Chapter 5-

Cost-Volume-Profit-Analysis.
Summer, 2011. Edited May 23, 2011.
Copyright © 2011, Dr. Howard Godfrey

This file contains illustrative problems

that will be used in the lecture to
illustrate important concepts and
procedures.
Copyright 2011. Dr. Howard Godfrey - M11-Chp-05-1A- Cost-Volume-Profit-Analysis -2011-
0523 1
After studying Chapter 5, you should be able to:
LO1 Explain how changes in activity affect contribution margin and
net operating income.
LO2 Prepare and interpret a cost volume-profit (CVP) graph and a
profit graph.
LO3 Use the contribution margin ratio (CM ratio) to compute
changes in contribution margin and net operating income
resulting from changes in sales volume.
LO4 Show the effects on net operating income of changes in variable
costs, fixed costs, selling price, and volume.
LO5 Determine the level of sales needed for a desired target profit.
LO6 Determine the break-even point.
LO7 Compute the margin of safety and explain its significance.
LO8 Compute degree of operating leverage and explain how it can be
used to predict changes in net operating income.
LO9 Compute the break-even point for a multiproduct company and
explain the effects of shifts in the sales mix on contribution 2
margin and the break-even point.
Introduction
3
 American Motors-1
A company reported the following sales
and earnings over a four-year period:
Year Units Sold Pretax Earnings
1 194,000 $(16,700,000)
2 104,000 (30,000,000)
3 119,000 (11,000,000)
4 189,000 26,000,000
Does this seem to be a misprint?
Unit sales were less in year 4, than in
year 1, but pretax earnings were
dramatically higher.
4
 American Motors-2
Results of a company in trouble:
American Motors Corp.
In 1957, (year 3 above)
the company had only 2% of the
automobile market.
The company bounced back, and
by 1960, its market share had
tripled, and it reported an
operating profit of $105 million.
5
 American Motors-3
Break-even analysis was an
important part of the company's
strategy.
The company's 1956 annual report
noted: "The primary automotive
objective since the merger has been
to reduce the automotive break-even
point, and simultaneously, to develop
new lines of cars needed to increase
sales to profitable levels."
6
Your salespersons are paid a commission
on their sales.
Are you concerned when you find that
you are paying more sales commissions.
[Sales drives commissions.]
Does an increase in sales also cause an
increase in fuel costs for delivery trucks.
Are fuel costs affected by the distance to
customers? Does an increase in sales
cause an increase in insurance premiums
on the delivery trucks?
7
 Break-Even Point-Question
At break-even point, the
contribution margin equals
total:
a. Variable Costs
b. Sales revenues
c. Selling and admin. Expenses
d. Fixed costs
8
Jan makes and sells fruit baskets.
A basket (& fruit) sells for: $10.00
Cost for a basket
(and fruit in basket) is: $6.00
Monthly store rent is: $2,000
She has no other cost.
How many must be sold each
month for her to break even?
a. 400 b. 500 c. 1,000 d. 2,000 9
 Fruit Baskets
Selling price per unit $ 10.00
Variable cost per unit
Contribution per unit
Fixed costs
Breakeven in units
10
 Fruit Baskets
Selling price per unit $10.00
Variable cost per unit $6.00
Contribution per unit $4.00
Fixed costs $2,000
Breakeven in units 500
11
Fruit Baskets - Net Income
Sales [500 at $10]
Cost of sales
Gross Margin
Fixed costs
Profit
12
Fruit Basket Revised
Suppose Jan finds a supplier that
charges less for the fruit. She reduces
the total cost per basket and fruit to $5.
What does that do to break-even?

Suppose she also negotiates a

reduction in the monthly rent, from
$2,000 to $1,500.
13
 Fruit Baskets
Selling price per unit $ 10.00
Variable cost per unit
Contribution per unit
Fixed costs
Breakeven in units
14
1: CVP
concepts
15
 Concept Question
The cost-volume-profit analysis for a
breakeven chart does not assume that
a. Price will remain fixed.
b. Production will equal sales.
c. Some costs vary inversely with volume.
d. Costs are linear and continuous over the
relevant range.

16
 Concept Question
The most important information to be derived form a
break-even chart is:
a. The volume of operations at which a company exactly
breaks even
b. The relationship between revenues and costs at
various levels of output
c. The amount of variable revenues needed to cover
exactly the fixed costs of the company
d. The amount of sales revenue needed to cover the
variable costs incurred by the company

17
 Concept Question
At breakeven point of 400 units
sold, variable costs were $400 and
fixed costs were $200.
What will the 401st unit sold
contribute to profit before income
taxes?
a. $0 b. 0.50 c. $1.00 d.$1.50
18
 Concept Question
Total Unit
Sales in dollars $ 600 $ 1.50
Variable costs 400 1.00
Contribution 200 0.50
Fixed costs 200 0.50
Net Income or Loss $ - $ -
19
Fixed and Variable Costs
Ener the missing information in the shaded cells.

Case A Case A-2 Case B Case C

Selling price per unit
Basic Information

$8.00 $8.00 $10.00

Variable cost per unit $6.00 $6.00 $5.00

Contribution margin $2.00 $2.00 $5.00

Fixed Costs $100,000 $100,000 $200,000

Number of units sold 100,000 110,000 80,000 50,000

Revenue $800,000 $500,000

Income Statement

Variable costs ($600,000)

Contribution margin $200,000 $200,000

Fixed Costs ($100,000)

Net income (Loss) $100,000 $160,000

2: CVP and
profit
graphs
21
 Worlds Fair
Break-even Chart
You have a opportunity to
sell kites at the World's Fair.
Selling price per kite $5.00
Variable cost per kite $3.00
Monthly Booth rental $1,000
Prepare break-even
chart on next slide. 22
Graph Approach Break-even Chart - World's Fair Problem
Selling price per unit $5.00
Variable cost per unit $3.00
Monthly Booth rental - Fixed $1,000

$4,000
C
O $3,000
S
T
$2,500

&
$2,000

R $1,500
E
V
$1,000
N
U $500
E

-0-
100 200 300 400 500 600 700 800

Units Sold
23
Graph Approach Break-even Chart - World's Fair Problem
Selling price per unit $5.00
Variable cost per unit $3.00
Monthly Booth rental - Fixed $1,000 Profit Wedge

$4,000
C
O
$3,000
Total
S Total Revenue
T $2,500 Costs
(Fixed and Break-even
&
Variable) Point
$2,000

R
$1,500 Loss
E Wedge
V $1,000
N
U $500 Fixed
E Cost

-0-
100 200 300 400 500 600 700 800

Units Sold

24
3: CM
ratio
25
Super Glue - Breakeven
Super Glue sells for $2.00 per tube and has
variable costs of $1.20 per tube. Fixed
production expenses are $48,000 per month.

How many tubes of Super Glue must be sold

each month for the Super Glue Company to
break even?
(Ignore selling and administration costs.)
a. 45,000 b. 60,000
26
 Super Glue
Selling price per unit $ 2.00
Variable cost per unit
Contribution per unit
Fixed costs
Breakeven in units
27
 Super Glue
Selling price per unit $2.00
Variable cost per unit $1.20
Contribution per unit $0.80
Fixed costs $48,000
Breakeven in units 60,000
28
Kalik Co. sells radios for $60
each. Variable expenses are $40
per unit, while fixed expenses
total $30,000.
What total dollar amount must
Kalik sell to break even?
a. $40,000 b. $75,000
c. $90,000 d. $120,000 29
 Kalik - 1
Selling price per unit
Variable cost per unit
Contribution per unit
Contribution %
Fixed costs
Breakeven in dollars
30
 Kalik - 1
Selling price per unit $60.00
Variable cost per unit $40.00
Contribution per unit $20.00
Contribution % 33.33%
Fixed costs 30,000
Breakeven in dollars $90,000 31
Kalik Co. sells radios for $60 each.
Variable expenses are $40 per unit,
while fixed expenses total $30,000.
How many radios must Kalik sell to
earn an operating income of
$70,000?
a. 5,000 b. 3,500 c. 2,500 d. 1,500

32
 Kalik-2
Selling price per unit
Variable cost per unit
Contribution per unit
Fixed costs
Desired profit
Total Contribution needed
Sales needed - in units

33
 Kalik-2
Selling price per unit $60.00
Variable cost per unit $40.00
Contribution per unit $20.00
Fixed costs $30,000
Desired profit $70,000
Total Contribution needed $100,000
Sales needed - in units 5,000

34
Koby Co. has sales of $200,000 with
variable expenses of $150,000, fixed
expenses of $60,000, and an operating loss
of $10,000. (Variable costs are always 75%
of sales.)
By how much would Koby have to increase
its sales in order to have operating income
of 10% of sales?
a. $400,000 b. $251,000
c. $231,000 d. $200,000
35
Koby Co. has sales of $200,000 with
variable expenses of $150,000, fixed
expenses of $60,000, and an operating loss
of $10,000. (Variable costs are always 75%
of sales.)
By how much would Koby have to increase
its sales in order to have operating income
of 10% of sales?
a. $400,000 b. $251,000
c. $231,000 d. $200,000 Increase
36
Koby
Sales = Variable + Fixed + Profit
Costs Costs

X = .75X + $60,000 + .1X

37
Koby
Sales = Variable+ Fixed + Profit
Costs Costs

X = .75X + $60,000 + .1X

X = .85X + $60,000
.15X = + $60,000

X = $400,000 Total
38
 Roxford Company - 1
Roxford Company had sales of $3,000,000,
variable costs of $1,800,000 and fixed costs
of $800,000 for a product.
What are sales dollars at a level which
generates net income of $160,000?
a. $2,000,000 b. $2,400,000
c. $2,600,000 d. $2,760,000
e. none of these
39
 Roxford - 2
Sales in Dollars
Variable costs
Contribution Margin
Contribution Margin - %
Fixed costs
Desired Profit
Contribution needed
Target Sales in Dollars
40
 Roxford - 3
Sales in Dollars $ 3,000,000
Variable costs 1,800,000
Contribution Margin 1,200,000
Contribution Margin - % 40.00%
Fixed costs 800,000
Desired Profit 160,000
Contribution needed 960,000
Target Sales in Dollars $ 2,400,000
41
4: Effects of
changes in
parameter
s 42
Kern Company prepared the following
forecast concerning product A for 2010:
Sales $500,000
Selling price per unit $ 5.00
Variable costs $300,000
Fixed costs $150,000
If the unit selling price is increased by 20%,
volume is expected to decrease of only 10%.
With these changes in its 2010 forecast, what
will be the operating income from product
A?
a. $66,000 b. $90,000
c. $120,000 d. $145,000 43
 Kern-1
Current
Units Per Unit Total
Sales in dollars 100,000 $ 5.00 $ 500,000
Variable costs 100,000 3.00 300,000
Contribution 100,000 2.00 200,000
Fixed costs 100,000 1.50 150,000
Net Income 100,000 $ 0.50 $ 50,000

44
 Kern-2
New Budget
Units Per Unit Total
Sales in dollars 90,000 $ 6.00 $ 540,000
Variable costs 90,000 3.00 270,000
Contribution 90,000 3.00 270,000
Fixed costs 90,000 1.67 150,000
Net Income 90,000 $ 1.33 $ 120,000
45
5: Target
profit
analysis
46
Calculate sales
volume in
total dollars and
total units
for a target profit.
47
Sales to generate target profit
Super Glue sells for $2.00 per tube and has
variable costs of $1.20 per tube. Fixed
production expenses are $48,000 per month.

How many tubes of Super Glue must be sold

each month for the Super Glue Company to
have a monthly income (before income
taxes) of $60,000?
a. 45,000 b. 60,000
c. 90,000 d. 135,000 48
 Super Glue
Selling price per unit $2.00
Variable cost per unit $1.20
Contribution per unit $0.80
Fixed costs
Desired profit
Total Contribution needed
Sales needed - in units

49
 Super Glue
Selling price per unit $2.00
Variable cost per unit $1.20
Contribution per unit $0.80
Fixed costs $48,000
Desired profit $60,000
Total Contribution needed $108,000
Sales needed - in units 135,000
50
6: Break-
even
analysis
51
Koby Co. has sales of $200,000 with
variable expenses of $150,000, fixed
expenses of $60,000, and an
operating loss of $10,000.
(Variable costs are 75% of sales.)
Compute break-even sales using a
formula?
a. $400,000 b. $240,000
c. $231,000 d. $200,000
52
Koby
Sales = Variable + Fixed
Costs Costs
X = .75X + $60,000
.25X = + $60,000
X = $240,000
53
 Kolby
Sales $240,000
Variable cost
Contribution
Fixed costs
Net Income
54
 Kolby
Sales $240,000
Variable cost (180,000)
Contribution 60,000
Fixed costs (60,000)
Net Income $0
55
7: Margin
of safety
56
Big company has sales of
$200,000, a contribution
margin of 20%, and a margin
of safety of $80,000.
What is fixed cost?
a. $16,000 c. $24,000
c. $80,000 d. $96.000
57
8: Operating
leverage
58
9: Multiproduct
CVP
59
 Super Dinner serves dinner each day - 1
Company sells a total of 600 dinners per
day:
300 large dinners - price of $10 each.
300 small dinners - price of $6 each.
Large dinners have variable cost of $5 each.
(Food, napkins, electricity, etc.)
Small dinners have variable cost of $4 each.
Fixed costs are $2,000 per day for salaries,
rent, insurance, etc.
What is the profit or loss per day?
See next slide. 60
 Super Dinner - 2
Large Small Total
Dinners sold per day 300 300 600
Price per Dinner $10 $6
Var. costs per dinner $5 $4
Meal Revenue $3,000 $1,800 $4,800
Variable costs
Contribution per day
Fixed Costs per day
Profit per day

61
 Super Dinner - 3
Large Small Total
Dinners sold per day 300 300 600
Price per Dinner $10 $6
Var. costs per dinner $5 $4
Meal Revenue $3,000 $1,800 $4,800
Variable costs (1,500) (1,200) (2,700)
Contribution per day $1,500 $600 $2,100
Fixed Costs per day $2,000
Profit per day $100

62
 Super Dinner - 4
What is break-even sales in
dollars per day?
See next slide.

63
 Super Dinner - 5
Large Small Total
Dinners sold per day 300 300 600
Price per Dinner $10 $6
Var. costs per dinner $5 $4
Meal Revenue $3,000 $1,800 $4,800
Variable costs (1,500) (1,200) (2,700)
Contribution per day $1,500 $600 $2,100
50% 33%
Fixed Costs per day
Break-even-Sales Dollars Per Day
64
 Super Dinner - 5A
Large Small Total
Dinners sold per day 300 300 600
Price per Dinner $10 $6
Var. costs per dinner $5 $4
Meal Revenue $3,000 $1,800 $4,800
Variable costs (1,500) (1,200) (2,700)
Contribution per day$1,500 $600 $2,100
50% 33% 43.75%
Fixed Costs per day $2,000
Break-even-Sales Dollars Per Day $4,571
65
 Super Dinner -6
Super Dinner is able to change the
mix of 600 dinners per day to:
400 large and 200 small dinners.
How does that affect profit?
See next slide.
(Chic-Fil-A began advertising its chicken
salad sandwich along with other sandwiches
on its product board. Sales of chicken salad
sandwiches increased 300%.) 66
 Super Dinner - 7
Large Small Total
Dinners sold per day 400 200 600
Price per Dinner $10 $6
Var. costs per dinner $5 $4
Meal Revenue $4,000 $1,200 $5,200
Variable costs
Contribution per day
Fixed Costs per day
Profit per day
67
 Super Dinner - 7A
Large Small Total
Dinners sold per day 400 200 600
Price per Dinner $10 $6
Var. costs per dinner $5 $4
Meal Revenue $4,000 $1,200 $5,200
Variable costs (2,000) (800) (2,800)
Contribution per day $2,400
Fixed Costs per day $2,000
Profit per day $400
Compare with profit on earlier slide-600 meals
68
 Sales Mix
Thomas sells products X, Y and Z. Thomas sells 3
units of X for each unit of Z and 2 units of Y for
each unit of X.
The contribution margins are $1.00 per unit for
X, $1.50 per unit for Y, and $3.00 per unit for Z.
Fixed costs are $600,000.
How many units of X would Thomas sell at
break-even point?
a. 40,000 b. 120,000
c. 360,000 d. 400,000

69
 Thomas - Sales Mix
Product
X Y Z Total
Units Sold (Mix)
Sales of Z 1
Sales of X 3
Sales of Y 6
Contribution/Unit $ 1.00 $ 1.50 $ 3.00
Subtotal $ 3.00 $ 9.00 $ 3.00
Combined Contribution $15.00
Fixed Costs $600,000
Number of sets to be sold 40,000
Number of units of X to be sold 120,000
70
Compute cost-
volume-profit
relationships
on an
after-tax basis 71
Sticky Glue sells for $2.00 per tube and has
related variable expenses of $1.50 per tube.
Fixed expenses of producing Sticky Glue are
$100,000 per month.
Sticky Glue is in the 40% income tax bracket.
How many tubes of Sticky Glue must be sold
each month for the Sticky Glue Company to
have a monthly income (after income taxes)
of $60,000?
a. 400,000 b. 300,000
c. 200,000 d. 135,000 e. 450,000 72
Sticky Glue
Net = Net income - Income
Income before tax Tax

Net = Net income - 40% x Net Income

Income before tax before tax

Net = 60% x Net Income

Income before tax

Net = Net Income

Income before tax
60%
73
 Sticky Glue - 2
After tax goal $60,000
1-tax rate 60%
Before-Tax Profit Goal
Fixed Costs
Total Contribution needed
Contribution per unit
Sales required (in units)
74
 Sticky Glue - 3
After tax goal $60,000
1-tax rate 60%
Before Tax Profit Goal 100,000
Fixed Costs 100,000
Total Contribution needed $200,000
Contribution per unit $0.50
Sales required (in units) 400,000
75
Additional practice
problems are
provided in the
following slides
76
Reliable Racket Co. makes tennis rackets. This year,
fixed costs are expected to be $150,000. Each racket
requires $10 of variable cost to produce and will be sold
for $15.
1. What is the break-even point in units?
a. 10,000 b. 15,000 c. 6,000 d. 30,000 e. 45,000

2. What is the break-even point in dollars?

a. $300,000 b. $450,000
c. $150,000 d. $90,000 e. $675,000

3. How many rackets must be sold to earn an annual

profit of $20,000?
a. 4,000 b. 14,000 c. 24,000 d. 34,000 e. 44,000
77
 Reliable Racket-1
Selling price per unit $ 15.00
Variable cost per unit $ 10.00
Contribution per unit $ 5.00
Fixed costs
Sales needed - in units

78
 Reliable Racket-1
Selling price per unit $ 15.00
Variable cost per unit $ 10.00
Contribution per unit $ 5.00
Fixed costs $ 150,000
Sales needed - in units 30,000

79
 Reliable Racket-2
Selling price per unit $ 15.00
Variable cost per unit $ 10.00
Contribution per unit $ 5.00
Contribution percentage
Fixed costs
Sales needed - in dollars
80
 Reliable Racket-2
Selling price per unit $ 15.00
Variable cost per unit $ 10.00
Contribution per unit $ 5.00
Contribution percentage 33.3333%
Fixed costs $150,000
Sales needed - in dollars 450,000
81
 Reliable Racket-3
Selling price per unit
Variable cost per unit
Contribution per unit
Fixed costs
Desired profit
Total Contribution needed
Sales needed - in units

82
 Reliable Racket-3
Selling price per unit $ 15.00
Variable cost per unit $ 10.00
Contribution per unit $ 5.00
Fixed costs $ 150,000
Desired profit $ 20,000
Total Contribution needed $ 170,000
Sales needed - in units 34,000

83
Reliable Racket Co. makes tennis rackets.
This year, fixed costs are expected to be
$150,000. Each racket requires $10 of
variable cost to produce and will be sold
for $15. Continued…

4. If 25,000 rackets are sold this year, and

fixed costs are increased to $160,000, the
overall profit or loss will be
a. $25,000 profit b. $25,000 loss
c. $35,000 loss. d. $45,000 loss.
e. $45,000 profit.
84
Reliable Racket - 4
Sales in Dollars
Variable costs
Contribution
Fixed costs
Profit
85
Reliable Racket - 4
Sales in Dollars $ 375,000
Variable costs 250,000
Contribution 125,000
Fixed costs 160,000
Profit (Loss) $ (35,000)
86
Zarlin Co. is considering an expansion
program based on the following data:
Expected sales $600,000
Variable costs 400,000
Fixed expenses 105,000
What are sales at break-even?
a. $400,000 b. $420,000
c. $390,000 d. $315,000
e. none of these 87
 Zarlin
Sales in Dollars
Variable costs
Contribution Margin
Contribution Margin - %
Fixed costs
Breakeven Sales $ 88
 Zarlin
Sales in Dollars $ 600,000
Variable costs 400,000
Contribution Margin 200,000
Contribution Margin - % 33.3333%
Fixed costs $ 105,000
Breakeven Sales $ $ 315,000
89
A Frosty-Dip Ice Cream Stand has:
Selling price per gallon $10.00
Variable costs per gallon
Ice cream $2.30
Cups, cones, supplies 0.20
Total Fixed Costs per month:
Rent $400
Utilities 120
Wages (including benefits) 1,130
Base salary of manager 1,500
Other fixed costs 150
Monthly break-even point in gallons?
a. 100 b. 440 c. 550 d. 1,000 90
A Frosty-Dip Ice Cream Stand has:
Selling price per gallon $10.00
Variable costs per gallon
Ice cream $2.30
Cups, cones, supplies 0.20
Total Fixed Costs per month:
Rent $400
Utilities 120
Wages (including benefits) 1,130
Base salary of manager 1,500
Other fixed costs 150
Total Fixed Costs per month: $3,300
91
 Frosty Dip
Selling price per unit $ 10.00
Variable cost per unit $ 2.50
Contribution per unit
Fixed costs
Sales needed - in units

92
 Frosty Dip
Selling price per unit $ 10.00
Variable cost per unit $ 2.50
Contribution per unit $ 7.50
Fixed costs $ 3,300
Sales needed - in units 440

93
 A Frosty-Dip Ice Cream Stand has:
Selling price per gallon $ 10.00
Variable costs per gallon
Ice cream $ 2.30
Cups, cones, supplies 0.20
Total Fixed Costs per month:
Rent $ 400
Utilities 120
Wages (including benefits) 1,130
Base salary of manager 1,500
Other fixed costs 150
Investor needs after tax profit of $1,500/mo.
The investor is in the 40% tax bracket.
Sales level needed to reach the goal? 94
 Frosty-Dip Ice Cream Stand
After Tax Profit required $ 1,500
Factor: (1-income tax rate) 60%
Before Tax Profit Needed $ 2,500
Fixed costs $ 3,300
Contribution needed $ 5,800
Contribution per unit $ 7.50
Sales needed - in units 773.33
95
The most likely strategy to reduce break-even
point would be to:
a. Increase both fixed costs and the
contribution margin.
b. Decrease both fixed costs and the
contribution margin.
c. Decrease fixed costs and increase
contribution margin.
d. Increase fixed costs and decrease
contribution margin.
96
Del Company has fixed costs of
$100,000 and
breakeven sales of $800,000.
What is its projected profit at
sales of $1,200,000?
a. $50,000 b. $150,000
c. $200,000 d. $400,000
97
The End

98