3.

Cost Volume Profit (CVP) Analysis

1.ScholarPak Company produced and sold 70,000 backpacks during the

year just ended at an average price of $30 per unit. Variable
manufacturing costs were $12 per unit, and variable marketing costs
were $6 per unit sold. Fixed costs amounted to $540,000 for
manufacturing and $216,000 for marketing.
There was no year-end work-in-process inventory. (Ignore income
taxes.)
Required:
1. Compute ScholarPak’s break-even point in sales dollars for the year.
2. Compute the number of sales units required to earn a net income of
$540,000 during the year.
3. ScholarPak’s variable manufacturing costs are expected to increase
by 10 percent in the coming year. Compute the firm’s break-even point in
sales dollars for the coming year.
4. If ScholarPak’s variable manufacturing costs do increase by 10
percent, compute the selling price that would yield the same
contribution-margin ratio in the coming year.
 1. Break-even point in sales dollars, using the contribution-margin ratio:
fixed expenses
Break - even point =
contribution - margin ratio
$540,000 + $216,000 $756,000
= =
$30 − $12 − $6 .4
$30
= $1,890,000

2. Target net income, using contribution-margin approach:

fixed expenses + target net income
Sales units required to earn income of $540,000 =
unit contribution margin
$756,000 + $540,000 $1,296,000
= =
$30 − $12 − $6 $12
= 108,000 units

3. New unit variable manufacturing cost = $12  110%

= $13.20
Break-even point in sales dollars:
$756,000 $756,000
Break - even point = =
$30.00 − $13.20 − $6.00 .36
$30
= $2,100,000
4. Let P denote the selling price that will yield the same contribution-margin ratio:
$30.00 − $12.00 − $6.00 P − $13.20 − $6.00
=
$30.00 P
P − $19.20
.4 =
P
.4P = P − $19.20
$19.20 = .6P
P = $19.20/.6
P = $32.00

Check: New contribution-margin ratio is:

$32.00 − $13.20 − $6.00
= .4
$32.00
2. Surreal Sound, Inc., manufactures and sells compact disks. Price and
cost data are as follows:
Selling price per unit (package of two CDs) ..................................... $ 25.00
Variable costs per unit:
Direct material ……................................................................................ $ 8.20
Direct labor ............................................................................................... 4.00
Manufacturing overhead ......................................................................... 6.00
Selling expenses ..................................................................................... 1.60
Total variable costs per unit .............................................................. $ 19.80
Annual fixed costs:
Manufacturing overhead ................................................................. $ 288,000
Selling and administrative ................................................................. 414,000
Total fixed costs .............................................................................. $ 702,000
Forecasted annual sales volume (140,000 units) ....................... $3,500,000
In the following requirements, ignore income taxes.
Required:
1. What is Surreal Sound’s break-even point in units?
2. What is the company’s break-even point in sales dollars?
3. How many units would Surreal Sound have to sell in order to earn
$390,000?
4. What is the firm’s margin of safety?
5. Management estimates that direct-labor costs will increase by 10
percent next year. How many units will the company have to sell next
year to reach its break-even point?
6. If the company’s direct-labor costs do increase by 10 percent, what
selling price per unit of product must it charge to maintain the same
contribution-margin ratio?
 fixed costs
1. Break - even point (in units) =
unit contribution margin
$702,000
= = 135,000 units
$25.00 − $19.80
fixed cost
2. Break - even point (in sales dollars) =
contribution - margin ratio
$702,000
= = $3,375,000
$25.00 − $19.80
$25.00

fixed costs + target net profit

3. Number of sales units required to =
earn target net profit unit contribution margin
$702,000 + $390,000
= = 210,000 units
$25.00 − $19.80
4. Margin of safety = budgeted sales revenue – break-even sales revenue
= (140,000)($25) – $3,375,000 = $125,000

5. Break-even point if direct-labor costs increase by 10 percent:

New unit contribution margin = $25.00 – $8.20 – ($4.00)(1.10) – $6.00 – $1.60

= $4.80
fixed costs
Break-even point =
new unit contribution margin
$702,000
= = 146,250 units
$4.80
 unit contribution margin
6. Contribution-margin ratio =
sales price
$25.00 − $19.80
Old contribution-margin ratio =
$25.00
= .208

Let P denote sales price required to maintain a contribution-margin ratio of .208. Then
P is determined as follows:
P − $8.20 − ($4.00)(1.10) − $6.00 − $1.60
= .208
P
P − $20.20 = .208P
.792P = $20.20
P = $25.51(rounded)
Check: New contribution- $25.51 − $8.20 − ($4.00)(1.10) − $6.00 − $1.60
margin ratio =
$25.51
= .208 (rounded)
3. Detroit Disk, Inc. is a retailer for digital video disks. The projected net
income for the current year is $600,000 based on a sales volume of
400,000 video disks. Detroit Disk has been selling the disks for $24 each.
The variable costs consist of the $15 unit purchase price of the disks
and a handling cost of $3 per disk. Detroit Disk’s annual fixed costs are
$1,800,000.
Management is planning for the coming year, when it expects that the
unit purchase price of the video disks will increase 30 percent. (Ignore
income taxes.)
Required:
1. Calculate Detroit Disk’s break-even point for the current year in
number of video disks.
2. What will be the company’s net income for the current year if there is
a 10 percent increase in projected unit sales volume?
3. What volume of sales (in dollars) must Detroit Disk achieve in the
coming year to maintain the same net income as projected for the
current year if the unit selling price remains at $24, but the unit purchase
price of the disks increases by 30 percent as expected?
4. In order to cover a 30 percent increase in the disk’s purchase price for
the coming year and still maintain the current contribution-margin ratio,
what selling price per disk must Detroit Disk establish for the coming
year?
1. Break-even point in units, using the equation approach:

$24X – ($15 + $3)X – $1,800,000 = 0

$6X = $1,800,000
$1,800,000
X =
$6
= 300,000 units

2. New projected sales volume = 400,000  110%

= 440,000 units
Net income = (440,000)($24 – $18) – $1,800,000

= (440,000)($6) – $1,800,000

= $2,640,000 – $1,800,000 = $840,000

3. Target net income = $600,000 (from original problem data)

New disk purchase price = $15  130% = $19.50

Volume of sales dollars required:

fixed expenses + target net profit

Volume of sales dollars required =
contributi on - margin ratio
$1,800,000 + $600,000 $2,400,000
= =
$24 − $19.50 − $3 .0625
$24
= $38,400,000

4. Let P denote the selling price that will yield the same contribution-margin ratio:
$24 − $15 − $3 P − $19.50 − $3
=
$24 P
P − $22.50
.25 =
P
.25 P = P − $22.50
$22.50 = .75P
P = $22.50/.75
P = $30
4. Premier Corporation sells two models of home ice cream makers,
Mister Ice Cream and Cold King. Current sales total 60,000 units,
consisting of 21,000 Mister Ice Cream units and 39,000 Cold King units.
Selling price and variable cost information follows.
Mister Ice Cream Cold King
Selling price ............................................... $37.00 $43.00
Variable cost ................................................ 20.50 32.50
Salespeople currently receive flat salaries that total $200,000.
Management is contemplating a change to a compensation plan that is
based on commissions in an effort to boost the company’s presence in
the marketplace. Two plans are under consideration:
Plan A: 10% commission computed on gross dollar sales. Mister Ice
Cream sales are anticipated to be 19,500 units. Cold King sales are
expected to total 45,500 units.
Plan B: 30% commission computed on the basis of production
contribution margins. Mister Ice Cream sales are expected to total 39,000
units. Cold King sales are anticipated to be 26,000 units.
Required:
1. Define the term sales mix.
2. Comparing Plan A to the current compensation arrangement:
a. Will Plan A achieve management’s objective of an increased presence
in the marketplace?
Briefly explain.
b. From a sales-mix perspective, will the salespeople be promoting the
product that one would logically expect? Briefly discuss.
c. Will the sales force likely be satisfied with the results of Plan A? Why?
d. Will Premier likely be satisfied with the resulting impact of Plan A on
company profitability? Why?
3. Assume that Plan B is under consideration.
a. Compare Plan A and Plan B with respect to total units sold and the
sales mix. Comment on the results.
b. In comparison with flat salaries, is Plan B more attractive to the sales
force? To the company? Show calculations to support your answers.
1. Sales mix refers to the relative proportion of each product sold when a company
sells more than one product.

2. (a) Yes. Plan A sales are expected to total 65,000 units (19,500 + 45,500), which
compares favorably against current sales of 60,000 units.

(b) Yes. Sales personnel earn a commission based on gross dollar sales. As
the following figures show, Cold King sales will comprise a greater
proportion of total sales under Plan A. This is not surprising in light of the
fact that Cold King has a higher selling price than Mister Ice Cream ($43 vs.
$37).

Current Plan A

Sales Sales
Units Mix Units Mix

Mister Ice Cream ......... 21,000 35% 19,500 30%

Cold King..................... 39,000 65% 45,500 70%
Total ....................... 60,000 100% 65,000 100%

(c) Yes. Commissions will total $267,800 ($2,678,000 x 10%), which compares
favorably against the current flat salaries of $200,000.

Mister Ice Cream sales: 19,500 units x $37 ............ $ 721,500

Cold King sales: 45,500 units x $43 ........................ 1,956,500
Total sales ........................................................... $2,678,000

(d) No. The company would be less profitable under the new plan.

Current Plan A
Sales revenue:
Mister Ice Cream: 21,000 units x $37; 19,500 units x $37.............. $ 777,000 $ 721,500
Cold King: 39,000 units x $43; 45,500 units x $43 ......................... 1,677,000 1,956,500
Total revenue.............................................................................. $2,454,000 $2,678,000
Less variable cost:
Mister Ice Cream: 21,000 units x $20.50; 19,500 units x $20.50.... $ 430,500 $ 399,750
Cold King: 39,000 units x $32.50; 45,500 units x $32.50 ............... 1,267,500 1,478,750
Sales commissions (10% of sales revenue) .................................. 267,800
Total variable cost...................................................................... $1,698,000 $2,146,300
Contribution margin .............................................................................. $ 756,000 $ 531,700
Less fixed cost (salaries) ...................................................................... 200,000 ----___
Net income ............................................................................................. $ 556,000 $ 531,700
3. (a) The total units sold under both plans are the same; however, the sales mix
has shifted under Plan B in favor of the more profitable product as judged by the
contribution margin. Cold King has a contribution margin of $10.50 ($43.00 -
$32.50), and Mister Ice Cream has a contribution margin of $16.50 ($37.00 - $20.50).

Plan A Plan B

Sales Sales
Units Mix Units Mix

Mister Ice Cream ............. 19,500 30% 39,000 60%

Cold King ......................... 45,500 70% 26,000 40%
Total ............................ 65,000 100% 65,000 100%

(b) Plan B is more attractive both to the sales force and to the company.
Salespeople earn more money under this arrangement ($274,950 vs.
$200,000), and the company is more profitable ($641,550 vs. $556,000).

Current Plan B
Sales revenue:
Mister Ice Cream: 21,000 units x $37; 39,000 units x $37 .............. $ 777,000 $1,443,000
Cold King: 39,000 units x $43; 26,000 units x $43 .......................... 1,677,000 1,118,000
Total revenue .............................................................................. $2,454,000 $2,561,000
Less variable cost:
Mister Ice Cream: 21,000 units x $20.50; 39,000 units x $20.50 .... $ 430,500 $ 799,500
Cold King: 39,000 units x $32.50; 26,000 units x $32.50 ................ 1,267,500 845,000
Total variable cost ...................................................................... $1,698,000 $1,644,500
Contribution margin ............................................................................... $ 756,000 $ 916,500
Less: Sales force compensation:
Flat salaries....................................................................................... 200,000
Commissions ($916,500 x 30%)....................................................... 274,950
Net income .............................................................................................. $ 556,000 $ 641,550
5. Phoenix-based CompTronics manufactures audio speakers for
desktop computers. The following data relate to the period just ended
when the company produced and sold 42,000 speaker sets:
Sales ............................................................................................... $4,032,000
Variable costs .................................................................................. 1,008,000
Fixed costs ....................................................................................... 2,736,000
Management is considering relocating its manufacturing facilities to
northern Mexico to reduce costs. Variable costs are expected to average
$21.60 per set; annual fixed costs are anticipated to be $2,380,800.
(In the following requirements, ignore income taxes.)
Required:
1. Calculate the company’s current income and determine the level of
dollar sales needed to double that figure, assuming that manufacturing
operations remain in the United States.
2. Determine the break-even point in speaker sets if operations are
shifted to Mexico.
3. Assume that management desires to achieve the Mexican break-even
point; however, operations will remain in the United States.
a. If variable costs remain constant, what must management do to fixed
costs? By how much must fixed costs change?
b. If fixed costs remain constant, what must management do to the
variable cost per unit? By how much must unit variable cost change?
4. Determine the impact (increase, decrease, or no effect) of the
following operating changes.
a. Effect of an increase in direct material costs on the break-even point.
b. Effect of an increase in fixed administrative costs on the unit
contribution margin.
c. Effect of an increase in the unit contribution margin on net income.
d. Effect of a decrease in the number of units sold on the break-even
point.
1. Current income:

Sales revenue………………………... $4,032,000

Less: Variable costs………………… $1,008,000
Fixed costs……………………. 2,736,000 3,744,000
Net income……………………………. $ 288,000

CompTronics has a contribution margin of $72 [($4,032,000 - $1,008,000) ÷ 42,000

sets] and desires to increase income to $576,000 ($288,000 x 2). In addition, the
current selling price is $96 ($4,032,000 ÷ 42,000 sets). Thus:

Required sales = (fixed costs + target net profit) ÷ unit contribution margin
= ($2,736,000 + $576,000) ÷ $72
= 46,000 sets, or $4,416,000 (46,000 sets x $96)

2. If operations are shifted to Mexico, the new unit contribution margin will be $74.40
($96.00 - $21.60). Thus:

Break-even point = fixed costs ÷ unit contribution margin

= $2,380,800 ÷ $74.40
= 32,000 units
3. (a) CompTronics desires to have a 32,000-unit break-even point with a $72 unit
contribution margin. Fixed costs must therefore drop by $432,000
($2,736,000 - $2,304,000), as follows:

Let X = fixed costs

X ÷ $72 = 32,000 units
X = $2,304,000

(b) As the following calculations show, CompTronics will have to generate a

contribution margin of $85.50 to produce a 32,000-unit break-even point.
Based on a $96.00 selling price, this means that the company can incur
variable costs of only $10.50 per unit. Given the current variable cost of
$24.00 ($96.00 - $72.00), a decrease of $13.50 per unit ($24.00 - $10.50) is
needed.
Let X = unit contribution margin
$2,736,000 ÷ X = 32,000 units
X = $85.50

4. (a) Increase

(b) No effect

(c) Increase

(d) No effect