution margin per unit = $32,000 – $28,000 – $400 = $ 3,600

Breakeven units per month = = = 37 cars

2. Tax rate: 40%

Target net income: $69,120

Target operating income = $115,200

= 69
cars
Example: 4
Perfect Fit Jeans Co. sells blue jeans wholesale to major retailers across the country. Each pair of
jeans has a selling price of $50 with $35 in variable costs of goods sold. The company has fixed
manufacturing costs of $2,250,000 and fixed marketing costs of $250,000. Sales commissions are
paid to the wholesale sales reps at 10% of revenues. The company has an income tax rate of 20%.

Required:

[Link] many jeans must Perfect Fit sell in order to break even?
[Link] many jeans must the company sell in order to reach:
a.a target operating income of $420,000?
b.a net income of $420,000?
[Link] many jeans would Perfect Fit have to sell to earn the net income in requirement 2b if:
(Consider each requirement independently.)
[Link] contribution margin per unit increases by 10%.
[Link] selling price is increased to $51.50.
[Link] company outsources manufacturing to an overseas company increasing variable costs
per unit by $2.00 and saving 70% of fixed manufacturing costs.

Solution: 4

CVP analysis, sensitivity analysis.

1. CMU = $50−$35−(0.10 × $50) = $10

FC
Q = CMU =
= 250,000 pairs
Note: No income taxes are paid at the breakeven point because operating income is $0.

FC + TOI
2a. Q = CMU =

=
= 292,000 pairs

2b. Target operating income = $525,000

= 302,500 pairs

3a. Contribution margin per unit increases by 10%

Contribution margin per unit = $10 × 1.10 = $11
 =

= 275,000 pairs

The net income target in units decreases from 302,500 pairs in requirement 2b to 275,000
pairs.

3b. Increasing the selling price to $51.50

Contribution margin per unit = $51.50 − $35 − (0.10 × $51.50) = $11.35

= 266,520 pairs (rounded)

The net income target in units decreases from 302,500 pairs in requirement 2b to 266,520
pairs.

3c. Increase variable costs by $2 per unit and decrease fixed manufacturing costs by 70%.
Contribution margin per unit = $50 – $37 ($35 + $2) – (0.10 × $50) = $8
Fixed manufacturing costs = (1 – 0.7) × $2,250,000 = $675,000
Fixed marketing costs = $250,000
Total fixed costs = $675,000 + $250,000 = $925,000

= 181,250 pairs
The net income target in units decreases from 302,500 pairs in requirement 2b to 181,250
pairs.