Management Advisory Services

COST-VOLUME PROFIT (CVP) ANALYSIS

Cost-Volume Profit Analysis -examines the behavior in total revenues, total costs, and operating income as
changes occur in the output level, selling price, variable cost per unit, or fixed costs of a product.

Break-even Point (BEP) – the point of activity level (sales volume) where total revenue equal total cost.

BEP in Units = Fixed Costs BEP in Peso Sales = Fixed Costs

UCM CMR

Factors Affecting Profit

1. Selling Price per unit
2. Variable Costs per unit
3. Fixed Costs
4. Volume or number of units

Assumptions of CVP Analysis

1. Changes in the level of revenue and costs arise only because of changes in the number of product (or service)
units produced and sols.
2. Total costs can be separated into a fixed component that does not vary with the output level and a component
that is variable with respect to the output level.
3. When represented graphically, the behavior of total revenue and total costs are linear in relation to output level
within a relevant range and time period.
4. The selling price, variable cost per unit and fixed costs are known and constatnt.
5. The analysis either covers a single product or assumes that the sales mix, when multiple products are sold, will
remain constant as the level of total units sold changes.

Sales Mix – the composition of total sales in terms of various products.

BEP in Units = Fixed Costs / Weighted Average UCM

BEP in Peso Sales = Fixed Costs / Weighted Average CMR

Margin of Safety – indicates the amount by which actual or planned sales may be reduced without incurring a
loss. It is the difference between actual or planned sales volume and break-even sales.

Margin of Safety = Sales – Break-even Sales

Margin of Safety Ratio = Margin of Safety / Sales

Operating Leverage – a measure of the extent to which fixed costs are being used in an organization. The
greater the fixed costs in relation to variable cost, the greater is the operating leverage available and the greater is
the sensitivity of income to changes in sales.

Degree of Operating Leverage (DOL) – a measure of the sensitivity of profit changes to changes in sales
volume. DOL measures the percentage in profit that results from a percentage of changes in sales.

Degree of Operating Leverage (DOL) or Operating Leverage Factor – a measure, at a given level of sales, of
how a percentage change in sales volume will affect profits.
 DOL = Contribution Margin / Operating Income or Profit before tax

Percentage change in Profit = DOL x Percentage change in sales

Problems:

1. Dominic Company is studying the impact of the following:

a. An increase in sales price.

b. An increase in the variable cost per unit.
c. An increase in the number of units sold.
d. A decrease in fixed costs.

Required:
Determine the impact of each of these operating changes on Wilcox's per-unit contribution margin and break-
even point by completing the chart that follows. Your responses should be Increase (INC), Decrease (DEC), No
Effect (NE), or Insufficient Information to Judge (II).

Per-Unit
Contribution Break-Even Profit
Margin Point
a. ______ ______ ______
b. ______ ______ ______
c. ______ ______ ______
d. ______ ______ ______

2. Rafael Company manufactures an engine for carpet cleaners. Budgeted cost and revenue data for the engine
are given below, based on sales of 40,000 units.

Sales P1,600,000
Less: Cost of goods sold 1,120,000
Gross margin P 480,000
Less: Operating expenses 100,000
Net income P 380,000

Cost of goods sold consists of P800,000 of variable costs and P320,000 of fixed costs. Operating expenses
consist of P40,000 of variable costs and P60,000 of fixed costs.

Required:
a. Calculate the variable cost per unit, contribution margin per unit and fixed costs.
b. Calculate the break-even point in units and sales peso.
c. Calculate the safety margin.
d. Rafael received an order for 6,000 units at a price of P25.00. There will be no increase in fixed costs, but
variable costs will be reduced by P0.54 per unit because of cheaper packaging. Determine the projected increase
or decrease in profit from the order.

3. Martin recently sold 70,000 units, generating sales revenue of P4,900,000. The company's variable cost per
unit and total fixed cost amounted to P20 and P2,800,000, respectively. Management is in the process of
studying the peso impact of various transactions and events, and desires answers to the following independent
cases:
a. Management wants to lower the firm's break-even point to 52,000 units. All other things being equal, what
must happen to fixed costs to achieve this objective?

b. The company anticipates a P2 hike in the variable cost per unit. All other things being equal, if management
desires to keep the firm's current break-even point, what must happen to Martin's selling price? If selling price
remains constant, what must happen to the firm's total fixed costs?

4. Roger Corporation sells three products: M, A, and K. The following information was taken from a recent
budget:

M A K
Unit sales 40,000 130,000 30,000
Selling price P60 P80 P75
Variable cost 40 65 50

Total fixed costs are anticipated to be P2,450,000.

Required:
a. Determine Roger's sales mix.
b. Determine the weighted-average contribution margin.
c. Calculate the number of units of M, A, and K that must be sold to break even.

5. Andy Company, which produces and sells a single product, has provided the following data:

Sales .................................. 2,000 units

Selling price ...................... P60 per unit
Variable expense ............... P40 per unit
Fixed expense .................... P20,000

Consider each of the following questions independently.

a. If the peso contribution margin per unit is increased by 10% and if total fixed expense is decreased by 20%,
net operating income is expected to.
b. If the sales volume decreases by 25% and the variable expense per unit increases by 15%, net operating
income is expected to.
c. If the company's fixed expenses increased by P8,000, how many units must be sold to reach a target net
operating income of P36,000.
d. If the company's sales volume in units decreases by 30%, and if it desires a targeted net operating income of
P29,000, then the selling price should be.

6. Roland Inc. has provided the following budgeted data:

Sales .................................. 20,000 units

Selling price ...................... p100 per unit
Variable expense ............... P70 per unit
Fixed expense .................... P450,000

a. What is the company's margin of safety as a percentage of sales?

b. How many units would the company have to sell in order to have a net operating income equal to 5% of total
sales peso?
7. Marin Company has decided to introduce a new product. The product can be manufactured using either a
capital-intensive or labor-intensive method. The manufacturing method will not affect the quality or sales of the
product. The estimated manufacturing costs of the two methods are as follows:

Capital Labor
Variable manufacturing cost per unit ..................... P14.00 P17.60
Fixed manufacturing cost per year ......................... P2,440,000 P1,320,000

The company's market research department has recommended an introductory selling price of P30 per unit for
the new product. The annual fixed selling and administrative expenses of the new product are P500,000. The
variable selling and administrative expenses are P2 per unit regardless of how the new product is manufactured.

Required:
a. Calculate the break-even point in units if Marin Company uses the:
a.1. capital-intensive manufacturing method.
a.2. labor-intensive manufacturing method.
b. Determine the unit sales volume at which the net operating income is the same for the two manufacturing
methods.
c. Assuming sales of 250,000 units, what is the degree of operating leverage if the company uses the:
a.1. capital-intensive manufacturing method.
a.2. labor-intensive manufacturing method.

8. Novac Company has developed a new product that will be marketed for the first time during the next fiscal
year. Although the Marketing Department estimates that 35,000 units could be sold at P36 per unit, Novac's
management has allocated only enough manufacturing capacity to produce a maximum of 25,000 units of the
new product annually. The fixed expenses associated with the new product are budgeted at P450,000 for the
year. The variable expenses of the new product are P16 per unit.

Required:
a. How many units of the new product must Novak sell during the next fiscal year in order to break even on the
product?
b. What is the profit Novak would earn on the new product if all of the manufacturing capacity allocated by
management is used and the product is sold for P36 per unit?
c. What is the degree of operating leverage for the new product if 25,000 units are sold for P36 per unit?
d. The Marketing Department would like more manufacturing capacity to be devoted to the new product. What
would be the percentage increase in net operating income for the new product if its unit sales could be expanded
by 10% without any increase in fixed expenses and without any change in the unit selling price and unit variable
expense?
e. Novak's management has stipulated that the new product must earn a profit of at least P125,000 in the next
fiscal year. What unit selling price would achieve this target profit if all of the manufacturing capacity allocated
by management is used and all of the output can be sold at that selling price?