Chap-5: Cost-Volume-Profit (CVP) Relationships
Basics of CVP Analysis: The contribution income statement Per Unit Percentages
Racing Bicycle Company
Contribution Income Statement
For the Month of June
Sales (500 bicycles) $ 250,000
Less: Variable expenses 150,000
Contribution margin 100,000
Less: Fixed expenses 80,000
Net operating income $ 20,000
Sales, variable expenses, and contribution margin can also be expressed on a per unit basis. If Racing sells an additional
bicycle, $200 additional CM will be generated to cover fixed expenses and profit.
Example-1: If RBC sells 400 units in a month, show that it will be operating at the break-even point.
Solutions from Ex-1 to Ex-17 are at Lecture Notes (PPT Slides)
Example-2: If RBC sells one more bike (401 bikes), net operating income will increase by $.........
Example-3: If RBC sells 430 bikes, its net operating income will be $.......... (……….. units × $.......... per unit)
Profit = (P × Q – V × Q) – Fixed expenses
FORMULA: Profit = (P – V) × Q – Fixed expenses
Profit = Unit CM × Q – Fixed expenses
Units Sold
0 200 400 600
Sales $ - $ 100,000 $ 200,000 $ 300,000
Total variable expenses - 60,000 120,000 180,000
Contribution margin - 40,000 80,000 120,000
Fixed expenses 80,000 80,000 80,000 80,000
Net operating income (loss) $ (80,000) $ (40,000) $ - $ 40,000
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Preparing the CVP Graph
Preparing Sales, Fixed Expenses and Total Expenses Graph
Show break-even point, profit and loss area on the graph.
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Contribution Margin Ratio (CM Ratio) and the Variable Expense Ratio
Example-4: The contribution margin as a percentage of sales is referred to as the contribution margin ratio (CM ratio).
When 400 units sold, This ratio is computed as follows (Total Or Per-unit bases):
Example-5: The variable expenses as a percentage of sales is referred to as the variable expense ratio. This ratio is
computed as follows:
Applications of Contribution Ratio
Example-6: If RBC increases sales from 400 to 500 bikes ($50,000), total contribution margin will increase by $.........
Applications of Contribution Ratio – Increase in Sales Volume (Consider each case independently for Examples 7-12)
Example-7: If RBC increased its sales volume to 500 bikes, what would management expect profit or net operating
income to be?
Change in Fixed Cost and Sales Volume
Example-8: What is the profit impact if RBC can increase unit sales from 500 to 540 by increasing the monthly
advertising budget by $10,000?
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Change in Variable Costs and Sales Volume
Example-9: What is the profit impact if RBC can use higher quality raw materials, thus increasing variable costs per unit
by $10, to generate an increase in unit sales from 500 to 580?
Change in Fixed Cost, Selling Price, and Sales Volume
Example-10: What is the profit impact if RBC: a) cuts its selling price $20 per unit, b) increases its advertising budget by
$15,000 per month, and c) increases sales from 500 to 650 units per month?
Change in Variable Cost, Fixed Cost, and Sales Volume
Example-11: What is the profit impact if RBC: a) pays a $15 sales commission per bike sold instead of paying
salespersons flat salaries that currently total $6,000 per month, and b) increases unit sales from 500 to 575 bikes?
Change in Selling Price
Example-12: If RBC has an opportunity to sell 150 bikes to a wholesaler without disturbing sales to other customers or
fixed expenses, what price would it quote to the wholesaler if it wants to increase monthly profits by $3,000?
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Example-13 (REVIEW PROBLEM): Miller Company’s contribution format income statement for the most recent
month is shown below:
Total Per Unit
Sales (25,000 units) $450,000 $18.00
Variable expenses 250,000 10.00
Contribution margin $200,000 $ 8.00
Fixed expenses 85,000
Net operating income $115,000
Required: (Consider each case independently):
a. What is the revised net operating income if unit sales increase by 20%?
b. What is the revised net operating income if the selling price decreases by $2.00 per unit and the number of units
sold increases by 15%?
c. What is the revised net operating income if the selling price increases by $2.00 per unit, fixed expenses increase
by $15,000, and the number of units sold decreases by 4%?
d. What is the revised net operating income if the selling price per unit increases by 10%, variable expenses increase
by 80 cents per unit, and the number of units sold decreases by 8%?
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Break-Even Analysis: In Units: FORMULA:
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Example-14: Suppose RBC’s management wants to know how many bikes must be sold to break-even.
Break-Even Analysis: In Dollar Sales: FORMULA:
Target Profit Analysis: In Units: FORMULA
Example-15: Suppose RBC’s management wants to know how many bikes must be sold to earn a target profit of
$100,000.
Target Profit Analysis –In Sales Dollars: FORMULA:
Example-16: Suppose RBC management wants to know the sales volume that must be generated to earn a target profit of
$100,000.
Sales Mix and Break-Even Analysis
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Example-17: Let’s assume RBC sells bikes and carts and that the sales mix between the two products remains the same.
Bikes comprise 45% of RBC’s total sales revenue and the carts comprise the remaining 55%. RBC provides the following
information:
Bicycle Carts Total
Sales $ 250,000 ……% $ 300,000 ……..% $ ……….. ……..%
Variable expenses 150,000 …….% 135,000 ……..% ……….. ……..%
Contribution
margin 100,000 ……% 165,000 …….% ………… …….%
Fixed expenses 170,000
Net operating income $ ………..
Sales mix $ 250,000 …….% $ 300,000 ……… $ 550,000 ……..%
a. Compute the overall contribution margin (CM) ratio for the company.
b. Compute the overall break-even point for the company in dollar sales
c. Find the separate sales for bicycles and carts at the break-even.
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Example-18 (REVIEW PROBLEM): Northwood Company manufactures basketballs. The company has a ball that sells
for $25. At present, the ball is manufactured in a small plant that relies heavily on direct labor workers. Thus, variable
expenses are high, totaling $15 per ball, of which 60% is direct labor cost.
Last year, the company sold 30,000 of these balls, with the following results:
Sales (30,000 balls) $ 750,000
Variable expenses 450,000
Contribution margin 300,000
Fixed expenses 210,000
Net operating
$ 90,000
income
Required:
1. Compute last year's CM ratio and the break-even point in balls
2. Due to an increase in labor rates, the company estimates that next year's variable expenses will increase by $3 per ball.
If this change takes place and the selling price per ball remains constant at $25, what will be next year's CM ratio and the
break-even point in balls?
3. Refer to the data in requirement 2. If the expected change in variable expenses takes place, how many balls will have to
be sold next year to earn the same net operating income, $90,000, as last year?
4. Refer again to the data in requirement 2. The president feels that the company must raise the selling price of its
basketballs. If Northwood Company wants to maintain the same CM ratio as last year (as computed in requirement 1a),
what selling price per ball must it charge next year to cover the increased labor costs?
5. Refer to the original data. The company is discussing the construction of a new, automated manufacturing plant. The
new plant would slash variable expenses per ball by 40%, but it would cause fixed expenses per year to double. If the new
plant is built, what would be the company’s new CM ratio and new break-even point in balls?
6. Refer to the data in requirement 5, If the new plant is built, how many balls will have to be sold next year to earn the
same net operating income, $90,000, as last year?
1-
Selling price $ 25 100%
Variable expenses 15 60%
Contribution
margin
$ 10 40%
Profit = Unit CM × Q − Fixed expenses
$0 = $10 × Q − $210,000
$10Q = $210,000
Q = $210,000 ÷ $10
Q = 21,000 balls
2. The new CM ratio will be:
Selling price $ 25 100%
Variable expenses 18 72%
Contribution
margin
$7 28%
The new break-even point will be:
Profit = Unit CM × Q − Fixed expenses
$0 = $7 × Q − $210,000
$7Q = $210,000
Q = $210,000 ÷ $7
Q = 30,000 balls
3.
Profit = Unit CM × Q − Fixed expenses
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$90,000 = $7 × Q − $210,000
$7Q = $90,000 + $210,000
Q = $300,000 ÷ $7
Q = 42,858 balls (rounded)
4. The contribution margin ratio last year was 40%. If we let P equal the new selling price, then:
P = $18 + 0.40P
0.60P = $18
P = $18 ÷ 0.60
P = $30
To verify:
Selling price $ 30 100%
Variable expenses 18 60%
Contribution
margin
$ 12 40%
Therefore, to maintain a 40% CM ratio, a $3 increase in variable costs would require a $5 increase in the selling
price.
5. The new CM ratio would be:
Selling price $ 25 100%
Variable expenses 9* 36%
Contribution
margin
$ 16 64%
*$15 − ($15 × 40%) = $9
The new break-even point would be:
Profit = Unit CM × Q − Fixed expenses
$0 = $16 × Q − ($210,000 × 2)
$16Q = $420,000
Q = $420,000 ÷ $16
Q = 26,250 balls
6-
Profit = Unit CM × Q − Fixed expenses
$90,000 = $16 × Q − $420,000
$16Q = $90,000 + $420,000
Q = $510,000 ÷ $16
Q = 31,875 balls
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