Sensitivity Analysis

e
e

p c c
x q

a b x
a b

d d
Product A Product B

1. Product A breakeven occurs further to the right of the chart than that for Product B.
 High fixed costs tend to result in high break even points.
 Product B with lower fixed cost has a lower-breakeven point although marginal
cost is greater.
2. The angle p for Product A is greater than angle q for Product B.
 The angle of intersection is an indication of the sensitivity of a product to
variations in the level of activity.
 Example, as output increases for both of the product, Product A’s profitability
increases at a faster rate as compared to B.
 If output decreases for both products, Product A’s profitability decreases at a
faster rate than B.
 Therefore, Product A is more sensitive to changes in output than Product B.

Profit and break-even points are said to be sensitive to changes in price and cost.

Compiled by: Cheryl. TYX

 Sensitivity Analysis

A technique for analysing uncertainty about the outcome of a decision.

1. All forecasts are predictions of future outcomes. Forecasts of profitability are based on
the accuracy of the productions of future costs and future revenues.
2. The starting point is an estimate of what the outcome will be based on estimates for key
variables, such as selling price, sales volume and unit variable cost fixed cost
expenditures.
3. Sensitivity analysis may be used because there is uncertainty about some of these
estimates.

3 useful approaches:

a) To estimate by how much costs and revenues would need to differ from their estimated
values before the decision would change
b) To estimate whether a decision would change if estimated costs were x% higher than
estimated, or estimated revenues y% lower than estimated
c) To estimate by how much costs and/or revenues would need to differ from their estimated
values before the decision-maker would be indifferent between two options

Class Exercise

Awesome Co has estimated the following sales and profits for a new product which it may
launch on to the market.

$ $
Sales (2,000 units) 4 000
Direct materials 2 000
Direct labour 1 000 3 000
Contribution 1 000
Fixed costs 800
Profit 200

REQUIRED

Analyse the sensitivity of the project to changes on key variables.

Compiled by: Cheryl. TYX

 Example 1

Planned sales of ‘diorth’ are 5 000 units at $20 per unit.

Variable costs are predicted to be $5 per unit.

Fixed costs are estimated to be $52 000.

A forecast income statement based on this information shows:

$ $
Sales (5 000*$20) 100 000
Variable costs (5 000*$5) (25 000)
Fixed costs (52 000) (77 000)
Profit 23 000
000)*100
 Example 2

 The following information relates to budget for a certain product.

No. of units produced and sold: 10 000

$
Sales revenue 180 000
Variable costs 50 000
Fixed costs 100 000
Profit 30 000

a) Calculate the breakeven point in units.

b) Calculate the profit and the break-even points if
i. Fixed costs rise by 10% and not passed on to customer.
ii. Variable costs increases by 10% and are not passed to customers (no change in
fixed cost)
iii. Selling price per unit is only 90% of expectation and no change in cost
iv. Selling price per unit is only 90% of expectation and fixed costs increases by 10%
v. If all costs increases by 10% and are not passed to customers, selling price per unit
is only 90% of expectation.

Compiled by: Cheryl. TYX

Example 3

The following information relates to budget for a certain product.

No. of units produced and sold: 20 000

$
Fixed costs 80 000
Variable costs 60 000
Total costs 140 000
Sales 175 000
Profit 35 000

a) Calculate the breakeven point in units.

b) Calculate the profit and the break-even points if
i. Fixed costs rise by 15% and not passed on to customer.
ii. Variable costs increases by 15% and are not passed to customers (no change in
fixed cost)
iii. Fixed and variable costs increase by 15% and the increase are passed on to the
customers.

Example 4

Gentle Ltd makes 3 products, A, B and C. All 3 products are made from the same materials.
The production budget for June is as follows:

A B C
Budgeted production (units) 1 000 2 000 4 000
Materials per unit (kg) 2 4 5
Direct labour per unit (hours) 3 5 6
Selling price per unit $80 $130 $150

Material cost: $10 per kg

Labour rate per hour: $12
Total fixed cost for June: $115 000

REQUIRED

a) Calculate the budgeted profit for June. Show your workings.

After the budget for June was prepared, Gentle Ltd learned that there was a shortage of
material and that it would not be able to obtain more than 28 000 kg in June.

REQUIRED

b) Prepare a revised production budget which will ensure that Gentle Ltd can maximise
profit from available materials and calculate the budgeted profit.
c) State 3 assumptions which are made in the preparation of break-even charts, and state one
limitation for each assumption.

Compiled by: Cheryl. TYX