Briefly discuss the cost-volume-profit analysis model and how it is used. Use the attached PDF. APA Citation. 300 words.

REVISED PAGES 3 Chapter Three 1 Fundamentals of Cost-Volume-Prot Analysis Orientation P A R T LEARNING OBJECTIVES Preparing and Organizing Yourself After reading this chapter, you should be able to: for Success in College L.O.1 Use cost-volume-prot (CVP) analysis to analyze decisions. L.O.2 Understand the effect of cost structure on decisions. L.O.3 Use Microsoft Excel to perform CVP analysis. L.O.4 Incorporate taxes, multiple products, and alternative cost structures into the CVP analysis. L.O.5 Understand the assumptions and limitations of CVP analysis. C H A P T E R S I N P A R T O N E 1 Making Yourself Successful in College 2 Approaching College Reading and Developing a College-Level Vocabulary 3 Approaching College Assignments: Reading Textbooks and Following Directions Related Resources See pages 000 to 000 of the Annotated Instructor's Edition for general suggestions related to the chapters in Part One. 1 cor50782_ch01_001-072.indd 1 lan27114_ch03_080-109.indd 80 10/5/09 11:09:29 PM 10/22/09 10:33:41 PM REVISED PAGES P A R T I opened U-Develop because I love photography and I wanted to own my own business. I now get to spend most of my day working with employees and customers making sure that the photos they take are the best they can be. It also gives me a chance to encourage younger people who have an interest in photography, because I work with many of the school groups and after-school clubs here in town. That's the fun part of the job. But I also have to think about the nancial side of the business. I need a systematic way to understand the relation between my decisions and my prots. I've 1 read that managers can calculate the price they need to charge to break even (see the In Action item on CVP analysis and airlines). I should be able to apply the same analysis to my business. Orientation Jamaal Kidd was discussing the photo-nishing store that he owns and operates. Starting out ve years ago with a small storefront in the mall offering only photo developing, he has expanded the business and moved to a larger store downtown, where he now offers a wide range of products and services, some made in his own workshop. Preparing and Organizing Yourself for Success in College Our theme in this book is that the cost accounting system serves managers by providing them with information that supports good decision making. In this chapter and the next, we develop two common tools that managers can use to analyze situations and make decisions that will increase the value of the rm. We begin in this chapter by developing the relations among the costs, volumes, and prots of the rm. In the next chapter, we use these relations to make pricing and production decisions that increase prot. C H A P T E R S 1 cost-volume-prot (CVP) analysis Study of the relations among revenue, cost, and volume and their effect on prot. I N P A R T O N E Cost-Volume-Prot Analysis Making Yourself Successful in College Managers are concerned about the impact of their decisions on prot. The decisions they L.O. 1 make are about volume, pricing, or incurring a cost. Therefore, managers require an un2 Approaching College Reading and Use cost-volumederstanding of the relations among revenues, costs, volume, and prot. The cost accountDeveloping a College-Levelprofit (CVP) analysis Vocabulary ing department supplies the data and analysis, called cost-volume-prot (CVP) analysis, to analyze decisions. that support these managers. 3 Approaching College Assignments: Reading Textbooks and Following Directions Cost-Volume-Prot Analysis and Airline Pricing Cost-volume-prot analysis helps managers evaluate the impact of alternative product pricing strategies on prots. It can also be useful for evaluating competitors' pricing strategies and efforts to grow market share, as in the following examples: Aloha Airlines CEO David Banmiller and C. Thomas Nulty, senior vice president for marketing and sales, explain that their airline must charge $50 per seat to break even when planes are 62 percent full. Hawaiian Airlines, Aloha Airlines and go! are each losing money when they sell interisland tickets below $50, according to a study commissioned by Aloha Airlines. \"Why would somebody come in and charge $19, and $29, and $39 when their costs were substantially higher? Why would somebody do it?\" said Banmiller. cor50782_ch01_001-072.indd 1 In Action The Sabre study showed that when planes are 62 percent full, Aloha's costs are $50 per seat, Hawaiian's are $55, and go!'s are $67. Related Resources However, managers at the parent company of go! (Mesa See pages 000 their Airlines) disputed the estimates with a CVP analysis of to 000 of the Annotated Instructor's own: Edition for general suggesJonathan Ornstein, Mesa's chief executive ofcer, to the chapters tions related said yesterday that Aloha's cost estimates are wayOne. when off in Part it comes to his airline. He said go!'s expenses per passenger are about $40 when the planes are 80 percent full. 1 Note: Aloha Airlines is no longer in business. Source: Rick Daysog, \"Below-Cost Fares Puzzle Aloha Airlines CEO,\" Honolulu Advertiser, December 21, 2006. 10/5/09 11:09:29 PM 81 lan27114_ch03_080-109.indd 81 10/22/09 10:33:50 PM REVISED PAGES Part II 82 Cost Analysis and Estimation Prot Equation prot equation Operating prot equals total revenue less total costs. P A R T 1 The key relation for CVP analysis is the prot equation. Every organization's nancial operations can be stated as a simple relation among total revenues (TR), total costs (TC), and operating prot: Operating prot Total revenues Total costs TR TC Orientation go by different names (For not-for-prot and government organizations, the \"prot\" may Prot such as \"surplus\" or \"contribution to fund,\" but the analysis is the same.) Both total revenues and total costs are likely to be affected by changes in the amount of output.1 We rewrite the prot equation to explicitly include volume, allowing us to analyze the relations among volume, costs, and prot. Total revenue (TRand Organizing price per Preparing ) equals average selling Yourself unit (P) times the units of output (X): Total revenue Price for Success in College Units of output produced and sold TR PX In our prot equation, total costs (TC) may be divided into a xed component that does not vary with changes in output levels and a variable component that does vary. The xed component is made up of total xed costs (F) per period; the variable component is the product of the average variable cost per unit (V) multiplied by the quantity of output (X). Therefore, the cost function is Total costs (Variable costs per unit Units of output) Fixed costs TC VX F H A P T R S P A R T Substituting the expanded expressions in the protCequationE yieldsI aN form more O N E useful for analyzing decisions: Making Yourself Prot Total1revenue Total costs Successful in College TR TC 2 TC VX F Approaching College Reading and Developing a College-Level Vocabulary Therefore, Prot 3PX Approaching College Assignments: (VX F) Reading Textbooks and Following Directions Collecting terms gives Prot (Price Variable costs) Units of output Fixed costs (P V)X F unit contribution margin Difference between revenues per unit (price) and variable cost per unit. total contribution margin Difference between revenues and total variable costs. We dened contribution margin in Chapter 2 as the difference between the sales price and the variable cost per unit. We will refer to this as the unit contribution margin to distinguish it from the difference between the total revenues and total variable cost,Related Resources the total contribution margin. In other words, the total contribution margin is the unit con- 000 to 000 See pages tribution margin multiplied by the number of units (Price Variable costs) Units Annotated Instructor's of the of output, or (P V)X. It is the amount that units sold contribute toward (1) covering xed general suggesEdition for costs and (2) providing operating prots. Sometimes we use the contribution margin,related to the chapters tions in total, as in the preceding equation. Other times, we use the contribution margin per Part One. in unit, which is Price Variable cost per unit 1 PV 1 We adopt the simplifying assumption that production volume equals sales volume so that changes in can be ignored in this chapter. cor50782_ch01_001-072.indd inventory 1 lan27114_ch03_080-109.indd 82 10/5/09 11:09:29 PM 10/22/09 10:33:53 PM REVISED PAGES Chapter 3 Fundamentals of Cost-Volume-Profit Analysis 1 83 Recall from Chapter 2 that an important distinction for decision making is whether costs are xed or variable. That is, for decision making, P Aare concerned about cost we R T behavior, not the nancial accounting treatment, which classies costs as either manufacturing or administrative. Thus, V is the sum of variable manufacturing costs per unit and variable marketing and administrative costs per unit; F is the sum of total xed manufacturing costs and xed marketing and administrative costs for the period; and X refers to the number of units produced and sold during the period. Orientation CVP Example When Jamaal rst opened U-Develop, he offered one service only, developing prints. He charged an average price of $.60. The average variable cost of each print was $.36, computed as follows: Preparing and Organizing Yourself Cost of processing (materials and labor) . . . . . . . . . . . . . . . . . . . . . for Success $.30College in Other costs (sales and support). . . . . . . . . . . . . . . . . . . . . . . . . . . . .06 Average variable cost per print. . . . . . . . . . . . . . . . . . . . . . . . . . . $.36 The xed costs to operate the store for March, a typical month, were $1,500. In March, U-Develop processed 12,000 prints. The operating prot can be determined from the company's income statement for the month, as shown in Exhibit 3.1. As a manager, Jamaal might want to know how many units (prints) he needs to sell in order to achieve a specied prot. Assume, for example, that Jamaal is hoping for sales to improve in July, when the weather will improve and people take vacations. Given the data, price $.60, variable cost per unit $.36 (therefore, contribution margin per unit $.24), and xed costs $1,500, the manager asks two questions: What volumeS is I N P A R T O N C H A P T E R required to break even (earn zero prots)? What volume is required to make an $1,800 operating prot? Although we could use the income statement and guess at the answer to 1 Making Yourself Successful in College these questions, it is easier to set up an equation that summarizes the cost-volume-prot relation. Recall that in March, U-Develop processed 12,000 prints. Using the proCollege Reading and 2 Approaching t equation, the results for March, therefore, were: E Developing a College-Level Vocabulary Prot Contribution margin Fixed costs (P V ) X F 3 Approaching College Assignments: Reading ($.60 $.36) 12,000 prints $1,500 Textbooks and Following Directions $1,380 which is equal to the operating prot shown on the income statement in Exhibit 3.1. To simplify the equation, we use the term \"Prot\" in the equation to mean the same thing as \"Operating Prot\" on income statements. Exhibit Related Resources 3.1 U-DEVELOP Income Statement March Sales (12,000 prints at $.60) . . . . . . . . . . . . . . . . . . . . . . . Less Variable costs of goods sold (12,000 $.30) . . . . . . . . . Variable selling costs (12,000 $.06) . . . . . . . . . . . . . . . See pages 000 Income Statement to 000 $7,200 $3,600 720 4,320 Contribution margin . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Less xed costs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $2,880 1,500 Operating prot . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . of the Annotated Instructor's Edition for general suggestions related to the chapters in Part One. 1 $1,380 cor50782_ch01_001-072.indd 1 lan27114_ch03_080-109.indd 83 10/5/09 11:09:29 PM 10/22/09 10:33:53 PM REVISED PAGES Part II 84 Cost Analysis and Estimation 1 Finding Break-Even and Target Volumes We can use the prot equation to P A R T answer Jamaal's questions about volumes needed to break even or achieve a target prot by developing the formulas discussed here. We start with the answer to the rst question, which we call nding a break-even volume. Managers might want to know the break-even volume expressed either in units or in sales dollars. If the company makes many products, it is often much easier to think of volume in terms of sales dollars; if we are dealing with only one product, it's easier to work with units as the measure of volume. break-even point Volume level at which prots equal zero. Orientation Break-Even Volume in Units We can use the prot equation to nd the break-even point expressed in units: Prot 0 (P V ) X F F If Prot 0, then X _______ (P and Preparing V ) Organizing Yourself Fixed costs for _____________________ Break-even volume (in units) Success in College Unit contribution margin $1,500 $ .24 6,250 prints To show this is correct, if U-Develop processes 6,250 prints, its operating prot is Prot TR TC PX VX F ($.60 6,250 prints) ($.36 6,250 prints) $1,500 $0 contribution margin ratio Contribution margin as a percentage of sales revenue. C H A P T E R S I N P A R T O N E Break-Even Volume in Sales Dollars 1 To Makingbreak-evenSuccessfulterms of sales nd the Yourself volume in in College dollars, we rst dene a new term, contribution margin ratio. The contribution margin ratio is the contribution margin as a percentage of sales revenue. For example, for 2 Approaching as follows: U-Develop, the contribution margin ratio can be computed College Reading and Developing a College-Level Vocabulary Unit contribution margin Contribution margin ratio _____________________ Sales price per unit 3 Approaching College Assignments: $.24 ____ Reading Textbooks and Following Directions $.60 .40 (or 40%) Using the contribution margin ratio, the formula to nd the break-even volume follows:2 Fixed costs Break-even volume sales dollars _____________________ Contribution margin ratio 2 We can derive the break-even point for sales dollars from the original formula for units: F X ______ PV The modied formula for dollars multiplies both sides of the equation by P: FP PX ______ PV Since multiplying the numerator by P is the same as dividing the denominator by P, we obtain: F PX _________ (P V )P cor50782_ch01_001-072.indd The term (P V)/P is the contribution margin ratio. 1 lan27114_ch03_080-109.indd 84 Related Resources See pages 000 to 000 of the Annotated Instructor's Edition for general suggestions related to the chapters in Part One. 1 10/5/09 11:09:29 PM 10/22/09 10:33:53 PM REVISED PAGES Chapter 3 Fundamentals of Cost-Volume-Profit Analysis For U-Develop, the break-even volume expressed in sales dollars is P A R T $1,500 Break-even sales dollars ______ .40 $3,750 1 85 Note that $3,750 of sales dollars translates into 6,250 prints at a price of $.60 each. We get the same result whether expressed in units (6,250 prints) or dollars (sales of 6,250 prints generates revenue of $3,750). Orientation Target Volume in Units To nd the target volume, we use the prot equation with the target prot specied. The formula to nd the target volume in units is Fixed costs Target prot Target volume (units) ________________________ Preparing Contribution margin per unit and Organizing Yourself Using the data from U-Develop, we nd the volume that provides an operating prot of for Success in College $1,800 as follows: Fixed costs Target prot Target volume ________________________ Contribution margin per unit $1,500 $1,800 ______________ $.24 13,750 prints U-Develop must sell 13,750 prints per month to achieve the target prot of $1,800. Each additional print sold increases operating prots by $.24. C H P E R S Target Volume in Sales Dollars To nd the target volume in sales dollars,A weT use the I N P A R T O N contribution margin ratio instead of the contribution margin per unit. The formula to nd the target volume follows: 1 Making Yourself Successful in College E Fixed costs Target prot Target volume (sales dollars) ______________________ Contribution margin ratio 2 Approaching College Reading and For U-Develop the target volume expressed in sales dollars is Developing a College-Level Vocabulary $1,500 $1,800 Target volume (sales dollars) ______________ .40 3 Approaching College Assignments: Note that sales dollars of $8,250 translates into 13,750 printsReadingeach. We getand Following Directions at $.60 Textbooks the same target volume whether expressed in units (13,750 prints) or dollars (sales of 13,750 prints generates revenue of $8,250). Exhibit 3.2 summarizes the four formulas for finding break-even and target volumes. Break-Even Volume Fixed costs Break-even volume (units) ____________________ Unit contribution margin Fixed costs Break-even volume (sales dollars) ____________________ Contribution margin ratio Target Volume Fixed costs Target prot Target volume (units) ______________________ Unit contribution margin Exhibit Related Resources 3.2 Summary ofpages 000 to 000 See BreakEven and Target Volume of the Annotated Instructor's Formulas Edition for general suggestions related to the chapters in Part One. 1 Fixed costs Target prot Target volume (sales dollars) ______________________ Contribution margin ratio cor50782_ch01_001-072.indd 1 lan27114_ch03_080-109.indd 85 10/5/09 11:09:29 PM 10/22/09 10:33:53 PM REVISED PAGES Part II 86 Cost Analysis and Estimation Exhibit 3.3 CVP GraphU-Develop P A R T $8,000 Revenues, Costs $7,000 1 $6,000 $5,000 Total cost TC $1,500 $.36 X $4,000 Orientation $5,820 Break even TR TC $3,000 Preparing and Organizing Yourself for Success in College Total revenue $2,000 $1,000 $0 $7,200 TR $.60 X 0 2,000 4,000 6,000 8,000 10,000 12,000 Volume per period (X ) Graphic Presentation Exhibit 3.3 presents the cost-volume-prot (CVP) relations for U-Develop in a graph. Such a graph is a helpful aid in presenting cost-volume-prot relationships. We plot dollars on the vertical axis (revenue dollars or cost dollars,CforAexample). We plotAvolume N E on H P T E R S I N P R T O the horizontal axis (number of prints sold per month or sales dollars, for example). The total revenue (TR) line relates total revenue to volume (for example, if U-Develop sells 1 Making Yourself Successful in College 12,000 prints in a month, its total revenue would be $7,200, according to the graph). The slope of TR is the price per unit, P (for example, $.60 per print for U-Develop). The total cost (TC) line shows the total cost for each volume. For example, the total cost 2 Approaching College Reading and for a volume of 12,000 prints is $5,820 ( [12,000 $.36] $1,500). The intercept of the total cost line is the xed cost for the period, FDeveloping a is the variable cost per unit, V , and the slope College-Level Vocabulary . The break-even point is the volume at which TR TC (that is, where the TR and TC lines intersect). Volumes lower than break even result in an College Assignments:TR 3 Approaching operating loss because TC; volumes higher than break even result in an operating prot because TR TC. For Reading Textbooks and Following Directions U-Develop, 6,250 prints is the break-even volume. Self-Study Question 1. The following information for Jennifer's Framing Supply is given for March: Sales. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Fixed manufacturing costs . . . . . . . . . . . . . . . . Fixed marketing and administrative costs . . . . . Total xed costs . . . . . . . . . . . . . . . . . . . . . . . . Total variable costs . . . . . . . . . . . . . . . . . . . . . . Unit price. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Unit variable manufacturing cost . . . . . . . . . . . Unit variable marketing cost . . . . . . . . . . . . . . . cor50782_ch01_001-072.indd 1 lan27114_ch03_080-109.indd 86 $360,000 35,000 25,000 60,000 240,000 90 55 5 Compute the following: Related Resources a. Monthly operating prot when sales total $360,000 See pages 000 to 000 (as here). of the Annotated Instructor's b. Break-even number in units. Edition for general suggesc. Number of units sold that would produce related to the chapters an tions operating prot of $120,000. in Part One. d. Sales dollars required to earn an operating prot of $20,000. 1 e. Number of units sold in March. f. Number of units sold that would produce an operating prot of 20 percent of sales dollars. The solution to this question is at the end of the chapter on page 109. 10/5/09 11:09:29 PM 10/22/09 10:33:53 PM REVISED PAGES Chapter 3 Fundamentals of Cost-Volume-Profit Analysis 1 87 The amount of operating prot or loss can be read from the graph by measuring the P A R T vertical distance between TR and TC. For example, the vertical distance between TR and TC when X 12,000 indicates Prot $1,380 ( $7,200 $5,820). Prot-Volume Model Instead of considering revenues and costs separately, we can analyze the relation between prot and volume directly. This approach to CVP analysis is called prot-volume analysis. A graphic comparison of prot-volume and CVP relationships is shown in Exhibit 3.4. The cost and revenue lines are collapsed into a single prot line. Note that the slope of the prot-volume line equals the unit contribution margin. The intercept equals the loss at zero volume, which equals xed costs. The vertical axis shows the amount of operating prot or loss. Orientation prot-volume analysis Version of CVP analysis using a single prot line. L.O. 2 Understand the effect of cost structure on decisions. Preparing and Organizing Yourself Exhibit 3.4 for Success in College Comparison of CVP Cost-Volume-Profit Relation Graph and Prot-Volume GraphU-Develop $8,000 Total revenue TR $.60 X Dollars $6,000 $4,000 Total cost TC $1,500 $.36 X C H A P T E R S I N P A R T O N E $2,000 1 $0 0 1,500 3,000 4,500 6,000 2 7,500 Making Yourself Successful in College Approaching College Reading and 9,000 10,500a 12,000 Developing College-Level Vocabulary Volume 3 Profit-Volume Relation Approaching College Assignments: Reading Textbooks and Following Directions $1,400 Operating profit Dollars $400 0 $600 1,500 3,000 4,500 6,000 7,500 9,000 10,500 12,000 Operating loss Profit Total contribution margin Total costs $.24X $1,500 Related Resources See pages 000 to 000 of the Annotated Instructor's Edition for general suggestions related to the chapters in Part One. 1 $1,600 Volume cor50782_ch01_001-072.indd 1 lan27114_ch03_080-109.indd 87 10/5/09 11:09:29 PM 10/22/09 10:33:53 PM REVISED PAGES Part II 88 Cost Analysis and Estimation Use of CVP to Analyze the Effect P A R T of Different Cost Structures cost structure Proportion of an organization's xed and variable costs to its total costs. operating leverage Extent to which an organization's cost structure is made up of xed costs. 1 An organization's cost structure is the proportion of xed and variable costs to total costs. Cost structures differ widely among industries and among rms within an industry. Electric utilities such as Southern California Edison or Public Service of New Mexico have a large investment in equipment, which results in a cost structure with high xed costs. In contrast, grocery retailers such as Albertsons or Safeway have a cost structure with a higher proportion of variable costs. The utility is capital intensive; the grocery store is labor intensive. An organization's cost structure has a signicant effect on the sensitivity of its prots to changes in volume. Operating leverage describes the extent to which an organization's cost structure is made up of xed costs. Operating leverage can vary within an industry as Preparing and Organizing Yourself well as between industries. The airline industry in the United States, for example, consists of so-called legacy carriers, such as American Airlines and Continental Airlines, which for Success in College have high xed labor, pension, and other costs and which operate using a hub and spoke system. Newer carriers, such as Southwest Airlines and Jet Blue Airlines, have lower labor costs and operate out of lower cost and less-congested airports. Therefore, the operating leverage of American Airlines is higher than that of Jet Blue. Operating leverage is high in rms with a high proportion of xed costs and a low proportion of variable costs and results in a high contribution margin per unit. The higher the rm's xed costs, the higher the break-even point. Once the break-even point has been reached, however, prot increases at a high rate. Exhibit 3.5 demonstrates the primary differences between two companies, Lo-Lev Company (with relatively high variable costs) and Hi-Lev Company (with relatively high xed costs). Orientation C H A P T E R S I N P A R T O N E 1 Making Yourself Successful in College 2 Approaching College Reading and Developing a College-Level Vocabulary 3 Approaching College Assignments: Reading Textbooks and Following Directions Different industries have different cost structures. Electric utilities (left) have high xed costs and high operating leverage. Grocery stores (right) have lower xed costs and low operating leverage. Exhibit 3.5 Lo-Lev Company (1,000,000 units) Comparison of Cost Structures Amount Sales . . . . . . . . . . . . Variable costs . . . . . . Contribution margin . . Fixed costs . . . . . . . . Operating prot . . . . Percentage $1,000,000 750,000 _________ $ 250,000 50,000 _________ $ 200,000 _________ _________ 100 75 25 5 20 Break-even point . . . 200,000 units Contribution margin per unit $0.25 cor50782_ch01_001-072.indd 1 lan27114_ch03_080-109.indd 88 Related Resources See pages 000 to 000 Hi-Lev Company (1,000,000 units) of the Annotated Instructor's Edition for general suggesAmount Percentage tions related to the chapters in $1,000,000 100 Part One. 250,000 _________ $ 750,000 550,000 _________ $ 200,000 _________ _________ 733,334 units $0.75 25 75 55 20 1 10/5/09 11:09:29 PM 10/23/09 4:49:33 AM REVISED PAGES Chapter 3 Fundamentals of Cost-Volume-Profit Analysis 89 Effect of Cost Structure on Operating P A R T and Investing Decisions In Action Different cost structures lead to different decisions that rms make concerning operations and investments. Consider the following two statements: 1. 2. \"Ahold now has about $23 billion in sales among its six U.S. supermarket chainslarge but uncomfortably behind giants such as Wal-Mart, Kroger, and Albertson's. The logic of consolidation is that, in a business with such slim prot margins, bigger companies gain important competitive advantage by being able to negotiate better terms and prices from suppliers, better rents from landlords and better advertising deals from media outlets\" (Washington Post, February 8, 2004). \"Many experts say the airlines throw planes on a route to grab market share from rivals. Robert L. 1 Crandall, the former chief executive of American Airlines, said that airlines added planes because growth spreads xed costs over more passenger miles. 'If everybody is growing to keep their costs down, then there's constantly a great deal of capacity in the market,' Mr. Crandall said. 'So long as there's lots of capacity, people have an incentive to cut prices'\" (The New York Times, December 9, 2003). Orientation Preparing and Organizing Yourself for Success in College In the case of rms with low operating leverage, such as grocery chains, the prot margins are small, so rms do what they can to improve those marginseven small savings translate to large improvements in prots. In the case of rms with high operating leverage, such as airlines, each additional unit (seat-mile) sold provides a large contribution to prot, so the emphasis is on increasing volume. S Note that although these rms have the same sales revenue and operating prot, they have different cost structures. Lo-Lev Company's cost structure is dominated by variable costs with a lower contribution margin ratio of .25. Every dollar of sales contributes $.25 toward xed costs and prot. Hi-Lev Company's cost structure is dominated by xed costs with a higher contribution margin of .75. Every dollar of sales contributes $.75 C H A P T E R S I N P A R T O N E toward xed costs and prot. Suppose that both companies experience a 10 percent increase in sales. Lo-Lev Company's prot increases by $25,000 ($.25 $100,000), and Hi-Lev Company's prot in1 Making Yourself Successful in College creases by $75,000 ($.75 $100,000). Of course, if sales decline, the fall in Hi-Lev's prots is much greater than the fall in Lo-Lev's prots. In general, companies with lower 2 market demands than Reading and xed costs have the ability to be more exible to changes in Approaching Collegedo Developing companies with higher xed costs and are better able to survive tough times.a College-Level Vocabulary Margin of Safety 3 Approaching College Assignments: The margin of safety is the excess of projected (or actual) salesReading break-even sales Following Directions over the Textbooks and margin of safety level. This tells managers the margin between current sales and the break-even point. In The excess of projected or a sense, margin of safety indicates the risk of losing money that a company faces, that is, actual sales over the breakthe amount by which sales can fall before the company is in the loss area. The margin of even volume. safety formula is Sales volume Break-even sales volume Margin of safety If U-Develop sells 8,000 prints and its break-even volume is 6,250, then its margin of safety is Sales Breakeven 8,000 6,250 1,750 prints Sales volume could drop by 1,750 prints per month before it incurs a loss, all other things held constant. In practice, the margin of safety also may be expressed in sales dollars or as a percent of current sales. The excess of the projected or actual sales volume expressed as a percentage of the break-even volume is the margin of safety percentage. If U-Develop sells 8,000 prints and the break-even volume is 6,250 prints, the margin of safety percentage is 22 percent ( 1,750 8,000). This means that volume can fall by 22 percent, a relatively large amount, before U-Develop nds itself operating at a loss. cor50782_ch01_001-072.indd 1 lan27114_ch03_080-109.indd 89 Related Resources See pages 000 to 000 of the Annotated Instructor's Edition for general suggestions related to the chapters in Part One. margin of safety 1 percentage The excess of projected or actual sales over the breakeven volume expressed as a percentage of the break-even volume. 10/5/09 11:09:29 PM 10/22/09 10:33:59 PM REVISED PAGES Part II 90 Cost Analysis and Estimation CVP Analysis with Spreadsheets L.O. 3 Use Microsoft Excel to perform CVP analysis. P A R T 1 It is important to be able to do CVP analysis and understand the relations, so it is important to work examples and do problems by hand at rst. However, a spreadsheet program such as Microsoft Excel is ideally suited to doing CVP routinely. Exhibit 3.6 shows a Microsoft Excel worksheet for U-Develop. The basic data (price per unit, variable cost per unit, and total xed costs) for U-Develop are entered. The prot equation (or formula) is shown in the formula bar of the spreadsheet. Once the data are entered, an analysis tool such as Goal Seek can be used to nd the volume associated with a given desired prot level. In the left side screenshot of Exhibit 3.7, the problem is set up as follows: Orientation 1. With the spreadsheet open, choose the \"Data\" tab and select \"What-If Analysis\" from Preparing and Organizing Yourself the ribbon. Then select \"Goal Seek\" from the drop-down box. 2. In the \"Set cell:\" edit eld, enter the cell address for the target prot calculation (B7). for Success in College The formula in cell B7 is: ((B3-B4)*B8)-B5. 3. In the \"To value:\" edit eld, enter the target prot (in this example, the target prot is zero because we are looking for the break-even point). 4. In the \"By changing cell:\" edit eld, enter the cell address of the volume variable ($B$8). (The 5,000 volume in cell B8 in Exhibit 3.6 is only a placeholder; any number will sufce.) 5. Click \"OK\" and the program will nd the break-even volume as shown in the right side screenshot of Exhibit 3.7. Although this spreadsheet is extremely simple, it can easily be edited to analyze alternative scenarios, so-called what-if analyses. For example, we could ask, \"Given that I expect to sell 5,000 prints, what price do I need to charge to break even?\" In this case, we C H and R S N P A R T O would change Step 4 above to enter the cell for Price (B3) A P TEnd the Ianswer ($0.66).N E Exhibit 3.6 1 2 3 4 5 6 7 8 9 Screenshot of Spreadsheet Program for CVP Analysis U-Develop Exhibit 3.7 Screenshot of Spreadsheet Analysis ToolGoal Seek 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 A U-Develop B Price Variable cost Fixed cost $ 0.60 $ 0.36 $ 1,500 Profit Volume $ (300) 5,000 Set cell: B7 To value: 0 By changing cell: $B$8 cor50782_ch01_001-072.indd 1 lan27114_ch03_080-109.indd 90 OK 1 Price Variable cost Fixed cost 2 Profit Volume 3 C ? Goal Seek A U-Develop Cancel X 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 B C Making Yourself Successful in College $ 0.60 $ Approaching College Reading and 0.36 $ Developing a College-Level Vocabulary 1,500 $ (300) 5,000 Approaching College Assignments: Reading Textbooks and Following Directions A U-Develop B Price Variable cost Fixed cost $ 0.60 $ 0.36 $ 1,500 Profit Volume $ Goal Seeking with Cell B7 found a solution. 0 Current value: $- D - 6,250 Goal Seek Status Target value: C ? X Related Resources See pages 000 to 000 of the Annotated Instructor's Edition for general suggestions related to the chapters in Part One. OK Cancel 1 Step Pause 10/5/09 11:09:29 PM 10/22/09 10:33:59 PM REVISED PAGES Chapter 3 Fundamentals of Cost-Volume-Profit Analysis 1 91 Extensions of the CVP Model P A R T The basic CVP model that we have developed can be easily extended to answer other questions or modied to incorporate complications. For example, we can use the model to determine the xed costs required to achieve a certain prot for a given volume. We can incorporate the effects of income taxes by modifying the prot equation to include taxes. Making some simplifying assumptions, we can extend the analysis to rms that make multiple products. Finally, we can incorporate more complicated cost structures (for example, step xed costs) by incorporating these complications in the prot equation. We illustrate these extensions here. Orientation Income Taxes L.O. 4 Incorporate taxes, multiple products, and alternative cost structures into the CVP analysis. Assuming that operating prots before taxes and taxable Preparing and Organizing income are the same, income taxes may be incorporated into the basic model as follows: Yourself for Success in College After-tax prot [(P V)X F] (1 t) where t is the tax rate. Rearranging, we can nd the target volume as follows; Fixed costs [Target prot(1 t)] Target volume (units) ______________________________ Unit contribution margin Notice that taxes affect the analysis by changing the target prot. That is, to determine the volume required to earn a target after-tax income, you rst determine the required before-tax operating income ( target after-tax income [1 tax rate]) and then solve for the target volume using the required before-tax income as before. For example, suppose that the owner of U-Develop wants to nd the number ofEprints I N P A R T O N C H A P T R S required to generate after-tax operating prots of $1,800. Recall that P $.60, V $.36, the contribution margin per unit $.24, and F $1,500. We assume the tax rate t .25; 1 Making Yourself Successful in College that is, U-Develop has a 25 percent tax rate. To nd the target volume, rst determine the required before-tax income, which is $2,400 ( $1,800 [1 .25]). Now, we can use the formula to determine the volume required to earn a target prot of $2,400:College Reading and 2 Approaching E Developing Fixed costs [Target prot(1 t)] a College-Level Vocabulary Target volume (units) ______________________________ Unit contribution margin $1,500 $2,400 ______________ $.24 3 Approaching College Assignments: Reading Textbooks and Following Directions 16,250 prints Multiproduct CVP Analysis When U-Develop started, it provided only one service, print processing. After a short time, a second service, enlargements of photos, was offered. The prices and costs of the two follow: Prints Selling price. . . . . . . . . . . . . . Variable cost . . . . . . . . . . . . . Contribution margin. . . . . . . . Enlargements $.60 .36 __ __ $.24 __ __ __ __ $1.00 .56 _____ $ .44 _____ _____ When these two services were offered, monthly xed costs totaled $1,820. Without some assumptions, there is an innite number of combinations of the two services that would cor50782_ch01_001-072.indd 1 achieve a given level of prot. To simplify matters, managers often lan27114_ch03_080-109.indd 91 Related Resources See pages 000 to 000 of the Annotated Instructor's Edition for general suggestions related to the chapters in Part One. 1 10/5/09 11:09:29 PM 10/22/09 10:34:00 PM REVISED PAGES Part II 92 Cost Analysis and Estimation 1 assume a particular product mix and compute break-even P A T or target volumesRusing either of two methods, a xed product mix or weighted-average contribution margin, both of which give the same result. Fixed Product Mix Using the xed product mix Orientation Managers compute the break-even or target volume of a bundle or package of products. method, managers dene a package or bundle of products in the typical product mix and then compute the breakeven or target volume for the package. For example, suppose that the owner of U-Develop is willing to assume that the prints and enlargements will sell in a 9:1 ratio; that is, of every ten \"units\" of service sold, nine will be prints and Preparing and Organizing Yourself one will be an enlargement. Dening X as a package of nine prints and one enlargement, the contribution margin from this for Success in College package is Prints . . . . . . . . . . . . . . . . . Enlargements . . . . . . . . . . . Contribution margin . . . . . . 9 $.24 1 $.44 $2.16 .44 _____ $2.60 _____ _____ Now the break-even point is computed as follows X Fixed costs Contribution margin $1,820 $2.60 C H A P T E R S I N P A R T O N E 700 packages 1 Making Yourself Successful in College where X refers to the break-even number of packages. This means that the sale of 700 packages of nine prints and one enlargement per package, totaling 6,300 prints and 700 enlargements, is required to break even.2 Approaching College Reading and Developing a College-Level Vocabulary Weighted-Average Contribution Margin The weighted-average contribution margin also requires an assumed product mix, which we continue to assume is 90 percent 3 Approaching solved by using a weightedprints and 10 percent enlargements. The problem can be College Assignments: average contribution margin per unit. When Reading Textbooksaand Following Directions a company assumes constant product mix, the contribution margin is the weighted-average contribution margin of all of its products. For U-Develop, the weighted-average contribution margin per unit can be computed by multiplying each product's proportion by its contribution margin per unit (.90 $.24) (.10 $.44) $.26 The multiple product breakeven for U-Develop can be determined from the break-even Related Resources formula: X $1,820 $.26 7,000 units of service See pages 000 to 000 of the Annotated Instructor's Edition for general suggestions related to the chapters that Uin Part One. where X refers to the break-even number. The product mix assumption means Develop must sell 6,300 ( .90 7,000) prints and 700 ( .10 7,000) enlargements to break even. Find Breakeven in Sales Dollars To nd the breakeven in sales dollars, divide the xed costs by the weighted-average contribution margin percent. The weighted-average contribution margin percent is the ratio of the weighted-average contribution margin cor50782_ch01_001-072.indd (which is $.26 in our example) divided by the weighted-average revenue. 1 lan27114_ch03_080-109.indd 92 1 10/5/09 11:09:29 PM 10/22/09 10:34:00 PM REVISED PAGES Chapter 3 Fundamentals of Cost-Volume-Profit Analysis 1 93 To nd the weighted-average revenue, multiply the proportion of sales (90 percent P A Prints prints and 10 percent enlargements) by the sales prices per unit. R T sell for $.60 per unit and enlargements sell for $1.00 per unit. Therefore, the weighted-average revenue can be found as follows: (.90 $.60) for prints (.10 $1.00) for enlargements $.64 Orientation Now, the weighted-average contribution margin percent is found as follows: $.26 weighted-average contribution margin $.64 weighted-average revenue 40.625% The break-even sales amount in dollars is: $1,820 xed costs .40625 weighted-average contribution margin and Organizing Preparing percent $4,480 (You can verify that $4,480 $.64 7,000 units.) Yourself for Success in College Alternative Cost Structures The cost structures we have considered so far have been relatively simple. We have separated costs into xed and variable and we have assumed that the variable cost per unit is the same for all levels of volume. In Chapter 2, we dened other cost behavior patterns, including semivariable costs and step costs. We illustrate how more complicated cost structures can be analyzed by assuming that the xed costs of U-Develop include the rental of equipment for photo developing and that the capacity of these machines is limited. Suppose, for example, that the xed costs of $1,500 (from Exhibit 3.1) are sufcient for monthly volumes less H A P orEequal I N P A R T O N C than T R S to 5,000 prints. For every additional 5,000 prints, another machine, renting monthly for $480, is required. Now what is the break-even volume for U-Develop? We know from our analysis earlier in the chapter that 1 a xed cost of $1,500, the for Making Yourself Successful in College break-even point is 6,250 prints. But 6,250 prints cannot be developed without the additional machine. At a volume of 6,250 prints, U-Develop's prot will be 2 Approaching College Reading and E Developing Prot ($0.60 $0.36) 6,250 ($1,500 $480) ($480)a College-Level Vocabulary which is less than breakeven. If we are going to have to sell more than 5,000 prints 3 break even, we are going to to Approaching College Assignments: have to rent the additional machine. Therefore, to break even, our monthly xed costs and Following Directions Reading Textbooks will be (at least) $1,980 ( $1,500 $480). At this level of xed costs, the break-even point is Fixed costs Break-even volume _____________________ Unit contribution margin $1,980 ______ $ 0.24 Related Resources See pages 000 to 000 of the Annotated Instructor's Edition for general suggestions related to the chapters in Part One. 8,250 which is less than 10,000 prints. Therefore, U-Develop can break even at a volume of 8,250 prints. If we had found that the new break-even point was greater than 10,000 prints, we would have repeated the analysis, adding another $480 for an additional machine. Assumptions and Limitations of CVP Analysis As with all methods of analysis, CVP analysis relies on certain assumptions and these assumptions might limit the applicability of the results for decision making. It is important to understand, however, that the limitations are due to the assumptions that the cost analyst makes; that is, they are not inherent limitations to the method of CVP analysis itself. cor50782_ch01_001-072.indd 1 lan27114_ch03_080-109.indd 93 L.O. 5 Understand the assumptions and limitations of CVP analysis. 1 10/5/09 11:09:29 PM 10/22/09 10:34:02 PM REVISED PAGES Part II 94 Cost Analysis and Estimation 1 For example, many people point to the assumptions of constant unit variable cost and P as R T constant unit prices for all levels of volumeA important limitations of CVP analysis. As we saw in the previous section, however, these assumptions are simplifying assumptions that are made by the analyst. If we know that unit prices are lower for higher volumes, we can incorporate that relation into the CVP analysis. The result will be a more complicated relation among costs, volumes, and prots than we have worked with here and the breakeven and target volume formulas will not be as simple as those we have derived. But with analysis tools such as Microsoft Excel we can model the more complicated relations and nd the break-even point (or points) if they exist. The lesson from this is that CVP analysis is a tool that the manager can use to help with decisions. The more important the decision, the more the manager will want to ensure that the assumptions made are applicable. In addition, if the decisions are sensitive to the assumptions made (for example, that prices do not depend on volume), the manPreparing and Organizing Yourself ager should be cautious about depending on CVP analysis without considering alternative assumptions. for Success in College Orientation Self-Study Questions 2. 3. High Desert Campgrounds (HDC) rents spaces for recreational vehicles (RVs) by the day. HDC charges $15 per day for a space. The variable costs (including cleaning, maintenance, and supplies) are $7 per day. The xed costs of HDC are $60,000 per year. HDC is subject to a tax rate of 35 percent on its income. If a \"unit\" is one space rented for one day, how many units does HDC have to rent annually to earn $48,750 after taxes? Suppose HDC rents spaces for both RVs and tent camping. The price and cost characteristics for each are as follows (one unit is a tent or RV space rented for one day): Price per Unit Tent space . . . . RV space . . . . . Variable Cost per Unit Units Rented per Year $ 6 15 $3 7 6,000 9,000 C H A P T E R S I N P A R T O N E The xed costs of HDC are $60,000 annually. Assuming the mix of tent and Yourself Successful as the current 1 Making RV spaces is the same in College mix, how many tent spaces and how many RV spaces must be rented annually for HDC to break even? 2 Approaching College Reading and 3 Approaching College Assignments: Reading Textbooks and Following Directions The solutions to these questions are at the end of the chapter on Developing a College-Level Vocabulary page 109. The Debrief Jamaal Kidd considered the spreadsheet he developed for his business and reected on how it will help him as a manager: The cost-volume-profit analysis I learned in this chapter gives me a simple and intuitive approach to understanding how my decisions affect my prots. I know that there are limitations to the use of CVP analysis and that for many decisions, I will want to develop Related Resources more detailed analyses. But for quick answers for rouSee pages 000 to 000 tine decisions, CVP analysis is just what I need. of the Annotated Instructor's Edition for general suggestions related to the chapters in Part One. Summary The cost analysis approach to decision making is used when the decisions affect costs and revenues and, hence, prot. In this chapter we considered the cost-volume-prot (CVP) analysis framework cor50782_ch01_001-072.indd for cost analysis. 1 lan27114_ch03_080-109.indd 94 1 10/5/09 11:09:29 PM 10/22/09 10:34:02 PM REVISED PAGES Chapter 3 Fundamentals of Cost-Volume-Profit Analysis 1 95 The following summarizes key ideas tied to the chapter's learning objectives. P A R T L.O. 1. Use cost-volume-prot (CVP) analysis to analyze decisions. CVP analysis is both a management tool for determining the impact of selling prices, costs, and volume on prots and a conceptual tool, or way of thinking, about managing a company. It helps management focus on the objective of obtaining the best possible combination of prices, volume, variable costs, and xed costs. CVP analysis examines the impact of prices, costs, and volume on operating prots, as summarized in the prot equation Prot PX (VX F) Orientation where P Average unit selling price V Average unit variable costs X Quantity of output F Total xed costs Preparing and Organizing Yourself for Success in College Management can use CVP analysis to plan future projects and to help in determining a project's feasibility. By altering different variables within the equation (e.g., selling price or amount of output), managers are able to perform a what-if analysis (often referred to as sensitivity analysis). L.O. 2. Understand the effect of cost structure on decisions. An organization's cost structure is the proportion of xed and variable costs to total costs. Operating leverage is high in rms with a high proportion of xed costs, a small proportion of variable costs, and the resulting high contribution margin per unit. The higher the rm's leverage, the higher the degree of the prot's sensitivity to volume. L.O. 3. Use Microsoft Excel to perform CVP analysis. A spreadsheet program such as Microsoft Excel can be used to perform most CVP analyses. For example, the Goal Seek function of Excel is designed to nd values of variables such as volume that set other variables (for example, prot) equal to a selected target value (such as zero). C H A P T E L.O. 4. Incorporate taxes, multiple products, and alternative cost structures into the CVPR S I N P A R T O N E analysis. More complicated relations among costs, volumes, and prots can be analyzed. With income taxes, the target prot, which is after income taxes, has to be converted to 1 Making Yourself Successful in College a target prot before income taxes. With multiple products, an assumption about product mix allows the application of CVP analysis by treating the multiple products as if they are a \"basket\" of goods. More complicated cost structures, such as step xedCollege Reading and 2 Approaching costs, can be analyzed by considering costs at different volumes. Developing a College-Level Vocabulary L.O. 5. Understand the assumptions and limitations of CVP analysis. All analysis methods require assumptions that limit the applicability of the results. The cost analyst must understand which assumptions are most important for the decision being made and Assignments: 3 Approaching College consider how sensitive the decision is to the assumptions before relying on CVP Reading Textbooks and Following Directions analysis alone to make a decision. Key Terms break-even point, 84 contribution margin ratio, 84 cost structure, 88 cost-volume-prot (CVP) analysis, 81 margin of safety, 89 margin of safety percentage, 89 operating leverage, 88 prot equation, 82 prot-volume analysis, 87 total contribution margin, 82 unit contribution margin, 82 Related Resources See pages 000 to 000 of the Annotated Instructor's Edition for general suggestions related to the chapters in Part One. Review Questions Write out the prot equation and describe each term. What are the components of total costs in the prot equation? How does the total contribution margin differ from the gross margin that is often shown on companies' 1 cor50782_ch01_001-072.inddnancial statements? 1 3-1. 3-2. 3-3. lan27114_ch03_080-109.indd 95 10/5/09 11:09:29 PM 10/22/09 10:34:02 PM REVISED PAGES Part II 96 3-4. 3-5. 3-6. 3-7. 3-8. 3-9. 3-10. 3-11. Cost Analysis and Estimation 1 Compare cost-volume-prot (CVP) analysis with prot-volume analysis. How do they P A R T differ? Fixed costs are often dened as \"xed over the short run.\" Does this mean that they are not xed over the long run? Why or why not? What is operating leverage? Why is knowledge of a rm's operating leverage important to its managers? What is the margin of safety? Why is this important for managers to know? Write out the equation for the target volume (in units) prot equation when the income tax rate is t. How do income taxes affect the break-even equation? Why? Why is it common to assume a xed sales mix before nding the break-even volume with multiple products? What are some important assumptions commonly made in CVP analysis. Do these assumptions impose serious limitations on the analysis? Why or why not? Orientation Preparing and Organizing Yourself for Success in College Critical Analysis and Discussion Questions 3-12. 3-13. 3-14. 3-15. 3-16. 3-17. 3-18. Exercises Why might the operating prot calculated by CVP analysis differ from the net income reported in nancial statements for external reporting? Why does the accountant use a linear representation of cost and revenue behavior in CVP analysis? How is this justied? The typical cost-volume-prot graph assumes that prots increase continually as volume increases. What are some of the factors that might prevent the increasing prots that are indicated when linear CVP analysis is employed? \"The assumptions of CVP analysis are so simplisticC that noTErm S I N make R T O N E H A P R would P A a decision based on CVP alone. Therefore, there is no reason to learn CVP analysis.\" Comment. \"I am going to work for a hospital, which is a not-for-prot organization. Because there are no prots, I will not be able to apply 1 CVP analysis in my work.\" Do you agree with this any Making Yourself Successful in College statement? Why or why not? Consider a class in a business school where volume is measured by the number of students 2 leverage is high or low? Why? in the class. Would you say the operating Approaching College Reading and Developing College-Level Vocabulary On January 1, 2009, a news report on msn.com includedathe following sentence: \"A report put out by brokerage house CLSA about Jet Airways said that the fall in ATF [fuel] prices has brought down the load factors (ight occupancy) required for the airline to break even 3 Approaching College limitations should be from 78 percent to 63 percent.\" What important assumptions andAssignments: Reading (The load factor Following Directions considered when using this piece of information? Textbooks and is the percentage of available seats on a ight that are occupied.) accounting 3-19. Prot Equation Components Identify each of the following prot equation components on the graph that follows: a. The total cost line. b. The total revenue line. c. The total variable costs area. d. Variable cost per unit. e. The xed costs area. f. The break-even point. g. The prot area (range of volumes leading to prot). h. The loss area (range of volumes leading to loss). cor50782_ch01_001-072.indd 1 (L.O. 1) lan27114_ch03_080-109.indd 96 Related Resources See pages 000 to 000 of the Annotated Instructor's Edition for general suggestions related to the chapters in Part One. 1 10/5/09 11:09:29 PM 10/22/09 10:34:02 PM REVISED PAGES Chapter 3 Fundamentals of Cost-Volume-Profit Analysis $ P A R T 1 97 Orientation Preparing and Organizing Yourself for Success in College 0 Volume 3-20. Prot Equation Components Identify the letter of each prot equation component on the graph that follows. (L.O. 1) C H A P T E R S $ I N P A R T O N E 1 Making Yourself Successful in College Line d 2 Approaching College Reading and c Developing a College-Level Vocabulary 3 Approaching College Assignments: Reading Textbooks and Following Directions Area e g b Area f a Volume 3-21. Basic Decision Analysis Using CVP Anu's Amusement Center has collected the following data for operations for the year: Total revenues . . . . . . . . . . . . . . . . . . Total xed costs. . . . . . . . . . . . . . . . . Total variable costs . . . . . . . . . . . . . . Total tickets sold . . . . . . . . . . . . . . . . cor50782_ch01_001-072.indd 1 lan27114_ch03_080-109.indd 97 $800,000 $218,750 $450,000 50,000 Related Resources See pages 000 to 000 of the Annotated Instructor's Edition for general suggestions related to the chapters (L.O. 1) in Part One. S 1 10/5/09 11:09:29 PM 10/22/09 10:34:02 PM REVISED PAGES Part II 98 Cost Analysis and Estimation 1 Required P A a. What is the average selling price for a ticket? R T b. What is the average variable cost per ticket? c. What is the average contribution margin per ticket? d. What is the break-even point? e. Anu has decided that unless the operation can earn at least $43,750 in operating prots, she will close it down. What number of tickets must be sold for Anu's Amusements to make a $43,750 operating prot for the year on ticket sales? Orientation (L.O. 1) 3-22. Basic CVP Analysis The manager of Kima's Food Mart estimates operating costs for the year will include $900,000 in xed costs. Required Preparing and Organizing Yourself a. Find the break-even point in sales dollars with a contribution margin ratio of 40 percent. b. Find the break-even point in sales dollars with a contributionin College25 percent. for Success margin ratio of c. Find the sales dollars required to generate a prot of $200,000 for the year assuming a contribution margin ratio of 40 percent. (L.O. 1) 3-23. CVP AnalysisEthical Issues Mark Ting desperately wants his proposed new product, DNA-diamond, to be accepted by top management. DNA-diamond is a piece of jewelry that contains the DNA of a boy or girl friend, spouse, or other loved one. Top management will not approve this product in view of its high break-even point. Mark knows that if he can reduce the xed costs in his proposal, then the break-even point will be reduced to a level that top management nds acceptable. Working with a friend in the company's nance department, Mark nds ways to credibly misstate the estimated xed costs of producing DNA-diamonds below those that any objective person would estimate. Mark knows that if the product is successful (and he is C H A P that R S I be), Pthen top mancertain T E it will N A R T O N E agement will not nd out about the understatement of xed costs. Mark believes that this product, once it is successful, will benet the shareholders and employees of the company. 1 (L.O. 1) Making Yourself Successful in College 2 Approaching College Reading and 3 Required Are Mark's actions ethical? Explain. Approaching College Assignments: Following Directions 3-24. Basic Decision Analysis Using CVP Developing a College-Level Vocabulary Cambridge, Inc., is considering the introduction of a new calculator with the following price and cost characteristics: Sales price . . . . . . . . . . . . . $ 18 each Variable costs . . . . . . . . Reading Textbooks and ... 10 each Fixed costs . . . . . . . . . . . . . . . . 20,000 per month Required a. What number must Cambridge sell per month to break even? b. What number must Cambridge sell to make an operating prot of $16,000 for the month? (L.O. 1) Related Resources 3-25. Basic Decision Analysis Using CVP See pages 000 to 000 Refer to the data for Cambridge, Inc., in Exercise 3-24. Assume that the projected number of units of the Annotated Instructor's sold for the year is 7,000. Consider requirements (b), (c), and (d) independently of each other. Edition for general sugges- Required tions related to the chapters in Part One. a. What will the operating prot be? b. What is the impact on operating prot if the sales price decreases by 10 percent? Increases by 20 percent? 1 c. What is the impact on operating prot if variable costs per unit decrease by 10 percent? Increase by 20 percent? d. Suppose that xed costs for the year are 10 percent lower than projected, and variable costs per unit are 10 percent higher than projected. What impact will these cost changes have on operating prot for the year? Will prot go up? Down? By how much? cor50782_ch01_001-072.indd 1 10/5/09 11:09:29 PM lan27114_ch03_080-109.indd 98 10/22/09 10:34:03 PM REVISED PAGES Chapter 3 Fundamentals of Cost-Volume-Profit Analysis 1 3-26. Basic Decision Analysis Using CVP P with T Balance, Inc., is considering the introduction of a new energy snackA R the following price and cost characteristics: Sales price . . . . . . . . . . . Variable costs . . . . . . . . . Fixed costs . . . . . . . . . . . $ 1.00 per unit 0.20 per unit 400,000 per month 99 (L.O. 1) Orientation Required a. What number must Balance sell per month to break even? b. What number must Balance sell per month to make an operating prot of $100,000? 3-27. Basic Decision Analysis Using CVP (L.O. 1) Preparing and 700,000 Refer to the data for Balance, Inc., in Exercise 3-26. Assume that the company plans to sell Organizing Yourself units per month. Consider requirements (b), (c), and (d) independently of each other. for Success in College Required a. What will be the operating prot? b. What is the impact on operating prot if the sales price decreases by 10 percent? Increases by 20 percent? c. What is the impact on operating prot if variable costs per unit decrease by 10 percent? Increase by 20 percent? d. Suppose that xed costs for the year are 10 percent lower than projected, and variable costs per unit are 10 percent higher than projected. What impact will these cost changes have on operating prot for the year? Will prot go up? Down? By how much? 3-28. Analysis of Cost Structure (L.O. 2) The Dollar Store's cost structure is dominated by variable costs with a contribution A P T E R S I N P A R T O N C H margin ratio of .30 and xed costs of $30,000. Every dollar of sales contributes 30 cents toward xed costs and prot. The cost structure of a competitor, One-Mart, is dominated by xed costs with a higher con1 of sales contributes Successful in College tribution margin ratio of .80 and xed costs of $280,000. Every dollar Making Yourself80 cents toward xed costs and prot. Both companies have sales of $500,000 for the month. E 2 Approaching College Reading and Required Developing a College-Level Vocabulary a. Compare the two companies' cost structures using the format shown in Exhibit 3.5. b. Suppose that both companies experience a 15 percent increase in sales volume. By how much would each company's prots increase? 3 Approaching College Assignments: Reading Textbooks and Following Directions (L.O. 2) 3-29. Analysis of Cost Structure Foxx Company's cost structure is dominated by variable costs with a contribution margin ratio of .25 and xed costs of $100,000. Every dollar of sales contributes 25 cents toward xed costs and prot. The cost structure of a competitor, Beyonce, Inc., is dominated by xed costs with a higher contribution margin ratio of .80 and xed costs of $400,000. Every dollar of sales contributes 80 cents toward xed costs and prot. Both companies have sales of $600,000 per month. Required a. Compare the two companies' cost structures using the format shown in Exhibit 3.5. b. Suppose that both companies experience a 20 percent increase in sales volume. By how much would each company's prots increase? 3-30. CVP and Margin of Safety Rainbow Tours gives walking tours of Springeld. Rainbow charges $40 per person for the tour and incurs $16 in variable costs for labor, drinks, and maps. The monthly xed costs for Rainbow Tours are $3,600. Required a. How many tours must Rainbow sell every month to break even? b. Rainbow Tours's owner believes that 175 people a month will sign up for the walking tour. What is the margin cor50782_ch01_001-072.indd 1 of safety in terms of the number of people signing up for the tour? lan27114_ch03_080-109.indd 99 Related Resources See pages 000 to 000 of the Annotated Instructor's Edition for general suggestions related to the chapters (L.O. 1, 2) in Part One. S 1 10/5/09 11:09:29 PM 10/22/09 10:34:03 PM REVISED PAGES Part II 100 (L.O. 3) Cost Analysis and Estimation 3-31. Using Microsoft Excel to Perform CVP Analysis P A R Refer to the data for Cambridge, Inc., in Exercise 3-24. T 1 Required Using the Goal Seek function in Microsoft Excel, a. What number must Cambridge sell to break even? b. What number must Cambridge sell to make an operating prot of $6,000 per month? (L.O. 3) Orientation 3-32. Using Microsoft Excel to Perform CVP Analysis Refer to the data for Balance, Inc., in Exercise 3-26. Required Using the Goal Seek function in Microsoft Excel, a. What number must Balance, Inc., sell to break even? b. What number must Balance, Inc., sell to make an operating proOrganizing Yourself Preparing and t of $8,000 per month? (L.O. 4) 3-33. CVP with Income Taxes for Success in College Crest Industries sells a single model of satellite radio receivers for use in the home. The radios have the following price and cost characteristics: Sales price . . . . . . . . . . . Variable costs . . . . . . . . . Fixed costs . . . . . . . . . . . $ 80 per radio $ 32 per radio $360,000 per month Crest is subject to an income tax rate of 40 percent. Required a. How many receivers must Crest sell every month to break even? b. How many receivers must Crest sell to earn a monthly operating prot of $90,000 after taxes? C H A P T E R S (L.O. 4) I N P A R T O N E 3-34. Multiproduct CVP Analysis Rio Coffee Shoppe sells two coffee drinks, a regular coffee and a latte. The two drinks have the 1 Making Yourself Successful in College following prices and cost characteristics: Regular Coffee Latte Approaching College Reading and Sales price (per