Chapter 003 Fundamentals of Cost-Volume-Profit Analysis

True / False Questions

 

1. The basic profit equation used for cost-volume-profit (CVP) analysis is based on the
income statement. 
TRUE

AACSB: Analytic
Difficulty: Simple
Learning Objective: 1
 

2. Both total revenues (TR) and total costs (TC) are likely to be affected by changes in the
output. 
TRUE

AACSB: Analytic
Difficulty: Simple
Learning Objective: 1
 

3. Costs and expenses are either variable or fixed. 

FALSE

AACSB: Analytic
Difficulty: Simple
Learning Objective: 1
 

4. Cost-volume-profit (CVP) analysis assumes that the production volume equals sales
volume so that changes in unit prices can be ignored. 
FALSE

AACSB: Analytic
Difficulty: Moderate
Learning Objective: 1
 

3-1
 Chapter 003 Fundamentals of Cost-Volume-Profit Analysis

5. The total contribution margin is the unit contribution margin multiplied by the number of
units minus the fixed component of the total costs (TC). 
FALSE

AACSB: Analytic
Difficulty: Moderate
Learning Objective: 1
 

6. Operating profit is the unit contribution margin multiplied by the number of units minus the
fixed component of the total costs (TC). 
TRUE

AACSB: Analytic
Difficulty: Moderate
Learning Objective: 1
 

7. In financial accounting, costs are classified as either manufacturing or non-manufacturing

but not as fixed or variable. 
TRUE

AACSB: Analytic
Difficulty: Simple
Learning Objective: 1
 

8. If the average selling price is $.60 per unit, the average variable cost is $.36 per unit, and
the total fixed costs are $1,500, then sales of 15,000 units will result in operating profits of
$3,600. 
FALSE

AACSB: Analytic
Difficulty: Moderate
Learning Objective: 1
 

3-2
 Chapter 003 Fundamentals of Cost-Volume-Profit Analysis

9. If the average selling price is $.60 per unit, the average variable cost is $.36 per unit, and
the total fixed costs are $1,500, then sales of 8,000 units will result in a break-even point of
6,250 units. 
TRUE

AACSB: Analytic
Difficulty: Complex
Learning Objective: 1
 

10. If the average selling price is $.60 per unit, the average variable cost is $.36 per unit, and
the total fixed costs are $1,500, then operating profits of $900 will require a sales volume of
2,500 units. 
FALSE

AACSB: Analytic
Difficulty: Moderate
Learning Objective: 1
 

11. The contribution margin ratio is the contribution margin per unit divided by the selling
price per unit. 
TRUE

AACSB: Analytic
Difficulty: Moderate
Learning Objective: 1
 

12. If the fixed costs are $2,400, targeted operating profit is $1,200, and the contribution
margin ratio is 40%, then the break-even point is $6,000. 
FALSE

AACSB: Analytic
Difficulty: Moderate
Learning Objective: 1
 

3-3
 Chapter 003 Fundamentals of Cost-Volume-Profit Analysis

13. If the fixed costs are $2,400, targeted operating profit is $1,200, selling price per unit is
$2, and the contribution margin ratio is 40%, then the sales volume is 9,000 units. 
FALSE

AACSB: Analytic
Difficulty: Complex
Learning Objective: 1
 

14. The break-even point in sales dollars is fixed costs divided by the contribution margin
ratio. 
TRUE

AACSB: Analytic
Difficulty: Simple
Learning Objective: 1
 

15. The break-even point in sales dollars is when the total contribution margin equals the total
fixed costs. 
TRUE

AACSB: Analytic
Difficulty: Simple
Learning Objective: 1
 

16. The break-even point in sales dollars is when the total contribution margin equals the total
costs. 
FALSE

AACSB: Analytic
Difficulty: Moderate
Learning Objective: 1
 

3-4
 Chapter 003 Fundamentals of Cost-Volume-Profit Analysis

17. The vertical axis on the cost-volume-profit (CVP) graph represents the volume of activity
for a period. 
FALSE

AACSB: Analytic
Difficulty: Simple
Learning Objective: 1
 

18. An organization's break-even point is inversely related to its sales volume. 

FALSE

AACSB: Analytic
Difficulty: Complex
Learning Objective: 1
 

19. The slope of the total revenue (TR) line on the cost-volume-profit (CVP) graph is the
selling price per unit. 
TRUE

AACSB: Analytic
Difficulty: Simple
Learning Objective: 1
 

20. The slope of the profit line in profit-volume analysis is the operating profit per unit. 
FALSE

AACSB: Analytic
Difficulty: Moderate
Learning Objective: 2
 

21. An organization's cost structure is the proportion of fixed and variable costs to total costs. 
TRUE

AACSB: Analytic
Difficulty: Simple
Learning Objective: 2
 

3-5
 Chapter 003 Fundamentals of Cost-Volume-Profit Analysis

22. Organizations in the same industry have similar cost structures (e.g., airlines), although
cost structures vary widely among different industries. 
TRUE

AACSB: Analytic
Difficulty: Moderate
Learning Objective: 2
 

23. An organization's operating leverage is high when it has a low proportion of variable costs
in its total costs. 
TRUE

AACSB: Analytic
Difficulty: Moderate
Learning Objective: 2
 

24. An increase in the selling price per unit will decrease an organization's operating leverage,
assuming no other change in its cost structure. 
FALSE

AACSB: Analytic
Difficulty: Complex
Learning Objective: 2
 

25. The break-even point for an organization with a low operating leverage will be relatively
higher than the break-even point for an organization with a high operating leverage. 
FALSE

AACSB: Analytic
Difficulty: Complex
Learning Objective: 2
 

3-6
 Chapter 003 Fundamentals of Cost-Volume-Profit Analysis

26. The margin of safety is the difference between the actual operating profit and the break-
even operating point. 
FALSE

AACSB: Analytic
Difficulty: Moderate
Learning Objective: 2
 

27. An increase in an organization's fixed costs will result in a lower margin of safety. 
TRUE

AACSB: Analytic
Difficulty: Complex
Learning Objective: 2
 

28. In practice, the margin of safety can be expressed in sales dollars or as a percent of the
break-even point. 
FALSE

AACSB: Analytic
Difficulty: Moderate
Learning Objective: 2
 

29. Spreadsheets can be used to analyze "what-if" scenarios (i.e., changes in the current data
or sets of alterative data). 
TRUE

AACSB: Analytic
Difficulty: Simple
Learning Objective: 3
 

30. An increase in an organization's tax rate will cause an increase in its break-even point. 
FALSE

AACSB: Analytic
Difficulty: Moderate
Learning Objective: 4
 

3-7
 Chapter 003 Fundamentals of Cost-Volume-Profit Analysis

31. Before-tax operating profits are equal to the after-tax operating profits divided by (1    
tax rate). 
TRUE

AACSB: Analytic
Difficulty: Simple
Learning Objective: 4
 

32. If an organization's before- and after-tax operating incomes are $10,000 and 7,000,
respectively, then its tax rate is 30%. 
TRUE

AACSB: Analytic
Difficulty: Moderate
Learning Objective: 4
 

33. If an organization's fixed costs are $2,400, tax rate is 40%, and contribution margin is
$5,200, then its after-tax operating profits are $1,680. 
TRUE

AACSB: Analytic
Difficulty: Moderate
Learning Objective: 4
 

34. If the fixed costs are $2,400, targeted before-tax operating profit is $1,200, tax rate is
25%, selling price per unit is $2, and contribution margin ratio is 40%, then the sales volume
is 9,000 units. 
FALSE

AACSB: Analytic
Difficulty: Complex
Learning Objective: 4
 

3-8
 Chapter 003 Fundamentals of Cost-Volume-Profit Analysis

35. Cost-volume-profit (CVP) analysis is more complicated for organizations with multiple

products because each product has a different contribution margin ratio. 
TRUE

AACSB: Analytic
Difficulty: Simple
Learning Objective: 4
 

36. The JK Manufacturing Company sells two products, J and K. J has a higher contribution
margin ratio than K. If the product mix shifts towards K, the company's break-even point in
total units (i.e., J plus K) will increase. 
TRUE

AACSB: Analytic
Difficulty: Complex
Learning Objective: 4
 

37. In multi-product cost-volume-profit (CVP) analysis, the fixed product mix method and the
weighted average contribution margin method give different break-even points. 
FALSE

AACSB: Analytic
Difficulty: Moderate
Learning Objective: 4
 

3-9
 Chapter 003 Fundamentals of Cost-Volume-Profit Analysis

Multiple Choice Questions

 

38. Cost-volume-profit (CVP) analysis is a simple but powerful tool to assist management

make operating decisions. Which of the following does not represent a potential use of CVP
analysis? 
a. Ability to compute the break-even point.
b. Ability to determine optimal sales volumes.
C. Aids in evaluating tax planning alternatives.
d. Aids in determining optimal pricing policies.

AACSB: Analytic
Difficulty: Simple
Learning Objective: 1
 

39. Which of the following would not cause the breakeven point to change? 
a. Sales price increases.
b. Fixed costs decreases.
C. Sales volume decreases.
d. Variable costs per unit increases.
e. Product mix shifts towards the cheaper products.

AACSB: Analytic
Difficulty: Moderate
Learning Objective: 1
 

40. If the fixed costs for a product decrease and the variable costs (as a percentage of sales
dollars) decrease, what will be the effect on the contribution margin ratio and the breakeven
point respectively?

    
a. 
B. 
c. 
d. 

AACSB: Analytic
Difficulty: Moderate
Learning Objective: 1
 

3-10
 Chapter 003 Fundamentals of Cost-Volume-Profit Analysis

41. The Blue Company is currently selling its single product for $15. Variable costs are
estimated to remain at 70% of the current selling price and fixed costs are estimated to be
$4,800 per month. If Blue increases its selling price by 10%, its variable cost ratio will 
a. not change
B. decrease
c. increase

$15(.70) = $10.50
$15(1.10) = $16.50
$10.50/$16.50 = 63.6% (vs. 70%)

AACSB: Analytic
Difficulty: Moderate
Learning Objective: 1
 

42. Expense A is a fixed cost expense, B is a variable cost. During the current year the volume
of output has decreased. In terms of cost per unit of output, we would expect that 
a. expense A has remained unchanged.
b. expense B has decreased.
c. expense A has decreased.
D. expense B has remained unchanged.

AACSB: Analytic
Difficulty: Simple
Learning Objective: 1
 

43. If both the variable cost per unit and the selling price per unit decrease, the new
contribution margin ratio in relation to the old contribution margin ratio will be: 
a. Lower.
b. Higher.
c. Unchanged.
D. Not enough information to tell.

AACSB: Analytic
Difficulty: Complex
Learning Objective: 1
 

3-11
 Chapter 003 Fundamentals of Cost-Volume-Profit Analysis

44. A company's break-even point will not be increased by: 

a. an increase in total fixed costs.
b. a decrease in the selling price per unit.
c. an increase in the variable cost per unit.
d. a decrease in the contribution margin ratio.
E. an increase in the number of units produced and sold.

AACSB: Analytic
Difficulty: Moderate
Learning Objective: 1
 

45. Which of the following changes to a company's contribution income statement will always
lower the breakeven point (either in units or in dollars)? 
A. Sales price increases by 10% and sales volume decreases by 5%.
b. Sales price decreases by 5% and sales volume increases by 15%.
c. Variable costs increase by 10% and fixed costs decrease by 5%.
d. Variable costs decrease by 5% and fixed costs increase by 10%.

AACSB: Analytic
Difficulty: Complex
Learning Objective: 1
 

46. Operating leverage refers to the extent to which an organization's cost structure is made up
of: 
a. differential costs.
b. opportunity costs.
C. fixed costs.
d. relevant costs.
e. product costs.

AACSB: Analytic
Difficulty: Simple
Learning Objective: 2
 

3-12
 Chapter 003 Fundamentals of Cost-Volume-Profit Analysis

47. A decrease in the margin of safety would be caused by a(n): 

A. increase in the total fixed costs.
b. increase in total revenue (sales).
c. decrease in the break-even point.
d. decrease in the variable cost per unit.

AACSB: Analytic
Difficulty: Complex
Learning Objective: 2
 

48. After-tax operating profits are equal to the before-tax operating profits when which of the
following occurs: 
a. income taxes are added.
b. income taxes are subtracted.
c. multiplied by (1 tax rate).
D. divided by (1 tax rate).

AACSB: Analytic
Difficulty: Simple
Learning Objective: 4 (Both B and D are correct)
 

49. At a break-even point of 400 units, variable costs were $400 and fixed costs were $200.
What will the 401st unit sold contribute to operating profits before income taxes? 
A. $.50
b. $1.00
c. $1.50
d. $2.00
e. some other answer _______________.

Variable costs = $400/400 = $1.00

400 = $200/(selling price $1.00); selling price = $1.50
$1.50 1.00 = $.50

AACSB: Analytic
Difficulty: Simple
Learning Objective: 1
 

3-13
 Chapter 003 Fundamentals of Cost-Volume-Profit Analysis

50. Barnes Corporation manufactures skateboards and is in the process of preparing next

year's budget. The pro forma income statement for the current year is presented below.

   

The breakeven point (rounded to the nearest dollar) for Barnes Corporation for the current
year is 
a. $146,341.
B. $636,364.
c. $729,730.
d. $181,818.
e. $658,537.

$250,000 + 150,000 + 75,000 + 200,000 = $675,000

($1,500,000 675,000)/1,500,000 = 55%
($100,000 + 250,000)/.55 = $636,364

AACSB: Analytic
Difficulty: Simple
Learning Objective: 1
 

3-14
 Chapter 003 Fundamentals of Cost-Volume-Profit Analysis

51. Barnes Corporation manufactures skateboards and is in the process of preparing next

year's budget. The pro forma income statement for the current year is presented below.

   

For the coming year, the management of Barnes Corporation anticipates a 10 percent increase
in sales, a 12 percent increase in variable costs, and a $45,000 increase in fixed expenses.

The breakeven point for next year would be 

A. $729,027.
b. $862,103.
c. $214,018.
d. $474,000.
e. $700,000.

($1,500,000 1.10) ($675,000 1.12)/$1,650,000 = .541818

($350,000 + 45,000)/.541818 = $729,027

AACSB: Analytic
Difficulty: Simple
Learning Objective: 1
 

3-15
 Chapter 003 Fundamentals of Cost-Volume-Profit Analysis

52. You have been provided with the following information:

   

If sales decrease by 500 units, how much will fixed expenses have to be reduced by to
maintain the current operating profit of $6,000? 
a. $9,000.
b. $7,500.
c. $6,000.
D. $3,000.
e. Some other answer ___________.

$45,000/15 = 3,000 units

[($15 9)(3,000 500)] FC = $6,000
FC = $9,000; thus FC will have to decrease by $3,000

AACSB: Analytic
Difficulty: Complex
Learning Objective: 1
 

53. XYZ Company's sales are $750,000 with operating profits of $130,000. If the contribution
margin ratio is 40%, what did the fixed costs amount to? 
a. $370,000.
b. $300,000.
c. $270,000.
D. $170,000.
e. $130,000.

($750,000 .40) FC = $130,000

FC = $170,000

AACSB: Analytic
Difficulty: Simple
Learning Objective: 1
 

3-16
 Chapter 003 Fundamentals of Cost-Volume-Profit Analysis

54. The following costs have been estimated based on sales of 30,000 units:

   

What selling price will yield a contribution margin of 40%? 

a. $59.38
b. $43.75
C. $39.58
d. $33.25
e. Some other answer _____________________.

($300,000 + $250,000 + $125,000 + $37,500)/30,000 = $23.75

(SP $23.75)/SP = .40
SP = $39.58

AACSB: Analytic
Difficulty: Complex
Learning Objective: 1
 

55. Fowler Manufacturing Company has a fixed cost of $225,000 for the production of tubes.
Estimated sales are 150,000 units. A before tax profit of $125,000 is desired by the controller.
If the tubes sell for $5 each, what unit contribution margin is required to attain the profit
target? 
a. $3.00.
B. $2.33.
c. $1.47.
d. $.90.
e. Some other answer _______________________________.

(CM per unit 150,000) 225,000 = $125,000

CM per unit = $2.33

AACSB: Analytic
Difficulty: Simple
Learning Objective: 1
 

3-17
 Chapter 003 Fundamentals of Cost-Volume-Profit Analysis

56. JJ Motors Inc. employs 45 sales personnel to market their line of luxury automobiles. The
average car sells for $23,000, and a 6 percent commission is paid to the salesperson. JJ
Motors is considering a change to the commission arrangement where the company would
pay each salesperson a salary of $2,000 per month plus a commission of 2 percent of the sales
made by that salesperson. The amount of total monthly car sales at which JJ Motors would be
indifferent as to which plan to select is 
A. $2,250,000.
b. $3,000,000.
c. $1,500,000.
d. $1,250,000.
e. $4,500,000.

$2,000 + (.02)(units)($23,000) = (.06)(units)($23,000)

Units = 2.173913
2.173913(45)($23,000) = $2,250,000

AACSB: Analytic
Difficulty: Complex
Learning Objective: 2
 

3-18
 Chapter 003 Fundamentals of Cost-Volume-Profit Analysis

57. The following data relate to a year's budgeted activity for Patsy corporation, a single
product company:

   

Total fixed costs remain unchanged within the relevant range of 25,000 units to total capacity
of 160,000 units.

What is the budgeted operating leverage assuming the Patsy Corporation produced and sold
110,000 units? 
a. 1.375.
b. 1.500.
C. 1.692.
d. 3.667.
e. 4.000.
f. Some other answer _______________.

[($5.00 1.00 2.00) 110,000] = $220,000

$220,000/$220,000 [($.25 + .65) 100,000] = 1.692

AACSB: Analytic
Difficulty: Complex
Learning Objective: 2
 

3-19
 Chapter 003 Fundamentals of Cost-Volume-Profit Analysis

58. Given the following information:

   

What would expected net income be if the company experienced a 10 percent increase in
fixed costs and 10 percent increase in sales volume? 
a. $1,750.
b. $1,550.
c. $1,250.
D. $1,375.
e. Some other answer _____________.

[$5,000 $1,750 1.10] ($2,000) (1.10) = $1,375

AACSB: Analytic
Difficulty: Simple
Learning Objective: 3
 

3-20
 Chapter 003 Fundamentals of Cost-Volume-Profit Analysis

59. Given the following data:

   

If sales decrease by 500 units, by what % would fixed expenses have to be reduced by to
maintain current net income? 
a. 50.0%.
b. 33.3%.
C. 25.0%.
d. 16.7%.
e. Some other percentage ____________.

$45,000/15 = 3,000 units

[($15 9) (3,000 500)] FC = $6,000
FC = $9,000; thus FC will have to decrease by $3,000
$3,000/12,000 = 25%

AACSB: Analytic
Difficulty: Complex
Learning Objective: 3
 

3-21
 Chapter 003 Fundamentals of Cost-Volume-Profit Analysis

60. The Dooley Co. manufactures two products, baubles and trinkets. The following are
projections for the coming year:

   

How many Baubles will be sold at the breakeven point, assuming that the facilities are jointly
used and the sales mix will remain constant? 
a. 9,900
b. 8,800
C. 6,600
d. 5,000
e. 3,300

($6,000/$10,000)(10,000/15,000) + ($4,000/$5,000)(5,000/15,000) = .66667

($2,000 + 4,600)/.66667 = 9,900 total units
9,900 (10,000/15,000) = 6,600

AACSB: Analytic
Difficulty: Complex
Learning Objective: 4
 

61. If sales dollars are used to measure activity levels, total costs and total revenues may be
read from the X and Y axis as follows: (CPA adapted, 5/90)

    
a. 
b. 
c. 
D. 

AACSB: Analytic
Difficulty: Simple
Learning Objective: 1
 

3-22
 Chapter 003 Fundamentals of Cost-Volume-Profit Analysis

62. Breakeven analysis assumes that over the relevant range (CPA, adapted 5/93): 
a. Total Fixed Costs are nonlinear.
b. Total Costs are unchanged.
C. Unit Variable Costs are unchanged.
d. Unit Revenues are nonlinear.

AACSB: Analytic
Difficulty: Simple
Learning Objective: 1
 

63. At the break-even point the contribution margin equals total: (CPA adapted, 11/93) 
a. Variable costs
b. Sales revenues
c. Selling and administrative costs
D. Fixed costs

AACSB: Analytic
Difficulty: Simple
Learning Objective: 1
 

64. The relevance of a particular cost to a decision is determined by the: (CMA adapted,

12/96) 
a. riskiness of the decision.
b. number of decision variables.
c. amount of the cost.
D. potential effect on the decision.
e. accuracy of the cost.

AACSB: Analytic
Difficulty: Simple
Learning Objective: 2
 

3-23
 Chapter 003 Fundamentals of Cost-Volume-Profit Analysis

65. In a decision analysis situation, which one of the following costs is not likely to contain a
variable cost component? (CMA adapted, 6/96) 
a. Labor
b. Overhead
C. Depreciation
d. Selling
e. Material

AACSB: Analytic
Difficulty: Simple
Learning Objective: 1
 

66. On January 1, 2006, Lake Co. increased its direct labor wage rates. All other budgeted
costs and revenues were unchanged. How did this increase affect Lake's budgeted break-even
point and budgeted margin of safety? (CPA adapted, 5/92)

    
a. 
B. 
c. 
d. 

AACSB: Analytic
Difficulty: Moderate
Learning Objective: 1
 

3-24
 Chapter 003 Fundamentals of Cost-Volume-Profit Analysis

67. During 2006, Thor Lab supplied hospitals with a comprehensive diagnostic kit for $120.
At a volume of 80,000 kits, Thor had fixed costs of $1,000,000 and a profit before income
taxes of $200,000. Due to an adverse legal decision, Thor's 2007 liability insurance increased
by $1,200,000 over 2006. Assuming the volume and other costs are unchanged, what should
the 2007 price be if Thor is to make the same $200,000 profit before income taxes? (CPA
adapted, 5/94) 
a. $122.50
B. $135.00
c. $152.50
d. $240.00
e. some other answer _______________.

[($120 VC)80,000] $1,000,000 = $200,000

VC = $105
[($SP $105)80,000] $2,200,000 = $200,000
SP = $135

AACSB: Analytic
Difficulty: Moderate
Learning Objective: 1
 

68. The following information pertains to Syl Co.:

   

What is Syl's breakeven point in sales dollars? (CPA adapted, 11/92) 

a. $200,000
b. $160,000
C. $50,000
d. $40,000
e. some other answer _______________.

($800,000 160,000)/$800,000 = 80%

$40,000/.80 = $50,000

AACSB: Analytic
Difficulty: Simple
Learning Objective: 1
 

3-25
 Chapter 003 Fundamentals of Cost-Volume-Profit Analysis

69. The following pertains to Clove Co. for the year ending December 31, 2008:

   

Clove's margin of safety is: (CPA adapted, 5/92) 

A. $300,000
b. $400,000
c. $500,000
d. $800,000
e. some other answer _______________.

$1,000,000 $700,000 = $300,000

AACSB: Analytic
Difficulty: Simple
Learning Objective: 1
 

3-26
 Chapter 003 Fundamentals of Cost-Volume-Profit Analysis

70. Kator Inc. manufactures industrial components. One of its products that is used as a
subcomponent in auto manufacturing is KB-96. The selling price and cost per unit data for
9,000 units of KB-96 is as follows.

   

During the next year, sales of KB-96 are expected to be 10,000 units. All costs will remain the
same except for fixed manufacturing overhead, which will increase 20%, and material, which
will increase 10%. The selling price per unit for next year will be $160. Based on this data,
Kator Inc.'s contribution margin for next year will be: (CMA adapted, 12/95) 
a. $882,000
b. $980,000
c. $972,000
D. $1,080,000
e. some other answer _______________.

[($160 22 15 12 3)10,000 units] = $1,080,000

AACSB: Analytic
Difficulty: Moderate
Learning Objective: 1
 

3-27
 Chapter 003 Fundamentals of Cost-Volume-Profit Analysis

  Donnelly Corporation manufactures and sells T-shirts imprinted with college names and
slogans. Last year, the shirts sold for $7.50 each, and the variable cost to manufacture them
was $2.25 per unit. The company needed to sell 20,000 shirts to break even. The net income
last year was $5,040. Donnelly's expectations for the coming year include the following:
(CMA adapted)

 The sales price of the T-shirts will be $9

 Variable cost to manufacture will increase by one-third
 Fixed costs will increase by 10%
 The income tax rate of 40% will be unchanged.

71. The selling price that would maintain the same contribution margin rate as last year is 
a. $9.00.
b. $8.25.
C. $10.00.
d. $9.75.
e. Some other amount _______________.

($7.50 2.25)/$7.50 = 70%

[SP (2.25 1.3)]/SP = 70%
SP = $10.00

AACSB: Analytic
Difficulty: Complex
Learning Objective: 4
 

72. The number of T-shirts Donnelly Corporation must sell to break even in the coming year
is 
a. 17,000.
B. 19,250.
c. 20,000.
d. 22,000.
e. Some other amount ________________.

FC (last year) = ($7.50 2.25) 20,000 units = $105,000

FC (this year) = $105,000 1.10 = $115,500
$115,500/(9 3) = 19,250

AACSB: Analytic
Difficulty: Complex
Learning Objective: 4
 

3-28
 Chapter 003 Fundamentals of Cost-Volume-Profit Analysis

73. Sales for the coming year are expected to exceed last year's by 1,000 units. If this occurs,
Donnelly's sales volume in the coming year will be 
A. 22,600 units.
b. 21,960 units.
c. 23,400 units.
d. 21,000 units.
e. Some other amount _______________.

$5,040/(1 .40) = $8,400

($105,000 + $8,400)/($7.50 2.25) = 20,960 units sold last year
20,960 + 1,000 = 21,960

AACSB: Analytic
Difficulty: Complex
Learning Objective: 4
 

74. If Donnelly Corporation wishes to earn $22,500 in net income for the coming year, the
company's sales volume in dollars must be 
a. $213,750.
b. $257,625.
C. $207,000.
d. $229,500.
e. Some other amount _______________.

$22,500/(1 .40) = $37,500

($115,500 + $37,500)/($9 3) = 23,000 units
23,000 $9 = $207,000

AACSB: Analytic
Difficulty: Complex
Learning Objective: 4
 

3-29
 Chapter 003 Fundamentals of Cost-Volume-Profit Analysis

Essay Questions
 

75. The Katie Corporation has budgeted fixed costs of $125,000 and an estimated selling
price of $16.50 per unit. The contribution margin ratio is 40% and the company plans to sell
25,000 units in 2007.

Required:
(a) Compute the margin of safety ratio for 2007.
(b) Compute the operating leverage for 2007. 

(a) BE = $125,000/.40 = $312,500

Estimated sales = 25,000 units     $16.50 = $412,500
Margin of safety = ($412,500     312,500)/412,500 = 24.2%

(b) CM = $412,500(.40) = $165,000

Operating profits = $165,000     125,000 = $40,000
Operating leverage = $165,000/40,000 = 4.125

AACSB: Analytic
Difficulty: Moderate
Learning Objective: 4
 

3-30
 Chapter 003 Fundamentals of Cost-Volume-Profit Analysis

76. The president of AMG Enterprises is considering expanding sales by producing three

different versions of their product. Each will be targeted by the marketing department to
different income levels and hence will be produced from three different qualities of materials.
After reviewing the sales forecasts, the sales department feels that for every item of A sold, 4
of M can be sold and 8 of G can be sold.

The following information has been assembled by the sales department and the production
department.

   

The fixed costs associated with the manufacture of these three products are $75,000 per year.

Required:
Determine the number of units of each product that would be sold at the breakeven point. 

Weighted average CM = [(15     9)(1) + (10     7)(4) + (5     4.50)(8)]/(1 + 4 + 8) =

$1.69231
BE = $75,000/1.69231 = 44,319 total units
A = 44,319     (1/13) = 3,410
M = 44,319     (4/13) = 13,637
G = 44,319     (8/13) = 27,274

AACSB: Analytic
Difficulty: Moderate
Learning Objective: 4
 

3-31
 Chapter 003 Fundamentals of Cost-Volume-Profit Analysis

77. Stanley Clipper, now retired, owns the Campus Barber Shop. He employs five (5) barbers
and pays each a base rate of $500 per month. One of the barbers serves as the manager and
receives an extra $300 per month. In addition to the base rate, each barber also receives a
commission of $3 per haircut. A barber can do as many as 20 haircuts a day, but the average
is 14 haircuts per day. The Campus Barber Shop is open 24 days a month.

Other costs are incurred as follows:

   

Stanley currently charges $8 per haircut.

Required: (For parts a through d, income taxes can be ignored (sole proprietors also have to
pay taxes?)
(a) Compute the break-even point in (1) number of haircuts, (2) total sales dollars, and (3) as a
percentage of capacity.
(b) In March, 1,400 haircuts were given. Compute the operating profits for the month.
(c) Stanley wants a $2,160 operating profit in April. Compute the number of haircuts that
must be given in order to achieve this goal.
(d) If 1,500 haircuts are given in April, compute the selling price that would have to be
charged in order to have $2,160 in operating profits.
(For parts e and f, assume the Campus Barber Shop is a corporation with a 30% tax rate.)
(e) Stanley wants to earn $2,160 in after-tax operating profits. Compute the number of
haircuts that must be given to reach this goal in July.
(f) In July, only 1,500 haircuts were given. Compute the price per haircut that Stanley should
have charged in July to earn $2,160 in after-tax operating profits. 

3-32
 Chapter 003 Fundamentals of Cost-Volume-Profit Analysis

Fixed costs = 5($500) + $300 + $200 + $400 + $175 + $25 = $3,600

Variable costs = $3.00 + $0.90 + $0.35 + $0.15 = $4.40 per haircut

(a) (1) $3,600/($8     4.40) = 1,000 haircuts

(2) 1,000     $8.00 = $8,000
(3) 1,000/(5     14     24) = 59.2%
(b) [($8.00     4.40)     1,400]     $3,600 = $1,440
(c) ($3,600 + $2,160)/($8.00     4.40) = 1,600 haircuts
(d) [($SP     4.40)     1,500]     3,600 = 2,160; SP = $8.24 per haircut.
(e) [($8     4.4)     number of haircuts]     3,600 = $2,160/(1     .3); number of haircuts =
1,858
(f) [($SP     4.40)1,500]     3,600 = 2,160/(1     .30); SP = $8.86 per haircut.

AACSB: Analytic
Difficulty: Complex
Learning Objective: 1
Learning Objective: 2
Learning Objective: 4
 

3-33
 Chapter 003 Fundamentals of Cost-Volume-Profit Analysis

78. You have been provided with the following information regarding the ALG
Manufacturing Company:

   

This information is based on forecasted sales of 25,000 units.

Required:
(a) What are the expected operating profits for the upcoming year?
(b) What is the break-even point in units?
(c) What is the break-even point in dollars?
(d) If $80,000 of operating profits is desired, how many units must be sold?
(e) How much in sales dollars is required to generate an operating profit of $75,000? 

(a) [($25     12     3)     25,000]     (180,000 + 40,000) = $30,000

(b) $220,000/$10 = 22,000 units
(c) 22,000     $25 = $550,000
(d) ($220,000 + 80,000)/10 = 30,000 units
(e) ($220,000 + 75,000)/10 = 29,500 units     $25 = $737,500

AACSB: Analytic
Difficulty: Complex
Learning Objective: 1
Learning Objective: 2
Learning Objective: 4
 

3-34
 Chapter 003 Fundamentals of Cost-Volume-Profit Analysis

79. Almo Company manufactures and sells adjustable canopies that attach to motor homes
and trailers. The market covers both new unit purchasers as well as replacement canopies.
Almo developed its 2007 business plan based on the assumption that canopies would sell at a
price of $400 each. The variable costs for each canopy were projected to be $200, and the
annual fixed costs were budgeted at $100,000. The goal for Almo's after-tax operating profits
was $240,000; the company's effective tax rate is 40%

While Almo's sales usually rise during the second quarter, the May financial statements
reported that sales were not meeting expectations. For the first five months of 2007, only 350
units had been sold at the established price, with variable costs as planned. It was clear that
the 2007 after-tax operating profit goal would not be reached unless some corrective actions
were taken. Almo's president assigned a management committee to analyze the situation and
develop several alternative courses of action. The following mutually exclusive alternatives
were presented to the president:

(a) Reduce the sales price by $40. The sales department predicts that with the significantly
reduced price, 2,700 units can be sold during the remainder of 2007. Total fixed and variable
unit costs will stay as budgeted.
(b) Lower variable costs per unit by $25 through the use of less expensive materials and
lightly modified manufacturing techniques. The sales price will also be reduced by $30. These
changes will yield sales of 2,200 for the remainder of 2007.
(c) Cut fixed costs by $10,000 and lower the sales price by 5%. Variable costs per unit will be
unchanged. Sales of 2,000 units can be expected for the remainder of 2007.

Required:
(a) If no changes are made to the selling price or cost structure, determine the number of units
that Almo must sell
(1.) in order to break-even, and
(2.) in order to achieve its after-tax operating profit objective.
(b) Determine which one of the alternatives Almo should select to achieve its after-tax
operating profit objective. Be sure to support your selection with appropriate computations. 

3-35
 Chapter 003 Fundamentals of Cost-Volume-Profit Analysis

Only alternative A achieves the targeted operating profit objective of $240,000, although
alternative B is close.

(a) (1) $100,000/($400     200) = 500 units

(2) [$100,000 + 240,000/(1     .40)]/(400     200) = 2,500 units

(b)
(A) {[(400     200)350] + {(360     200)2,700]     90,000}(1     .40) = $241,200
(B) {[(400     200)350] + [(370     175)2,200]     100,000}(1     .40) = $239,400
(C) {[(400     200)350] + [(380     200)2,000]     100,000}(1     .40) = $204,000

AACSB: Analytic
Difficulty: Complex
Learning Objective: 1
Learning Objective: 2
Learning Objective: 4
 

3-36
 Chapter 003 Fundamentals of Cost-Volume-Profit Analysis

80. T-Tunes, Inc. is considering the introduction of a new music player with the following
price and cost characteristics:

   

Required
(a) What number must T-Tunes sell to break even?
(b) What number must T-Tunes sell to make an operating profit of $120,000 for the year?

Consider requirements (b), (c), and (d) independent of each other, assuming that the projected
number for the year is 7,500 units.

(c) What will the operating profit be?

(d) What is the impact on operating profit if the selling price per unit decreases by 15%?
(e) What is the net income if variable costs per unit increase by 15% and T-Tunes has a 38%
tax rate? 

(a) $180,000/(125     75) = 3,600

(b) ($180,000 + 120,000)/(125     75) = 6,000
(c) [($125     75)7,500]     180,000 = $195,000
(d) [($106.25     75)7,500]     180,000 = $54,375,a decrease of 72%
(e) {($125     86.25)7,500]     180,000]}(1     .38) = $68,587.50

AACSB: Analytic
Difficulty: Complex
Learning Objective: 1
Learning Objective: 2
Learning Objective: 4
 

3-37
 Chapter 003 Fundamentals of Cost-Volume-Profit Analysis

81. Carson Corporation produces and sells three products. The three products, Alpha, Beta,
and Gamma, are sold in a local market and in a regional market. At the end of the first quarter
of the current year, the following income statement (in thousands of dollars) has been
prepared:

   

Management has expressed special concern with the regional market because of the extremely
poor return on sales. This market was entered a year ago because of excess capacity. It was
originally believed that the return on sales would improve with time, but after a year, no
noticeable improvement can be seen from the results as reported in the above quarterly
statement. In attempting to decide whether to eliminate the regional market, the following
information has been gathered:

   

All administrative costs and fixed manufacturing costs are common to the three products and
the two markets and are fixed for the period. Remaining marketing costs are fixed for the
period and separable by market. All fixed costs have been arbitrarily allocated to markets.
Required:
(a) Assuming there are no alternative uses for the Carson Corporation's present capacity,
would you recommend dropping the regional market? Why or why not?
(b) Prepare the quarterly income statement showing contribution margins by products. Do not
allocate fixed costs to products.
(c) It is believed that a new product can be ready for sale next year if the Carson Corporation
decides to go ahead with continued research. The new product can be produced by simply
converting equipment presently used in producing product Gamma. This conversion will
increase fixed costs by $40,000 per quarter. What must be the minimum contribution margin
per quarter for the new product to make the changeover financially feasible? 

3-38
 Chapter 003 Fundamentals of Cost-Volume-Profit Analysis

(a.) The regional market should not be dropped as this market not only covers all the variable
costs and separable fixed costs but also gives net market contribution of $65,000 toward the
common fixed costs.

   

(b.) Quarterly income statement (in thousands):

   

(c.) The new product must contribute at least $648 (= $608 + $40) per quarter so as not to
leave the company worse off when product C is replaced.

AACSB: Analytic
Difficulty: Complex
Learning Objective: 1
Learning Objective: 2
Learning Objective: 4
 

3-39