Fundamentals of Cost - Volume-Profit Analysis Chapter - 3

REVISED PAGES
Chapter Three
Fundamentals of
Cost-Volume-Profit
Analysis Orientation
P A R T
LEARNING OBJECTIVES
Preparing and Organizing Yourself
After reading this chapter, you should be able to:
for Success in College
L.O.1 Use cost-volume-profit (CVP) analysis to analyze decisions.
L.O.2 Understand the effect of cost structure on decisions.
L.O.3 Use Microsoft Excel to perform CVP analysis.
L.O.4 Incorporate taxes, multiple products, and alternative cost structures into
the CVP analysis.
L.O.5 Understand the assumptions and limitations of CVP analysis.

C H A P T E R S
I N
P A R T
O N E
Making Yourself Successful in College
Approaching College Reading and

Developing a College-Level Vocabulary
Approaching College Assignments:

Reading Textbooks and Following Directions
Related Resources
See pages 000 to 000
of the Annotated Instructors
Edition for general suggestions related to the chapters
in Part One.
1
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REVISED PAGES
P A R T
I opened U-Develop because I love photography and
I wanted to own my own business. I now get to spend
most of my day working with employees and customers
making sure that the photos they take are the best they
can be. It also gives me a chance to encourage younger
people who have an interest in photography, because
I work with many of the school groups and after-school
clubs here in town. Thats the fun part of the job.
But I also have to think about the financial side of
the business. I need a systematic way to understand
the relation between my decisions and my profits. Ive
read that managers can calculate the price they need

to charge to break even (see the In Action item on
CVP analysis and airlines). I should be able to apply
the same analysis to my business.
Orientation
Jamaal Kidd was discussing the photo-finishing store that

he owns and operates. Starting out five years ago with a
small storefront in the mall offering only photo developing,
he has expanded the business and moved to a larger store
downtown, where he now offers a wide range of products
and services, some made in his own workshop.

Our theme in this book is that the cost accounting system serves managers by providing them with information that supports good decision making. In this chapter and the
next, we develop two common tools that managers can use to analyze situations and
make decisions that will increase the value of the firm. We begin in this chapter by
developing the relations among the costs, volumes, and profits of the firm. In the next
chapter, we use these relations to make pricing and production decisions that increase
profit.
C H A P T E R S
cost-volume-profit
(CVP) analysis
Study of the relations among
revenue, cost, and volume
and their effect on profit.
I N
P A R T
O N E
Cost-Volume-Profi
t Analysis
Making
Yourself Successful in College
Managers are concerned about the impact of their decisions on profit. The decisions they
L.O. 1
make are about volume, pricing, or incurring a cost. Therefore,
managers require
an un2 Approaching
College
Reading
and
Use cost-volumederstanding of the relations among revenues, costs, volume, andDeveloping
profit. The cost
accounta College-Level
Vocabulary
profit (CVP) analysis
ing department supplies the data and analysis, called cost-volume-profit (CVP) analysis,
to analyze decisions.
that support these managers.

Cost-Volume-Profit Analysis and Airline Pricing

Cost-volume-profit analysis helps managers evaluate the impact of alternative product pricing strategies on profits. It can
also be useful for evaluating competitors pricing strategies
and efforts to grow market share, as in the following examples:
Aloha Airlines CEO David Banmiller and C. Thomas
Nulty, senior vice president for marketing and sales,
explain that their airline must charge $50 per seat to
break even when planes are 62 percent full.
Hawaiian Airlines, Aloha Airlines and go! are each
losing money when they sell interisland tickets below
$50, according to a study commissioned by Aloha
Airlines.
Why would somebody come in and charge $19, and
$29, and $39 when their costs were substantially higher?
Why would somebody do it? said Banmiller.
cor50782_ch01_001-072.indd 1
In Action
The Sabre study showed that when planes are

62 percent full, Alohas costs are $50 per seat,
Hawaiians are $55, and go!s are $67.
ofRelated
Resources
However, managers at the parent company
go! (Mesa
See
pages
000
to 000
Airlines) disputed the estimates with a CVP analysis of their
of
the
Annotated
Instructors
own:
Edition for general suggesJonathan Ornstein, Mesas chief executive
cer, tosaid
tionsoffi
related
the chapters
yesterday that Alohas cost estimates arein way
off when
Part One.
it comes to his airline. He said go!s expenses per passenger are about $40 when the planes are 80 percent
full.
1
Note: Aloha Airlines is no longer in business.
Source: Rick Daysog, Below-Cost Fares Puzzle Aloha Airlines
CEO, Honolulu Advertiser, December 21, 2006.
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REVISED PAGES
Part II
82
Cost Analysis and Estimation
Profit Equation
profit equation
Operating profit equals total
revenue less total costs.
P A R T
The key relation for CVP analysis is the profit equation. Every organizations financial
operations can be stated as a simple relation among total revenues (TR), total costs (TC),
and operating profit:
Operating profit Total revenues Total costs
TR

TC
Orientation
(For not-for-profit and government organizations, the profit may go by different names
Profit
such as surplus or contribution to fund, but the analysis is the same.) Both total
revenues and total costs are likely to be affected by changes in the amount of output.1 We
rewrite the profit equation to explicitly include volume, allowing us to analyze the relations among volume, costs, and profit. Total
revenue (TRand
) equals
average selling price
per
Preparing
Organizing
Yourself
unit (P) times the units of output (X):
in College
Total revenue Price for
UnitsSuccess
of output produced
and sold
TR PX
In our profit equation, total costs (TC) may be divided into a fixed component that
does not vary with changes in output levels and a variable component that does vary. The
fixed component is made up of total fixed costs (F) per period; the variable component is
the product of the average variable cost per unit (V) multiplied by the quantity of output
(X). Therefore, the cost function is
Total costs (Variable costs per unit Units of output) Fixed costs
TC VX F
H A P T E yields
R S
I aN form
P A more
R T
OuseN E
Substituting the expanded expressions in the profitCequation
ful for analyzing decisions:
Making
Yourself
Profit Total1revenue
Total
costs Successful in College
TR TC
TC VX 2 F Approaching College Reading and
Therefore,
Profit 3PX Approaching

(VX F) College Assignments:
Collecting terms gives
Profit (Price Variable costs) Units of output Fixed costs

(P V)X F
unit contribution margin
Difference between revenues
per unit (price) and variable
cost per unit.
total contribution
margin
Difference between revenues
and total variable costs.
We defined contribution margin in Chapter 2 as the difference between the sales

price and the variable cost per unit. We will refer to this as the unit contribution margin
to distinguish it from the difference between the total revenues and total variable cost,
the Resources
Related
total contribution margin. In other words, the total contribution margin is the unit
conSee pages 000 to 000
tribution margin multiplied by the number of units (Price Variable costs) Units
of
of the Annotated
Instructors
output, or (P V)X. It is the amount that units sold contribute toward (1) coveringEdition
fixed
for general suggescosts and (2) providing operating profits. Sometimes we use the contribution margin,
in to the chapters
tions related
total, as in the preceding equation. Other times, we use the contribution margin per
unit,
in Part One.
which is
Price Variable cost per unit
PV
1
We adopt the simplifying assumption that production volume equals sales volume so that changes in
can be ignored in this chapter.
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REVISED PAGES
Chapter 3
Fundamentals of Cost-Volume-Profit Analysis
83
Recall from Chapter 2 that an important distinction for decision making is whether
T
costs are fixed or variable. That is, for decision making, PweAareRconcerned
about cost
behavior, not the financial accounting treatment, which classifies costs as either manufacturing or administrative. Thus, V is the sum of variable manufacturing costs per unit and
variable marketing and administrative costs per unit; F is the sum of total fixed manufacturing costs and fixed marketing and administrative costs for the period; and X refers to
the number of units produced and sold during the period.
Orientation
CVP Example
When Jamaal first opened U-Develop, he offered one service only, developing prints. He
charged an average price of $.60. The average variable cost of each print was $.36, computed as follows:

Cost of processing (materials and labor) . . . . . . . . . . . . . . . . . . . . .
for Success $.30
in
College
Other costs (sales and support). . . . . . . . . . . . . . . . . . . . . . . . . . . .
.06
Average variable cost per print. . . . . . . . . . . . . . . . . . . . . . . . . . .
$.36
The fixed costs to operate the store for March, a typical month, were $1,500.
In March, U-Develop processed 12,000 prints. The operating profit can be determined from the companys income statement for the month, as shown in Exhibit 3.1.
As a manager, Jamaal might want to know how many units (prints) he needs to sell
in order to achieve a specified profit. Assume, for example, that Jamaal is hoping for
sales to improve in July, when the weather will improve and people take vacations. Given
the data, price $.60, variable cost per unit $.36 (therefore, contribution margin per
unit $.24), and fixed costs $1,500, the manager asks two questions: What
C H A volume
P T E R S is I N
P A R T
O N
required to break even (earn zero profits)? What volume is required to make an $1,800
operating profit? Although we could use the income statement and guess at the answer to
1 Making
Yourself Successful
in College
these questions, it is easier to set up an equation that summarizes
the cost-volume-profi
t
relation.
Recall that in March, U-Develop processed 12,000 prints.
the profiCollege
t equation,
2 Using
Approaching
Reading and
the results for March, therefore, were:
Profit Contribution margin Fixed costs

(P V ) X F

Reading
($.60 $.36) 12,000 prints
$1,500 Textbooks and Following Directions
$1,380
which is equal to the operating profit shown on the income statement in Exhibit 3.1. To
simplify the equation, we use the term Profit in the equation to mean the same thing as
Operating Profit on income statements.
Related Resources
Exhibit
3.1
U-DEVELOP
Income Statement
March
Sales (12,000 prints at $.60) . . . . . . . . . . . . . . . . . . . . . . .
Less
Variable costs of goods sold (12,000 $.30) . . . . . . . . .
Variable selling costs (12,000 $.06) . . . . . . . . . . . . . . .

Income Statement
$7,200
$3,600
720
4,320
Contribution margin . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Less fixed costs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$2,880
1,500
Operating profit . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$1,380
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in Part One.
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REVISED PAGES
Part II
84
Finding Break-Even and Target Volumes We can use the profit equation to
P needed
A R to
T break even or achieve a target profit
answer Jamaals questions about volumes
by developing the formulas discussed here. We start with the answer to the first question,
which we call finding a break-even volume. Managers might want to know the break-even
volume expressed either in units or in sales dollars. If the company makes many products,
it is often much easier to think of volume in terms of sales dollars; if we are dealing with
only one product, its easier to work with units as the measure of volume.
break-even point
Volume level at which profits
equal zero.
Orientation
Break-Even Volume in Units We can use the profit equation to find the break-even
point expressed in units:
Profit 0 (P V ) X F
F
If Profit 0, then X _______
(P
V)
Preparing
and
Organizing Yourself
Fixed
for Success
incosts
College
Break-even volume (in units)
_____________________
Unit contribution margin
$1,500
$ .24
6,250 prints
To show this is correct, if U-Develop processes 6,250 prints, its operating profit is
Profit TR TC
PX VX F
($.60 6,250 prints) ($.36 6,250 prints) $1,500
$0
contribution margin
ratio
Contribution margin as a
percentage of sales revenue.
C H A P T E R S
I N
P A R T
O N E
Break-Even Volume in Sales Dollars 1 To Making

find the break-even
volume in terms
of sales
Yourself Successful
in College
dollars, we first define a new term, contribution margin ratio. The contribution margin ratio is the contribution margin as a percentage of sales revenue. For example, for
2 canApproaching
Reading and
U-Develop, the contribution margin ratio
be computed College
as follows:
Developing
a College-Level
Unit contribution
margin Vocabulary
Contribution margin ratio _____________________
Sales price per unit
3 Approaching
College Assignments:
$.24
____
Reading
$.60 Textbooks and Following Directions
.40 (or 40%)
Using the contribution margin ratio, the formula to find the break-even volume
follows:2
Fixed costs
Break-even volume sales dollars _____________________
Contribution margin ratio
We can derive the break-even point for sales dollars from the original formula for units:
F
X ______
PV
The modified formula for dollars multiplies both sides of the equation by P:
FP
PX ______
PV
Since multiplying the numerator by P is the same as dividing the denominator by P, we obtain:
F
PX _________
(P V )P
cor50782_ch01_001-072.indd The
1 term (P V)/P is the contribution margin ratio.
lan27114_ch03_080-109.indd 84
Related Resources
in Part One.
1
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REVISED PAGES
Chapter 3
For U-Develop, the break-even volume expressed in sales dollars is
P A R T
$1,500
Break-even sales dollars ______
.40
$3,750
85
Note that $3,750 of sales dollars translates into 6,250 prints at a price of $.60 each.
We get the same result whether expressed in units (6,250 prints) or dollars (sales of 6,250
prints generates revenue of $3,750).
Orientation
Target Volume in Units To find the target volume, we use the profit equation with the
target profit specified. The formula to find the target volume in units is
Fixed costs Target profit
Target volume (units) ________________________
Preparing
Contribution margin
per unit
and Organizing Yourself

Using the data from U-Develop, we find the volume that provides
an operating
t of
for Success
in profi
College
$1,800 as follows:
Target volume ________________________
Contribution margin per unit
$1,500 $1,800
______________
$.24
13,750 prints
U-Develop must sell 13,750 prints per month to achieve the target profit of $1,800. Each
additional print sold increases operating profits by $.24.
C H A we
P T use
E R the
S
I N
P A R T
O N
Target Volume in Sales Dollars To find the target volume in sales dollars,
contribution margin ratio instead of the contribution margin per unit. The formula to find
the target volume follows:
1 Making Yourself Successful in College

Target volume (sales dollars) ______________________
Contribution
ratio
2 margin
Approaching
College Reading and
For U-Develop the target volume expressed in sales dollars is Developing a College-Level Vocabulary
$1,500 $1,800
Target volume (sales dollars) ______________
.40

Textbooks
Note that sales dollars of $8,250 translates into 13,750 printsReading
at $.60 each.
We getand
the Following Directions
same target volume whether expressed in units (13,750 prints) or dollars (sales of 13,750
prints generates revenue of $8,250).
Exhibit 3.2 summarizes the four formulas for finding break-even and target
volumes.
Break-Even Volume
Fixed costs
Break-even volume (units) ____________________
Fixed costs
Break-even volume (sales dollars) ____________________
Target Volume
Target volume (units) ______________________
Exhibit
3.2
Related Resources
SummarySee
ofpages
Break000 to 000
Even andofTarget
Volume
the Annotated
Instructors
FormulasEdition for general suggestions related to the chapters
in Part One.

Target volume (sales dollars) ______________________
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REVISED PAGES
Part II
86
Exhibit 3.3
CVP GraphU-Develop
P A R T
$8,000
Revenues, Costs
$7,000
1
$6,000
$5,000
Total cost
TC $1,500 $.36 X
$4,000
Orientation
$5,820
Break even
TR TC
$3,000

Total revenue
$2,000
$1,000
$0
$7,200
TR $.60 X
0
2,000
4,000
6,000
8,000
10,000
12,000
Volume per period (X )
Graphic Presentation
Exhibit 3.3 presents the cost-volume-profit (CVP) relations for U-Develop in a graph.
Such a graph is a helpful aid in presenting cost-volume-profit relationships. We plot dollars on the vertical axis (revenue dollars or cost dollars,Cfor
example). We
plot
volume
on
H A P T E R S
I N
P A R T
O N E
the horizontal axis (number of prints sold per month or sales dollars, for example). The
total revenue (TR) line relates total revenue to volume (for example, if U-Develop sells
1 would
Making
Yourself
Successful
College
12,000 prints in a month, its total revenue
be $7,200,
according
to theingraph).
The
slope of TR is the price per unit, P (for example, $.60 per print for U-Develop).
The total cost (TC) line shows the total cost for each volume. For example, the total cost
2 Approaching College Reading and
for a volume of 12,000 prints is $5,820 ( [12,000 $.36] $1,500). The intercept of the
College-Level
Vocabulary
total cost line is the fixed cost for the period, FDeveloping
, and the slopea is
the variable cost
per unit, V.
The break-even point is the volume at which TR TC (that is, where the TR and TC
lines intersect). Volumes lower than break
result in an College
operatingAssignments:
loss because TR
3 even
Approaching
TC; volumes higher than break even result in
an
operating
profi
t
because
TR TC.
For
Reading Textbooks and Following
Directions
U-Develop, 6,250 prints is the break-even volume.
Self-Study Question
1.
The following information for Jennifers Framing Supply

is given for March:
Sales. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Fixed manufacturing costs . . . . . . . . . . . . . . . .
Fixed marketing and administrative costs . . . . .
Total fixed costs . . . . . . . . . . . . . . . . . . . . . . . .
Total variable costs . . . . . . . . . . . . . . . . . . . . . .
Unit price. . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Unit variable manufacturing cost . . . . . . . . . . .
Unit variable marketing cost . . . . . . . . . . . . . . .
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$360,000
35,000
25,000
60,000
240,000
90
55
5
Compute the following:

Related Resources
a. Monthly operating profit when sales total $360,000
(as here).
b. Break-even number in units.
Edition for general suggesc. Number of units sold that would produce
an
tions related to the chapters
operating profit of $120,000.
in Part One.
d. Sales dollars required to earn an operating profit of
$20,000.
1
e. Number of units sold in March.
f. Number of units sold that would produce an
operating profit of 20 percent of sales dollars.
The solution to this question is at the end of the chapter on
page 109.
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REVISED PAGES
Chapter 3
87
The amount of operating profit or loss can be read from the graph by measuring the
P A distance
R T between TR and
vertical distance between TR and TC. For example, the vertical
TC when X 12,000 indicates Profit $1,380 ( $7,200 $5,820).
Profit-Volume Model
Instead of considering revenues and costs separately, we can analyze the relation between profit and volume directly. This approach to CVP analysis is called profit-volume
analysis. A graphic comparison of profit-volume and CVP relationships is shown in
Exhibit 3.4. The cost and revenue lines are collapsed into a single profit line. Note that the
slope of the profit-volume line equals the unit contribution margin. The intercept equals
the loss at zero volume, which equals fixed costs. The vertical axis shows the amount of
operating profit or loss.
Orientation
profit-volume analysis
Version of CVP analysis using
a single profit line.
L.O. 2
Understand the effect

of cost structure on
decisions.

Exhibit 3.4
for
Success
in
College
Comparison of CVP
Cost-Volume-Profit Relation
Graph and Profit-Volume
GraphU-Develop
$8,000
Total revenue
TR $.60 X
Dollars
$6,000
$4,000
Total cost
TC $1,500 $.36 X
C H A P T E R S
I N
P A R T
O N E
$2,000
1
$0
1,500
3,000
4,500
6,000
7,500

9,000
10,500a 12,000
Developing
College-Level Vocabulary
Volume
3 Approaching College Assignments:

Profit-Volume Relation
$1,400
Operating profit
Dollars
$400
0
$600
1,500
3,000
4,500
6,000
7,500
9,000 10,500 12,000
Operating loss
Profit Total contribution margin Total costs
$.24X $1,500
Related Resources
in Part One.
1
$1,600
Volume
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REVISED PAGES
Part II
88
Use of CVP to Analyze the Effect

P A R T
of Different Cost Structures
cost structure
Proportion of an organizations
fixed and variable costs to its
total costs.
operating leverage
Extent to which an
organizations cost structure is
made up of fixed costs.
An organizations cost structure is the proportion of fixed and variable costs to total
costs. Cost structures differ widely among industries and among firms within an industry.
Electric utilities such as Southern California Edison or Public Service of New Mexico
have a large investment in equipment, which results in a cost structure with high fixed
costs. In contrast, grocery retailers such as Albertsons or Safeway have a cost structure
with a higher proportion of variable costs. The utility is capital intensive; the grocery
store is labor intensive.
An organizations cost structure has a significant effect on the sensitivity of its profits
to changes in volume. Operating leverage describes the extent to which an organizations
cost structure is made up of fixed costs. Operating leverage can vary within an industry as
well as between industries. The airline industry in the United States, for example, consists
of so-called legacy carriers, such as American
Airlines andinContinental
for Success
CollegeAirlines, which
have high fixed labor, pension, and other costs and which operate using a hub and spoke
system. Newer carriers, such as Southwest Airlines and Jet Blue Airlines, have lower labor costs and operate out of lower cost and less-congested airports. Therefore, the operating leverage of American Airlines is higher than that of Jet Blue.
Operating leverage is high in firms with a high proportion of fixed costs and a low
proportion of variable costs and results in a high contribution margin per unit. The higher
the firms fixed costs, the higher the break-even point. Once the break-even point has been
reached, however, profit increases at a high rate. Exhibit 3.5 demonstrates the primary differences between two companies, Lo-Lev Company (with relatively high variable costs)
and Hi-Lev Company (with relatively high fixed costs).
Orientation
C H A P T E R S
I N
P A R T
O N E


Different industries have different cost structures. Electric utilities (left) have high fixed costs and
high operating leverage. Grocery stores (right) have lower fixed costs and low operating leverage.
Exhibit 3.5
Lo-Lev Company
(1,000,000 units)
Comparison of Cost
Structures
Sales . . . . . . . . . . . .
Variable costs . . . . . .
Contribution margin . .
Fixed costs . . . . . . . .
Operating profit . . . .
Amount
Percentage
$1,000,000
750,000
_________
$ 250,000
50,000
_________
$
200,000
_________
_________
100
75
25
5
20
Break-even point . . .
200,000 units
Contribution margin per unit $0.25
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Related Resources
See
pages 000 to 000
Hi-Lev Company
of
the
Annotated Instructors
(1,000,000 units)
Edition for general suggesAmount
Percentage
in Part One.
$1,000,000
100
250,000
_________
$ 750,000
550,000
_________
$
200,000
_________
_________
733,334 units
$0.75
25
75
55
20
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REVISED PAGES
Chapter 3
89
Effect of Cost Structure

P A R T on Operating
and Investing Decisions
In Action
Different cost structures lead to different decisions that

firms make concerning operations and investments.
Consider the following two statements:
1.
2.
Ahold now has about $23 billion in sales among

its six U.S. supermarket chainslarge but uncomfortably behind giants such as Wal-Mart, Kroger,
and Albertsons. The logic of consolidation is that,
in a business with such slim profit margins, bigger
companies gain important competitive advantage
by being able to negotiate better terms and prices
from suppliers, better rents from landlords and better advertising deals from media outlets (Washington Post, February 8, 2004).
Many experts say the airlines throw planes on a
route to grab market share from rivals. Robert L.
Crandall, the former chief executive of American Airlines, said that airlines added planes because growth
spreads fixed costs over more passenger miles. If
everybody is growing to keep their costs down, then
theres constantly a great deal of capacity in the market, Mr. Crandall said. So long as theres lots of capacity, people have an incentive to cut prices (The
New York Times, December 9, 2003).
Orientation

In the case of firms with low operating leverage, such as

grocery chains, the profit margins are small, so firms do
what they can to improve those marginseven small savings translate to large improvements in profits. In the case
of firms with high operating leverage, such as airlines, each
additional unit (seat-mile) sold provides a large contribution to profit, so the emphasis is on increasing volume.
Note that although these firms have the same sales revenue and operating profit, they
have different cost structures. Lo-Lev Companys cost structure is dominated by variable
costs with a lower contribution margin ratio of .25. Every dollar of sales contributes $.25
toward fixed costs and profit. Hi-Lev Companys cost structure is dominated by fixed
costs with a higher contribution margin of .75. Every dollar of sales contributes $.75
C H A P T E R S
I N
P A R T
O N E
toward fixed costs and profit.
Suppose that both companies experience a 10 percent increase in sales. Lo-Lev Companys profit increases by $25,000 ($.25 $100,000), and1 Hi-Lev
Companys
profi
t inMaking
Yourself
Successful
in College
creases by $75,000 ($.75 $100,000). Of course, if sales decline, the fall in Hi-Levs
profits is much greater than the fall in Lo-Levs profits. In general, companies with lower
2 in Approaching
College
Reading and
fixed costs have the ability to be more flexible to changes
market demands
than do
companies with higher fixed costs and are better able to surviveDeveloping
tough times.a College-Level Vocabulary
Margin of Safety
The margin of safety is the excess of projected (or actual) salesReading

over the break-even
margin ofDirections
safety
Textbookssales
and Following
level. This tells managers the margin between current sales and the break-even point. In The excess of projected or
a sense, margin of safety indicates the risk of losing money that a company faces, that is, actual sales over the breakthe amount by which sales can fall before the company is in the loss area. The margin of even volume.
safety formula is
Sales volume Break-even sales volume Margin of safety
If U-Develop sells 8,000 prints and its break-even volume is 6,250, then its margin of
safety is
Sales Breakeven 8,000 6,250
1,750 prints
Sales volume could drop by 1,750 prints per month before it incurs a loss, all other
things held constant. In practice, the margin of safety also may be expressed in sales dollars or as a percent of current sales.
The excess of the projected or actual sales volume expressed as a percentage of the
break-even volume is the margin of safety percentage. If U-Develop sells 8,000 prints
and the break-even volume is 6,250 prints, the margin of safety percentage is 22 percent
( 1,750 8,000). This means that volume can fall by 22 percent, a relatively large
amount, before U-Develop
finds itself operating at a loss.
cor50782_ch01_001-072.indd
1
lan27114_ch03_080-109.indd 89
Related Resources
in Part One.
margin of safety
1
percentage
The excess of projected or
actual sales over the breakeven volume expressed as a
percentage of the break-even
volume.
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REVISED PAGES
Part II
90
CVP Analysis with Spreadsheets

L.O. 3
Use Microsoft Excel to

perform CVP analysis.
P A R T
It is important to be able to do CVP analysis and understand the relations, so it is important to work examples and do problems by hand at first. However, a spreadsheet program
such as Microsoft Excel is ideally suited to doing CVP routinely. Exhibit 3.6 shows a
Microsoft Excel worksheet for U-Develop. The basic data (price per unit, variable cost
per unit, and total fixed costs) for U-Develop are entered. The profit equation (or formula)
is shown in the formula bar of the spreadsheet.
Once the data are entered, an analysis tool such as Goal Seek can be used to find
the volume associated with a given desired profit level. In the left side screenshot of Exhibit 3.7, the problem is set up as follows:
Orientation
1. With the spreadsheet open, choose the Data tab and select What-If Analysis from
andbox.
Organizing Yourself
the ribbon. Then select Goal SeekPreparing
from the drop-down
2. In the Set cell: edit field, enter the cell address for the target profit calculation (B7).
The formula in cell B7 is: ((B3-B4)*B8)-B5.
3. In the To value: edit field, enter the target profit (in this example, the target profit is
zero because we are looking for the break-even point).
4. In the By changing cell: edit field, enter the cell address of the volume variable
($B$8). (The 5,000 volume in cell B8 in Exhibit 3.6 is only a placeholder; any number will suffice.)
5. Click OK and the program will find the break-even volume as shown in the right
side screenshot of Exhibit 3.7.
Although this spreadsheet is extremely simple, it can easily be edited to analyze alternative scenarios, so-called what-if analyses. For example, we could ask, Given that I
expect to sell 5,000 prints, what price do I need to charge to break even? In this case, we
C H A
P TfiEnd
R the
S
Ianswer
N
P A ($0.66).
R T
O N E
would change Step 4 above to enter the cell for Price (B3)
and
Exhibit 3.6
1
2
3
4
5
6
7
8
9
Screenshot of
Spreadsheet Program
for CVP Analysis
U-Develop
Exhibit 3.7
Screenshot of
Spreadsheet
Analysis
ToolGoal
Seek
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
A
U-Develop
Price
Variable cost
Fixed cost
$ 0.60
$ 0.36
$ 1,500
Profit
Volume
$ (300)
5,000
Set cell:
B7
To value:
By changing cell:
$B$8
cor50782_ch01_001-072.indd 1
lan27114_ch03_080-109.indd 90
OK
Price
Variable cost
Fixed cost
Profit
Volume
Goal Seek
A
U-Develop
Cancel
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
C
Making Yourself
Successful in College
$ 0.60
College Reading and
$ Approaching
0.36
$ Developing
1,500
a College-Level Vocabulary
$ (300)
5,000
Approaching
A
U-Develop
Price
Variable cost
Fixed cost
$ 0.60
$ 0.36
$ 1,500
Profit
Volume
Goal Seeking with Cell B7

found a solution.
0
Current value:
$-
6,250
Goal Seek Status
Target value:
Related Resources
in Part One.
OK
Cancel
Step
Pause
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REVISED PAGES
Chapter 3
91
Extensions of the CVP Model
P A R T
The basic CVP model that we have developed can be easily extended to answer other
questions or modified to incorporate complications. For example, we can use the model to
determine the fixed costs required to achieve a certain profit for a given volume. We can
incorporate the effects of income taxes by modifying the profit equation to include taxes.
Making some simplifying assumptions, we can extend the analysis to firms that make
multiple products. Finally, we can incorporate more complicated cost structures (for example, step fixed costs) by incorporating these complications in the profit equation. We
illustrate these extensions here.
Orientation
Income Taxes
L.O. 4
Incorporate taxes,
multiple products,
and alternative cost
structures into the
CVP analysis.
Assuming that operating profits before taxes and taxable Preparing

income are the and
same, Organizing
income
taxes may be incorporated into the basic model as follows:
Yourself
After-tax profit [(P V)X F] (1 t)

where t is the tax rate.
Rearranging, we can find the target volume as follows;
Fixed costs [Target profit(1 t)]

Target volume (units) ______________________________
Notice that taxes affect the analysis by changing the target profit. That is, to determine the volume required to earn a target after-tax income, you first determine the required before-tax operating income ( target after-tax income [1 tax rate]) and then
solve for the target volume using the required before-tax income as before.
For example, suppose that the owner of U-Develop wants to find the number
C H A P of
T Eprints
R S
I N
P A R T
O N
required to generate after-tax operating profits of $1,800. Recall that P $.60, V $.36,
the contribution margin per unit $.24, and F $1,500. We assume the tax rate t .25;
1 volume,
Makingfirst
Yourself
Successful
in College
that is, U-Develop has a 25 percent tax rate. To find the target
determine
the
required before-tax income, which is $2,400 ( $1,800 [1 .25]). Now, we can use
the formula to determine the volume required to earn a target
t of $2,400:College Reading and
2 profi
Approaching
Developing
Fixed costs [Target profi
t(1 t)] a College-Level Vocabulary
Target volume (units) ______________________________
$1,500 $2,400
______________
$.24

16,250 prints
Multiproduct CVP Analysis

When U-Develop started, it provided only one service, print processing. After a short
time, a second service, enlargements of photos, was offered. The prices and costs of the
two follow:
Selling price. . . . . . . . . . . . . .
Variable cost . . . . . . . . . . . . .
Contribution margin. . . . . . . .
Prints
Enlargements
$.60
__.36
__
$.24
__
____
__
$1.00
.56
_____
$ .44
_____
_____
When these two services were offered, monthly fixed costs totaled $1,820.
Without some assumptions, there is an infinite number of combinations of the two
services that would1 achieve a given level of profit. To simplify matters, managers often
cor50782_ch01_001-072.indd
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Related Resources
in Part One.
1
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REVISED PAGES
Part II
92
assume a particular product mix and compute break-even

P A Rusing
T either of two methods, a fixed prodor target volumes
uct mix or weighted-average contribution margin, both of
which give the same result.
Fixed Product Mix Using the fixed product mix
Orientation
Managers compute the break-even or target volume of a

bundle or package of products.
method, managers define a package or bundle of products

in the typical product mix and then compute the breakeven or target volume for the package. For example, suppose that the owner of U-Develop is willing to assume that
the prints and enlargements will sell in a 9:1 ratio; that is,
of every ten units of service sold, nine will be prints and
Preparing
andDefiOrganizing
Yourself
one will be
an enlargement.
ning X as a package
of
nine prints and one enlargement, the contribution margin
Success
in College
from this for
package
is
Prints . . . . . . . . . . . . . . . . .
Enlargements . . . . . . . . . . .
Contribution margin . . . . . .
9 $.24
1 $.44
$2.16
.44
_____
$2.60
_____
_____
Now the break-even point is computed as follows

X Fixed costs Contribution margin
$1,820 $2.60
C H A P T E R S
I N
P A R T
O N E
700 packages
1 ofMaking
Yourself
Successful
College
where X refers to the break-even number
packages.
This means
that theinsale
of 700
packages of nine prints and one enlargement per package, totaling 6,300 prints and 700
enlargements, is required to break even.2 Approaching College Reading and
Weighted-Average Contribution Margin The weighted-average contribution

margin also requires an assumed product mix, which we continue to assume is 90 percent
3 problem
Approaching
prints and 10 percent enlargements. The
can be College
solved byAssignments:
using a weightedTextbooks
Following
average contribution margin per unit. When Reading
a company
assumes aand
constant
productDirections
mix,
the contribution margin is the weighted-average contribution margin of all of its products.
For U-Develop, the weighted-average contribution margin per unit can be computed by
multiplying each products proportion by its contribution margin per unit
(.90 $.24) (.10 $.44) $.26
The multiple product breakeven for U-Develop can be determined from the break-even
Related Resources
formula:
X $1,820 $.26
7,000 units of service

that
in PartUOne.
where X refers to the break-even number. The product mix assumption means
Develop must sell 6,300 ( .90 7,000) prints and 700 ( .10 7,000) enlargements
to break even.
Find Breakeven in Sales Dollars To find the breakeven in sales dollars, divide the
fixed costs by the weighted-average contribution margin percent. The weighted-average
contribution margin percent is the ratio of the weighted-average contribution margin
is $.26 in our example) divided by the weighted-average revenue.
cor50782_ch01_001-072.indd (which
1
lan27114_ch03_080-109.indd 92
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REVISED PAGES
Chapter 3
93
To find the weighted-average revenue, multiply the proportion of sales (90 percent
P unit.
A RPrints
T sell for $.60 per
prints and 10 percent enlargements) by the sales prices per
unit and enlargements sell for $1.00 per unit. Therefore, the weighted-average revenue
can be found as follows:
(.90 $.60) for prints (.10 $1.00) for enlargements
$.64
Orientation
Now, the weighted-average contribution margin percent is found as follows:
$.26 weighted-average contribution margin $.64 weighted-average revenue

40.625%
The break-even sales amount in dollars is:
$1,820 fixed costs .40625 weighted-average contribution
margin and
percentOrganizing
Preparing
$4,480
(You can verify that $4,480 $.64 7,000 units.)
Yourself
Alternative Cost Structures

The cost structures we have considered so far have been relatively simple. We have separated costs into fixed and variable and we have assumed that the variable cost per unit is
the same for all levels of volume. In Chapter 2, we defined other cost behavior patterns,
including semivariable costs and step costs.
We illustrate how more complicated cost structures can be analyzed by assuming
that the fixed costs of U-Develop include the rental of equipment for photo developing
and that the capacity of these machines is limited. Suppose, for example, that the fixed
costs of $1,500 (from Exhibit 3.1) are sufficient for monthly volumes less
C Hthan
A P or
T Eequal
R S
I N
P A R T
O N
to 5,000 prints. For every additional 5,000 prints, another machine, renting monthly for
$480, is required. Now what is the break-even volume for U-Develop?
Yourself
Successful
in College
We know from our analysis earlier in the chapter that 1for aMaking
fixed cost
of $1,500,
the
break-even point is 6,250 prints. But 6,250 prints cannot be developed without the additional machine. At a volume of 6,250 prints, U-Develops2 profi
t will be
Approaching
College Reading and
Developing
Profit ($0.60 $0.36) 6,250 ($1,500 $480)
($480)a College-Level Vocabulary
which is less than breakeven.
If we are going to have to sell more than 5,000 prints 3
to break
even, we are
going to
Approaching
College
Assignments:
have to rent the additional machine. Therefore, to break even, our
monthly
fi
xed
costs
will
be (at least) $1,980 ( $1,500 $480). At this level of fixed costs, the break-even point is
Fixed costs
Break-even volume _____________________
$1,980
______
$ 0.24
Related Resources
in Part One.
8,250
which is less than 10,000 prints. Therefore, U-Develop can break even at a volume of
8,250 prints. If we had found that the new break-even point was greater than 10,000
prints, we would have repeated the analysis, adding another $480 for an additional
machine.
Assumptions and Limitations of CVP Analysis

As with all methods of analysis, CVP analysis relies on certain assumptions and these assumptions might limit the applicability of the results for decision making. It is important
to understand, however, that the limitations are due to the assumptions that the cost analyst
makes; that is, they 1are not inherent limitations to the method of CVP analysis itself.
cor50782_ch01_001-072.indd
lan27114_ch03_080-109.indd 93
L.O. 5
Understand the
assumptions and
limitations of CVP
analysis.
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REVISED PAGES
Part II
94
For example, many people point to the assumptions of constant unit variable cost and
P Aas important
R T
constant unit prices for all levels of volume
limitations of CVP analysis. As
we saw in the previous section, however, these assumptions are simplifying assumptions
that are made by the analyst. If we know that unit prices are lower for higher volumes, we
can incorporate that relation into the CVP analysis. The result will be a more complicated
relation among costs, volumes, and profits than we have worked with here and the breakeven and target volume formulas will not be as simple as those we have derived. But with
analysis tools such as Microsoft Excel we can model the more complicated relations and
find the break-even point (or points) if they exist.
The lesson from this is that CVP analysis is a tool that the manager can use to help
with decisions. The more important the decision, the more the manager will want to
ensure that the assumptions made are applicable. In addition, if the decisions are sensitive
to the assumptions made (for example, that prices do not depend on volume), the manand
Organizing
Yourself
ager should be cautious about dependingPreparing
on CVP analysis
without
considering alternative
assumptions.
Orientation
Self-Study Questions
2.
3.
High Desert Campgrounds (HDC) rents spaces for

recreational vehicles (RVs) by the day. HDC charges
$15 per day for a space. The variable costs (including
cleaning, maintenance, and supplies) are $7 per day.
The fixed costs of HDC are $60,000 per year. HDC is
subject to a tax rate of 35 percent on its income. If a
unit is one space rented for one day, how many units
does HDC have to rent annually to earn $48,750 after
taxes?
Suppose HDC rents spaces for both RVs and tent
camping. The price and cost characteristics for each
are as follows (one unit is a tent or RV space rented for
one day):
Tent space . . . .
RV space . . . . .
Price per
Unit
Variable Cost
per Unit
Units Rented
per Year
$ 6
15
$3
7
6,000
9,000
C H A P T E R S
I N
P A R T
O N E
The fixed costs of HDC are $60,000 annually. Assuming

the mix
tent and Yourself
RV spacesSuccessful
is the same as
current
1 ofMaking
in the
College
mix, how many tent spaces and how many RV spaces
must be rented annually for HDC to break even?

The solutions to these questions are at the end of the chapter on

page 109.
The Debrief
Jamaal Kidd considered the spreadsheet he developed
for his business and reflected on how it will help him as a
manager:
The cost-volume-profit analysis I learned in this
chapter gives me a simple and intuitive approach to
understanding how my decisions affect my profits.

I know that there are limitations to the use of CVP analysis and that for many decisions, I will want to develop
Related Resources
more detailed analyses. But for quick answers for rouSee pages 000 to 000
tine decisions, CVP analysis is just what I need.
in Part One.
Summary
The cost analysis approach to decision making is used when the decisions affect costs and revenues
and, hence, profit. In this chapter we considered the cost-volume-profit (CVP) analysis framework
cor50782_ch01_001-072.indd for
1 cost analysis.
lan27114_ch03_080-109.indd 94
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REVISED PAGES
Chapter 3
95
The following summarizes key ideas tied to the chapters learning objectives.
P A R T
L.O. 1. Use cost-volume-profit (CVP) analysis to analyze decisions. CVP analysis is both
a management tool for determining the impact of selling prices, costs, and volume on
profits and a conceptual tool, or way of thinking, about managing a company. It helps
management focus on the objective of obtaining the best possible combination of prices,
volume, variable costs, and fixed costs. CVP analysis examines the impact of prices,
costs, and volume on operating profits, as summarized in the profit equation
Profit PX (VX F)
Orientation
where
P Average unit selling price
V Average unit variable costs
X Quantity of output
F Total fixed costs

forandSuccess
in College
Management can use CVP analysis to plan future projects
to help in determining
a
projects feasibility. By altering different variables within the equation (e.g., selling price
or amount of output), managers are able to perform a what-if analysis (often referred to
as sensitivity analysis).
L.O. 2. Understand the effect of cost structure on decisions. An organizations cost structure
is the proportion of fixed and variable costs to total costs. Operating leverage is high in
firms with a high proportion of fixed costs, a small proportion of variable costs, and the
resulting high contribution margin per unit. The higher the firms leverage, the higher
the degree of the profits sensitivity to volume.
L.O. 3. Use Microsoft Excel to perform CVP analysis. A spreadsheet program such as
Microsoft Excel can be used to perform most CVP analyses. For example, the Goal
Seek function of Excel is designed to find values of variables such as volume that set
other variables (for example, profit) equal to a selected target value (such as zero).
C H A P T E R S
I N
P A R T
O N E
L.O. 4. Incorporate taxes, multiple products, and alternative cost structures into
the CVP
analysis. More complicated relations among costs, volumes, and profits can be analyzed.
With income taxes, the target profit, which is after income
has toYourself
be converted
to
1 taxes,
Making
Successful
in College
a target profit before income taxes. With multiple products, an assumption about product
mix allows the application of CVP analysis by treating the multiple products as if they
are a basket of goods. More complicated cost structures,
as step fixedCollege
costs, canReading and
2 such
Approaching
be analyzed by considering costs at different volumes.
L.O. 5. Understand the assumptions and limitations of CVP analysis. All analysis methods
require assumptions that limit the applicability of the results. The cost analyst must
understand which assumptions are most important for the
being made
and Assignments:
3 decision
Approaching
College
consider how sensitive the decision is to the assumptions before relying on CVP
analysis alone to make a decision.
Key Terms
break-even point, 84
contribution margin ratio, 84
cost structure, 88
cost-volume-profit (CVP) analysis, 81
margin of safety, 89
margin of safety percentage, 89
operating leverage, 88
profit equation, 82
profit-volume analysis, 87
total contribution margin, 82
unit contribution margin, 82
Related Resources
in Part One.
Review Questions
Write out the profit equation and describe each term.
What are the components of total costs in the profit equation?
How does the total contribution margin differ from the gross margin that is often shown on
companies financial
statements?
cor50782_ch01_001-072.indd
1
3-1.
3-2.
3-3.
lan27114_ch03_080-109.indd 95
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REVISED PAGES
Part II
96
3-4.
3-5.
3-6.
3-7.
3-8.
3-9.
3-10.
3-11.
Compare cost-volume-profit (CVP) analysis with profit-volume analysis. How do they

P A R T
differ?
Fixed costs are often defined as fixed over the short run. Does this mean that they are not
fixed over the long run? Why or why not?
What is operating leverage? Why is knowledge of a firms operating leverage important to
its managers?
What is the margin of safety? Why is this important for managers to know?
Write out the equation for the target volume (in units) profit equation when the income tax
rate is t.
How do income taxes affect the break-even equation? Why?
Why is it common to assume a fixed sales mix before finding the break-even volume with
multiple products?
What are some important assumptions commonly made in CVP analysis. Do these
assumptions impose serious limitations on the analysis? Why or why not?
Orientation

Critical Analysis and Discussion Questions

3-12.
3-13.
3-14.
3-15.
3-16.
3-17.
3-18.
Exercises
Why might the operating profit calculated by CVP analysis differ from the net income
reported in financial statements for external reporting?
Why does the accountant use a linear representation of cost and revenue behavior in CVP
analysis? How is this justified?
The typical cost-volume-profit graph assumes that profits increase continually as volume
increases. What are some of the factors that might prevent the increasing profits that are
indicated when linear CVP analysis is employed?
The assumptions of CVP analysis are so simplisticC that
would
H A no
P TfiErm
R S
I N make
P A Ra Tdecision
O N E
based on CVP alone. Therefore, there is no reason to learn CVP analysis. Comment.
I am going to work for a hospital, which is a not-for-profit organization. Because there are
Making
Yourself
Successful
in College
no profits, I will not be able to apply 1any CVP
analysis
in my work.
Do you agree
with this
statement? Why or why not?
Consider a class in a business school where volume is measured by the number of students
2 Approaching
Reading and
in the class. Would you say the operating
leverage is high College
or low? Why?
Developing
a
College-Level
Vocabulary
On January 1, 2009, a news report on msn.com included the following sentence:
A report
put out by brokerage house CLSA about Jet Airways said that the fall in ATF [fuel] prices
has brought down the load factors (flight occupancy) required for the airline to break even
3 important
Approaching
College
from 78 percent to 63 percent. What
assumptions
andAssignments:
limitations should be
Reading Textbooks
and isFollowing
Directions
considered when using this piece of information?
(The load factor
the percentage
of
available seats on a flight that are occupied.)
accounting
3-19. Profit Equation Components

Identify each of the following profit equation components on the graph that follows:
a. The total cost line.
b. The total revenue line.
c. The total variable costs area.
d. Variable cost per unit.
e. The fixed costs area.
f. The break-even point.
g. The profit area (range of volumes leading to profit).
h. The loss area (range of volumes leading to loss).
cor50782_ch01_001-072.indd 1
(L.O. 1)
lan27114_ch03_080-109.indd 96
Related Resources
in Part One.
1
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REVISED PAGES
Chapter 3
P A R T
97
Orientation
Volume
3-20. Profit Equation Components

Identify the letter of each profit equation component on the graph that follows.
(L.O. 1)
C H A P T E R S
I N
P A R T
O N E
Making
Successful in College
LineYourself
d
Approaching
College Reading and
c

Area e
g
b
Area f
a
Volume
3-21. Basic Decision Analysis Using CVP

Anus Amusement Center has collected the following data for operations for the year:
Total revenues . . . . . . . . . . . . . . . . . .
Total fixed costs. . . . . . . . . . . . . . . . .
Total variable costs . . . . . . . . . . . . . .
Total tickets sold . . . . . . . . . . . . . . . .
cor50782_ch01_001-072.indd 1
lan27114_ch03_080-109.indd 97
$800,000
$218,750
$450,000
50,000
Related Resources
(L.O. 1)
in Part One.
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REVISED PAGES
Part II
98
Required
P A R T
a. What is the average selling price for a ticket?
b. What is the average variable cost per ticket?
c. What is the average contribution margin per ticket?
d. What is the break-even point?
e. Anu has decided that unless the operation can earn at least $43,750 in operating profits, she
will close it down. What number of tickets must be sold for Anus Amusements to make a
$43,750 operating profit for the year on ticket sales?
Orientation
(L.O. 1)
3-22. Basic CVP Analysis

The manager of Kimas Food Mart estimates operating costs for the year will include $900,000 in
fixed costs.
Required
a. Find the break-even point in sales dollars with a contribution margin ratio of 40 percent.
b. Find the break-even point in sales dollars
a contributionin
margin
ratio of 25 percent.
forwithSuccess
College
c. Find the sales dollars required to generate a profit of $200,000 for the year assuming a contribution margin ratio of 40 percent.
(L.O. 1)
3-23. CVP AnalysisEthical Issues

Mark Ting desperately wants his proposed new product, DNA-diamond, to be accepted by top
management. DNA-diamond is a piece of jewelry that contains the DNA of a boy or girl friend,
spouse, or other loved one. Top management will not approve this product in view of its high
break-even point.
Mark knows that if he can reduce the fixed costs in his proposal, then the break-even point will
be reduced to a level that top management finds acceptable. Working with a friend in the companys
finance department, Mark finds ways to credibly misstate the estimated fixed costs of producing
DNA-diamonds below those that any objective person would estimate.
Mark knows that if the product is successful (and he is Ccertain
H A P that
T E Rit SwillI be),
N
Pthen
A R top
T manO N E
agement will not find out about the understatement of fixed costs. Mark believes that this product,
once it is successful, will benefit the shareholders and employees of the company.
Required
Are Marks actions ethical? Explain.
(L.O. 1)

Following Directions

Cambridge, Inc., is considering the introduction of a new calculator with the following price and
cost characteristics:
Sales price . . . . . . . . . . . . . $
18 each
Textbooks
Variable costs . . . . . . . . Reading
...
10 each and
Fixed costs . . . . . . . . . . . . . . . .
20,000 per month
Required
a. What number must Cambridge sell per month to break even?
b. What number must Cambridge sell to make an operating profit of $16,000 for the month?
(L.O. 1)
Related Resources

Refer to the data for Cambridge, Inc., in Exercise 3-24. Assume that the projected number of units
sold for the year is 7,000. Consider requirements (b), (c), and (d) independently of each other.
Edition for general sugges-
Required
in Part One.
a. What will the operating profit be?
b. What is the impact on operating profit if the sales price decreases by 10 percent? Increases by
20 percent?
1
c. What is the impact on operating profit if variable costs per unit decrease by 10 percent? Increase by 20 percent?
d. Suppose that fixed costs for the year are 10 percent lower than projected, and variable costs per
unit are 10 percent higher than projected. What impact will these cost changes have on operating profit for the year? Will profit go up? Down? By how much?
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REVISED PAGES
Chapter 3

P Awith
R theT following price and
Balance, Inc., is considering the introduction of a new energy snack
cost characteristics:
Sales price . . . . . . . . . . .
Variable costs . . . . . . . . .
Fixed costs . . . . . . . . . . .
1.00 per unit

0.20 per unit
400,000 per month
99
(L.O. 1)
Orientation
Required
a. What number must Balance sell per month to break even?
b. What number must Balance sell per month to make an operating profit of $100,000?

(L.O. 1)
Preparing
Yourself
Refer to the data for Balance, Inc., in Exercise 3-26. Assume that the
company plansand
to sell Organizing
700,000
units per month. Consider requirements (b), (c), and (d) independently of each other.
Required
a. What will be the operating profit?
b. What is the impact on operating profit if the sales price decreases by 10 percent? Increases by
20 percent?
c. What is the impact on operating profit if variable costs per unit decrease by 10 percent? Increase by 20 percent?
d. Suppose that fixed costs for the year are 10 percent lower than projected, and variable costs per
unit are 10 percent higher than projected. What impact will these cost changes have on operating profit for the year? Will profit go up? Down? By how much?
3-28. Analysis of Cost Structure
(L.O. 2)
The Dollar Stores cost structure is dominated by variable costs with a contribution
C H Amargin
P T E Rratio
S
I N
P A R T
O N
of .30 and fixed costs of $30,000. Every dollar of sales contributes 30 cents toward fixed costs and
profit. The cost structure of a competitor, One-Mart, is dominated by fixed costs with a higher con1 Making
Yourself80Successful
in College
tribution margin ratio of .80 and fixed costs of $280,000. Every dollar
of sales contributes
cents
toward fixed costs and profit. Both companies have sales of $500,000 for the month.

Required
Developing
a College-Level Vocabulary
a. Compare the two companies cost structures using the format shown
in Exhibit 3.5.
b. Suppose that both companies experience a 15 percent increase in sales volume. By how much
would each companys profits increase?
3

(L.O. 2) Directions
3-29. Analysis of Cost Structure

Foxx Companys cost structure is dominated by variable costs with a contribution margin ratio of
.25 and fixed costs of $100,000. Every dollar of sales contributes 25 cents toward fixed costs and
profit. The cost structure of a competitor, Beyonce, Inc., is dominated by fixed costs with a higher
contribution margin ratio of .80 and fixed costs of $400,000. Every dollar of sales contributes
80 cents toward fixed costs and profit. Both companies have sales of $600,000 per month.
Required
a. Compare the two companies cost structures using the format shown in Exhibit 3.5.
b. Suppose that both companies experience a 20 percent increase in sales volume. By how much
would each companys profits increase?
3-30. CVP and Margin of Safety
Rainbow Tours gives walking tours of Springfield. Rainbow charges $40 per person for the tour
and incurs $16 in variable costs for labor, drinks, and maps. The monthly fixed costs for Rainbow
Tours are $3,600.
Required
a. How many tours must Rainbow sell every month to break even?
b. Rainbow Tourss owner believes that 175 people a month will sign up for the walking tour.
What is the margin
cor50782_ch01_001-072.indd
1 of safety in terms of the number of people signing up for the tour?
lan27114_ch03_080-109.indd 99
Related Resources
(L.O. 1, 2)
in Part One.
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REVISED PAGES
Part II
100
(L.O. 3)
3-31. Using Microsoft Excel to Perform CVP Analysis

P A 3-24.
R T
Refer to the data for Cambridge, Inc., in Exercise
Required
Using the Goal Seek function in Microsoft Excel,
a. What number must Cambridge sell to break even?
b. What number must Cambridge sell to make an operating profit of $6,000 per month?
(L.O. 3)
Orientation
3-32. Using Microsoft Excel to Perform CVP Analysis

Refer to the data for Balance, Inc., in Exercise 3-26.
Required
Using the Goal Seek function in Microsoft Excel,
a. What number must Balance, Inc., sell to break even?
b. What number must Balance, Inc., sell toPreparing
make an operating
profiOrganizing
t of $8,000 per month?
and
Yourself
(L.O. 4)
3-33. CVP with Income Taxes

Crest Industries sells a single model of satellite radio receivers for use in the home. The radios have
the following price and cost characteristics:
Sales price . . . . . . . . . . .
Variable costs . . . . . . . . .
Fixed costs . . . . . . . . . . .
$
80 per radio
$
32 per radio
$360,000 per month
Crest is subject to an income tax rate of 40 percent.

Required
a. How many receivers must Crest sell every month to break even?
b. How many receivers must Crest sell to earn a monthly operating profit of $90,000 after taxes?
C H A P T E R S
(L.O. 4)
I N
P A R T
O N E
3-34. Multiproduct CVP Analysis

Rio Coffee Shoppe sells two coffee drinks, a regular coffee and a latte. The two drinks have the
following prices and cost characteristics:
RegularCollege
Coffee Reading
Latte and
Approaching
a College-Level
Sales price (per cup) . . . . . . . . . . Developing
....
$1.50
$2.50 Vocabulary
Variable costs (per cup) . . . . . . . . . . . .
.70
1.30
The monthly fixed costs at Rio are $6,720. Based on experience, the manager at Rio knows that the
Reading
store sells 60 percent regular coffee and 40 percent
lattes. Textbooks and Following Directions
Required
How many cups of regular coffee and lattes must Rio sell every month to break even?
(L.O. 4)
3-35. Multiproduct CVP Analysis

Mission Foods produces two flavors of tacos, chicken and fish, with the following characteristics:
Selling price per taco . . . . . . . . . . .

Variable cost per taco. . . . . . . . . . .
Expected sales (tacos). . . . . . . . . .
Chicken
Fish
$3.00
$1.50
200,000
$ 4.50
$ 2.25
300,000
Related Resources
in Part One.
Required
The total fixed costs for the company are $117,000.
a. What is the anticipated level of profits for the expected sales volumes?
b. Assuming that the product mix would be 40 percent chicken and 60 percent fish at the breakeven point, compute the break-even volume.
c. If the product sales mix were to change to four chicken tacos for each fish taco, what would be
the new break-even volume?
cor50782_ch01_001-072.indd 1
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REVISED PAGES
Chapter 3
P A R T
101
Problems
accounting
3-36. CVP Analysis and Price Changes

(L.O. 1)
Argentina Partners is concerned about the possible effects of inflation on its operations. Presently,
the company sells 60,000 units for $30 per unit. The variable production costs are $15, and fixed
costs amount to $700,000. Production engineers have advised management that they expect unit
labor costs to rise by 15 percent and unit materials costs to rise by 10 percent in the coming year.
Of the $15 variable costs, 50 percent are from labor and 25 percent are from materials. Variable
overhead costs are expected to increase by 20 percent. Sales prices cannot increase more than
10 percent. It is also expected that fixed costs will rise by 5 percent as a result of increased taxes
and other miscellaneous fixed charges.
The company wishes to maintain the same level of profit in real dollar terms. It is expected
that to accomplish this objective, profits must increase by 6 percent during the year.
Required
for toSuccess
in College
a. Compute the volume in units and the dollar sales level necessary
maintain the present
profit
level, assuming that the maximum price increase is implemented.
b. Compute the volume of sales and the dollar sales level necessary to provide the 6 percent
increase in profits, assuming that the maximum price increase is implemented.
c. If the volume of sales were to remain at 60,000 units, what price increase would be required to
attain the 6 percent increase in profits?
Orientation
3-37. CVP Analysis and Price Changes

(L.O. 1)
Scholes Systems supplies a particular type of office chair to large retailers such as Target, Costco,
and Office Max. Scholes is concerned about the possible effects of inflation on its operations. Presently, the company sells 80,000 units for $60 per unit. The variable production costs are $30, and
fixed costs amount to $1,400,000. Production engineers have advised management that they expect
unit labor costs to rise by 15 percent and unit materials costs to rise by 10 percent in the coming
H A P T E VariR S
I N
P A R T
O N E
year. Of the $30 variable costs, 50 percent are from labor and 25 percent are fromC materials.
able overhead costs are expected to increase by 20 percent. Sales prices cannot increase more than
10 percent. It is also expected that fixed costs will rise by 5 percent as a result of increased taxes
and other miscellaneous fixed charges.
The company wishes to maintain the same level of profit in real dollar terms. It is expected
that to accomplish this objective, profits must increase by 6 percent during the year.
Required
a. Compute the volume in units and the dollar sales level necessary to maintain the present profit
level, assuming that the maximum price increase is implemented.
b. Compute the volume of sales and the dollar sales level necessary
to provide the
6 percent
3 Approaching
College
Assignments:
increase in profits, assuming that the maximum price increase is implemented.
c. If the volume of sales were to remain at 80,000 units, what price change would be required to
attain the 6 percent increase in profits?
3-38. CVP AnalysisMissing Data
Durant Manufacturers has performed extensive studies on its costs and production and estimates
the following annual costs based on 150,000 units (produced and sold):
Total Annual
Costs
(150,000 units)
Direct material . . . . . . . . . . . . . . . . . . . . . . . . . .
Direct labor. . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Manufacturing overhead . . . . . . . . . . . . . . . . . .
Selling, general, and administrative . . . . . . . . . .
Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$300,000
270,000
225,000
150,000
$945,000
Required
a. Compute Durants unit selling price that will yield a profit of $300,000, given sales of 150,000
units.
cor50782_ch01_001-072.indd
1
lan27114_ch03_080-109.indd 101
(L.O. 1)
Related Resources
in Part One.
1
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REVISED PAGES
Part II
102
b.
c.
(L.O. 1)
Compute Durants dollar sales that will yield a projected 20 percent profit on sales, assuming
P selling
A R price
T per unit and fixed costs are $420,000.
variable costs per unit are 60 percent of the
Management believes that a selling price of $8 per unit is reasonable given current market
conditions. How many units must Durant sell to generate the revenues (dollar sales) determined in requirement (b)?
3-39. CVP Analysis with Subsidies

Suburban Bus Lines operates as a not-for-profit organization providing local transit service. As a
not-for-profit, it refers to an excess of revenues over costs as a surplus and an excess of costs over
revenues as a deficit. Suburban charges $1.00 per ride. The variable costs of a ride are $1.50. The
fixed costs of Suburban are $200,000 annually. The county government provides Suburban with a
flat subsidy of $250,000 annually.
Orientation
Required
a. What is the break-even point for Suburban?
Preparing and Organizing
b. Suburban expects 75,000 riders this year. Will it operate at a surplus or deficit?
(L.O. 1)
Yourself
3-40. CVP AnalysisSensitivity Analysis (spreadsheet recommended)

Alameda Tile sells products to many people remodeling their homes and thinks that they could
profitably offer courses on tile installation, which might also increase the demand for their products. The basic installation course has the following (tentative) price and cost characteristics:
Tuition . . . . . . . . . . . . . . . . . . . . . . .
Variable costs
(tiles, supplies, and so on) . . . . . .
Fixed costs (advertising,
salaries, and so on) . . . . . . . . . . .
$ 400 per student

240 per student
80,000 per year
C H A P T E R S
I N
P A R T
O N E
Required
a. What enrollment will enable Alameda Tile to break even?
1 Tile
Making
Successful
in College
b. How many students will enable Alameda
to makeYourself
an operating
profit of $40,000
for the
year?
c. Assume that the projected enrollment for the year is 800 students for each of the following
(considered independently):
Developing
1. What will be the operating profit (for 800
students)? a College-Level Vocabulary
2. What would be the operating profit if the tuition per student (that is, sales price) decreased
by 10 percent? Increased by 20 percent?
Approaching
College
Assignments:
3. What would be the operating profit3if variable
costs per student
decreased
by 10 percent?
Increased by 20 percent?
4. Suppose that fixed costs for the year are 10 percent lower than projected, whereas variable
costs per student are 10 percent higher than projected. What would be the operating profit
for the year?
(L.O. 4)
3-41. Extensions of the CVP ModelSemifixed (Step) Costs

Sams Sushi serves only a fixed-price lunch. The price of $10 and the variable cost of $4 per meal
remain constant regardless of volume. Sam can increase lunch volume by opening and staffing
Related Resources
additional check-out lanes. Sam has three choices:
1 Lane . . . . . . . . . . .
2 Lanes . . . . . . . . .
3 Lanes . . . . . . . . .
Monthly Volume Range

(Number of Meals)
Total
Fixed Costs
05,000
5,0018,000
8,00110,000
$33,000
39,000
52,500

in Part One.
Required
a. Calculate the break-even point(s).
b. If Sam can sell all the meals he can serve, should he operate at one, two, or three lanes?
cor50782_ch01_001-072.indd 1
Support your answer.
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REVISED PAGES
Chapter 3
3-42. Extensions of the CVP ModelSemifixed (Step) Costs

P AoneRshift,
T two shifts, or three
Cesars Bottlers bottles soft drinks in a factory that can operate either
shifts per day. Each shift is eight hours long. The factory is closed on weekends. The sales price of
$2 per case bottled and the variable cost of $0.90 per case remain constant regardless of volume.
Cesars Bottlers can increase volume by opening and staffing additional shifts. The company has
the following three choices:
103
(L.O. 4)
Orientation
Daily Volume Range

Total Fixed Costs
(Number of Cases Bottled)
per Day
1 Shift . . . . . . . . . . .
2 Shifts . . . . . . . . . .
3 Shifts . . . . . . . . . .
(02,000)
(2,0013,600)
(3,6015,000)
$1,980
3,740
5,170
Required
a. Calculate the break-even point(s).
b. If Cesars Bottlers can sell all the units it can produce, should it operate at one, two, or three
shifts? Support your answer.
3-43. Extensions of the CVP ModelTaxes
Odd Wallow Drinks is considering adding a new line of fruit juices to its merchandise products.
This line of juices has the following prices and costs:
Selling price per case (24 bottles) of juice . . . . . . . . $
50
Variable cost per case (24 bottles) of juice . . . . . . . $
24
Fixed costs per year associated with
this product . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $8,112,000
Income tax rate . . . . . . . . . . . . . . . . . . . . . . . . . . . .
40%
C H A P T E R S
(L.O. 4)
I N
P A R T
O N E
Required
a. Compute Odd Wallow Drinkss break-even point in units per year.
b. How many cases must Odd Wallow Drinks sell to earn $1,872,000 per year after taxes on the
juice?

(L.O. 4)
Frightproof Commuter Airlines is considering adding a new flight to its current schedule from
Metro to Hicksville. This route has the following prices and costs:
Selling price per passenger per flight. . . . . . . . . . . . $ 80

Variable cost per passenger per flight . . . . . . . . . . . $ 20
Fixed cost per flight . . . . . . . . . . . . . . . . . . . . . . . . . $2,400
Income tax rate . . . . . . . . . . . . . . . . . . . . . . . . . . . .
30%
Required
a. Compute Frightproofs break-even point in number of passengers per flight.
b. How many passengers per flight must Frightproof have to earn $1,050 per flight after taxes?
c. Each aircraft has the capacity for 70 passengers per flight. In view of this capacity limitation,
can Frightproof carry enough passengers to break even? Can the company carry enough passengers to earn $1,050 per flight after taxes?
Lomas Electronics manufactures a portable testing device for use in oil exploration. The products
price and cost characteristics are:
cor50782_ch01_001-072.indd 1
lan27114_ch03_080-109.indd 103
Selling price per unit . . . . . . . . . . .

Variable cost per unit . . . . . . . . . . .
Fixed cost per year . . . . . . . . . . . .
130
70
420,000
Related Resources
in Part One.
(L.O. 4)
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REVISED PAGES
Part II
104
Required
P inAorder
R toTearn $117,000 in profits after taxes. What
The company must sell 10,000 units annually
is Lomas Electronicss tax rate?
(L.O. 4)

Action Games has developed a new computer game that it plans to sell for $32. The variable costs
associated with each game (for materials, shipping, and packaging) amount to $7. The fixed costs
associated with the game amount to $75,000 per year.
Required
a. Compute the break-even point in units for the game.
b. Assuming that the tax rate is 40 percent and the desired profit level is $120,000 after tax, compute the required unit sales level.
Orientation
(L.O. 4)
3-47. Extensions of the CVP AnalysisTaxes

Eagle Company makes the MusicFinder, a Preparing
sophisticated satellite
Eagle has experienced
a
andradio.
Organizing
Yourself
steady growth in sales for the past five years. However, Ms. Luray, Eagles CEO, believes that to
Success
College
maintain the companys present growth will for
require
an aggressivein
advertising
campaign next year.
To prepare for the campaign, the companys accountant, Mr. Bednarik, has prepared and presented
to Ms. Luray the following data for the current year, Year 1:
Variable costs:
Direct labor (per unit) . . . . . . . . . . . . . . . . . . . . . . . . .
Direct materials (per unit) . . . . . . . . . . . . . . . . . . . . . .
Variable overhead (per unit) . . . . . . . . . . . . . . . . . . . .
Total variable costs (per unit) . . . . . . . . . . . . . . . . .
Fixed costs (annual):
Manufacturing. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Selling. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Administrative . . . . . . . . . . . . . . . . . . . . . . . . C. .H. A. .P. T.
Total fixed costs (annual) . . . . . . . . . . . . . . . . . . . .
100.00
45.00
20.00
165.00
400,000
300,000
I N
P A
800,000
E R S
R T
O N E
$ 1,500,000
Selling price (per unit) . . . . .1. . . .Making

. . . . . . . Yourself
........
Expected sales revenues, Year 1 (25,000 units) . . . .
$400.00
Successful
in College
$10,000,000
Eagle has an income tax rate of 35 percent. 2 Approaching College Reading and
Developing
a College-Level
Ms. Luray has set the sales target for Year 2 at
a level of $11,200,000
(or 28,000Vocabulary
radios).
Required
a. What is the projected after-tax operating profit for Year 1?
b. What is the break-even point in units for Year 1?
c. Ms. Luray believes that to attain the sales target (28,000 radios) will require additional selling
expenses of $300,000 for advertising in Year 2, with all other costs remaining constant. What
will be the after-tax operating profit for Year 2 if the firm spends the additional $300,000?
d. What will be the break-even point in sales dollars for Year 2 if the firm spends the additional
$300,000 for advertising?
e. If the firm spends the additional $300,000 for advertising in Year 2, what is the sales level in
dollars required to equal the Year 1 after-tax operating profit?
Related Resources
f. At a sales level of 28,000 units, what is the maximum amount the firm can spend on advertisSee pages 000 to 000
ing to earn an after-tax operating profit of $750,000?
(CMA adapted)
Edition for general sugges-
(L.O. 4)

3-48. Extensions of the CVP ModelMultiple Products
On-the-Go, Inc., produces two models of traveling cases for laptop computers: the Programmer
in Part One.
and the Executive. The bags have the following characteristics:
Programmer
mhhe.com/lanen3e
cor50782_ch01_001-072.indd 1
Selling price per bag . . . . . . . . . . .

Variable cost per bag . . . . . . . . . . .
Expected sales (bags) per year . . .
$70
$30
8,000
Executive
$100
$40
12,000
10/5/09 11:09:29 PM
The total fixed costs per year for the company are $819,000.
lan27114_ch03_080-109.indd 104
10/23/09 5:25:35 AM
REVISED PAGES
Chapter 3
105
Required
A R T
a. What is the anticipated level of profits for the expected salesPvolumes?
b. Assuming that the product mix is the same at the break-even point, compute the break-even
point.
c. If the product sales mix were to change to nine Programmer-style bags for each Executivestyle bag, what would be the new break-even volume for On-the-Go?
Orientation

Sundial, Inc., produces two models of sunglasses: AU and NZ. The sunglasses have the following
characteristics:
Selling price per unit . . . . . . . .

Variable cost per unit . . . . . . . .
Expected units sold per year . .
AU
NZ
60,000
40,000
(L.O. 4)

$80
$80
$30
$40
for Success
in College
The total fixed costs per year for the company are $1,104,000.
Required
point.
c. If the product sales mix were to change to four pairs of AU sunglasses for each pair of NZ
sunglasses, what would be the new break-even volume for Sundial, Inc.?
C H A P T E R S
I N
P A R T
O N E

(L.O. 4)
Sell Block prepares three types of simple tax returns: individual, partnerships, and (small) corpora1 Making Yourself Successful in College
tions. The tax returns have the following characteristics:
Individuals
Price charged per tax return . . . . . . . . . . . .
Variable cost per tax return (including
wage paid to tax preparer) . . . . . . . . . . .
Expected tax returns prepared per year . .
$200
$180
60,000
2Partnerships
Approaching
College Reading and
Corporations
$1,000
$2,000
$900
$1,800
Approaching
4,000
16,000
The total fixed costs per year for the company are $3,690,000.
Required
point.
c. Suppose the product sales mix changes so that, for every ten tax returns prepared, six are for
individuals, one is for a partnership, and three are for corporations. Now what is the breakeven volume for Sell Block?
3-51. Extensions of CVP AnalysisMultiple Products (finding missing data)
Clovis Supply sells two models of saddles to retail outfittersbasic and custom. Basic saddles sell
for $1,000 each and custom saddles sell for $1,500. The variable cost of a basic saddle is $600 and
that of a custom saddle is $750. Annual fixed costs at Clovis are $280,500. The break-even point at
the current sales mix is 500 total units.
Required
How many basic saddles and how many custom saddles are sold at the break-even level? In other
cor50782_ch01_001-072.indd 1
words, what is the assumed sales mix?
lan27114_ch03_080-109.indd 105
(L.O. 4)
Related Resources
in Part One.
1
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10/22/09 10:34:04 PM
REVISED PAGES
Part II
106
3.52. Extensions of the CVP Basic ModelMultiple Products and Taxes

A R ofTcanned seafood with the following prices
Assume that Ocean King Products sells threePvarieties
and costs:
mhhe.com/lanen3e
Selling Price
per Case
Variable Cost
per Case
Fixed Cost
per Month
$3
5
10
$2
3
6
$46,200
Variety 1 . . . . . . . .
Variety 2 . . . . . . . .
Variety 3 . . . . . . . .
Entire firm. . . . . . .
(L.O. 4)
Orientation
The sales mix (in cases) is 40 percent VarietyPreparing

1, 35 percent Variety
and 25 percent Variety
3.
and2, Organizing
Yourself

Required
a. At what sales revenue per month does the company break even?
b. Suppose the company is subject to a 35 percent tax rate on income. At what sales revenue per
month will the company earn $40,950 after taxes assuming the same sales mix?
(L.O. 4)
3.53. Extensions of the CVP ModelMultiple Products and Taxes

Assume that Limitless Labs, Inc., offers three basic drug-testing services for professional athletes.
Here are its prices and costs:
Price
per Unit
Basic . . . . . . . . . . . . .
Retest . . . . . . . . . . . .
Vital . . . . . . . . . . . . . .
Variable Cost
per Unit
C H A P T
$ 500
$ 120
800
400
4,000
1 Making2,800
Yourself
Units Sold
per Year
E R S850
I N
100
50
Successful
P A R T
O N E
in College
Variable costs include the labor costs of 2the medical

technicians
at the
lab. Fixed
Approaching
College
Reading
andcosts of
$390,000 per year include building and equipment
costs and the
costs of administration.
A basic
Developing
a College-Level
Vocabulary
unit is a routine drug test administered. A retest is given if there is concern about the results
of the first test, particularly if the test indicates that the athlete has taken drugs that are on the
banned drug list. Retests are not done by the
that performed
basic test. A vital
3 laboratory
Approaching
Collegethe
Assignments:
test is the laboratorys code for a high-profile case. This might be a test of a famous athlete and/
or a test that might be challenged in court. The laboratory does extra work and uses expensive
expert technicians to ensure the accuracy of vital drug tests. Limitless Labs is subject to a 40
percent tax rate.
Required
a. Given the above information, how much will Limitless Labs earn each year after taxes?
b. Assuming the above sales mix is the same at the break-even point, at what sales revenue
does
Related Resources
Limitless Labs break even?
c. At what sales revenue will the company earn $180,000 per year after taxes assuming theof above
the Annotated Instructors
sales mix?
Edition for general suggesd. Limitless Labs is considering becoming more specialized in retests and vitaltions
cases.
related to the chapters
What would be the companys break-even revenues per year if the number of inretests
Part One.
increased to 400 per year and the number of vital tests increased to 200 per year, while
the number of basic tests dropped to 100 per year? With this change in product mix, the
1
company would increase fixed costs to $420,000 per year. What would be the effect of
this change in product mix on Limitless Labss earnings after taxes per year? If the laboratorys managers seek to maximize the companys after-tax earnings, would this change
be a good idea?
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REVISED PAGES
Chapter 3
3.54. Extensions of the CVP ModelMultiple Products and Taxes

P services.
A R Here
T are its prices and
Assume that Painless Dental Clinics, Inc., offers three basic dental
costs:
Cleaning . . . . . . . . . . . .
Filling . . . . . . . . . . . . . .
Capping . . . . . . . . . . . .
Price
per Unit
Variable Cost
per Unit
$ 120
400
1,200
$ 80
300
500
107
(L.O. 4)
Units Sold
per Year
Orientation
9,000
900
100
Variable costs include the labor costs of the dental hygienists and dentists. Fixed costs of $400,000
Organizing
per year include building and equipment costs, marketing costs,Preparing
and the costs of and
administration.
Painless Dental Clinics is subject to a 30 percent tax rate on income.
Success
College
A cleaning unit is a routine teeth cleaning that takes aboutfor
45 minutes.
A filling in
unit
is the
work done to fill one or more cavities in one session. A capping unit is the work done to put a
crown on one tooth. If more than one tooth is crowned in a session, then the clinic counts one unit
per tooth (e.g., putting crowns on two teeth counts as two units).
Yourself
Required
a. Given the above information, how much will Painless Dental Clinics, Inc., earn each year after
taxes?
b. Assuming the above sales mix is the same at the break-even point, at what sales revenue does
Painless Dental Clinics, Inc., break even?
c. Assuming the above sales mix, at what sales revenue will the company earn $140,000 per year
after taxes?
C H A P Tand
E R fiSll- I N
P A R T
O N
d. Painless Dental Clinics, Inc., is considering becoming more specialized in cleanings
ings. What would be the companys revenues per year if the number of cleanings increased
to 12,000 per year, the number of fillings increased to 1,000 per year, while the number of
cappings dropped to zero? With this change in product mix, the company would increase its
fixed costs to $450,000 per year. What would be the effect of this change in product mix on
the clinics earnings after taxes per year? If the clinics managers
to maximizeCollege
the clinics
2 seek
Approaching
Reading and
after-tax earnings, would this change be a good idea?
Integrative Case

(L.O. 1, 2,Directions
3, 4, 5)
3-55. Financial Modeling

Three entrepreneurs were looking to start a new brewpub near Sacramento, California, called
Roseville Brewing Company (RBC). Brewpubs provide two products to customersfood from the
restaurant segment and freshly brewed beer from the beer production segment. Both segments are
typically in the same building, which allows customers to see the beer-brewing process.
After months of research, the owners created a financial model that showed the following
projections for the first year of operations:
Sales
Beer sales . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Food sales. . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Other sales . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$ 781,200
1,074,150
97,650
Total sales . . . . . . . . . . . . . . . . . . . . . . . . . . .
Less cost of sales . . . . . . . . . . . . . . . . . . . . . . . . .
$1,953,000
525,358
Gross margin . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Less marketing and administrative expenses . . . .
$1,427,642
1,125,430
Operating profit . . . . . . . . . . . . . . . . . . . . . . . . . . .
$ 302,212
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Related Resources
in Part One.
1
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REVISED PAGES
Part II
108
In the process of pursuing capital through private investors and financial institutions, RBC was
P A represents
R T a sample of the more common quesapproached with several questions. The following
tions asked:
What is the break-even point?

What sales dollars will be required to make $200,000? To make $500,000?
Is the product mix reasonable? (Beer tends to have a higher contribution margin ratio than
food, and therefore product mix assumptions are critical to profit projections.)
What happens to operating profit if the product mix shifts?
How will changes in price affect operating profit?
How much does a pint of beer cost to produce?
Orientation
It became clear to the owners of RBC that the initial financial model was not adequate for answering these types of questions. After further research, RBC created another financial model that
and Organizing Yourself
provided the following information for the fiPreparing
rst year of operations:
Sales
Beer sales (40% of total sales) . . . . . . . . . . . . . . . . . .
$ 781,200
Food sales (55% of total sales) . . . . . . . . . . . . . . . . . .
1,074,150
Other sales (5% of total sales) . . . . . . . . . . . . . . . . . . .
97,650
Total sales . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$1,953,000
Variable Costs
Beer (15% of beer sales) . . . . . . . . . . . . . . . . . . . . . . .
$ 117,180
Food (35% of food sales) . . . . . . . . . . . . . . . . . . . . . . .
375,953
Other (33% of other sales) . . . . . . . . . . . . . . . . . . . . . .
32,225
Wages of employees (25% of sales) . . . . . . . . . . . . . .
488,250
Supplies (1% of sales) . . . . . . . . . . . . . . . . . . . . . . . . .
19,530
Utilities (3% of sales) . . . . . . . . . . . . . . . . . . . . . . . . . .
58,590
T E R S
I N
P A R T
O N E
Other: credit card, misc. (2% of sales) . . . . . . . . . . . . . C H A P 39,060
Total variable costs . . . . . . . . . . . . . . . . . . . . . . . . . .
$1,130,788
Contribution margin . . . . . . . . . . . . . . . . . . . . . . . . . . .
$ 822,212
Fixed Costs
Salaries: manager, chef, brewer . . . . . . . . . . . . . . . . .
$ 140,000
Maintenance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
30,000
2 Approaching College
Reading and
Advertising . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
20,000
Developing
a
College-Level
Vocabulary
Other: cleaning, menus, misc. . . . . . . . . . . . . . . . . . . .
40,000
Insurance and accounting . . . . . . . . . . . . . . . . . . . . . .
40,000
Property taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
24,000
College
Depreciation . . . . . . . . . . . . . . . . . . . . . .3. . . .Approaching
.......
94,000Assignments:
Reading Textbooks
and Following Directions
132,000
Debt service (interest on debt) . . . . . . . . . . . . . . . . . . .

Total fixed costs . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$ 520,000
Operating profit. . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$ 302,212
Required
a. What were potential investors and financial institutions concerned with when asking the
quesRelated Resources
tions listed in the case?
b. Why was the first financial model prepared by RBC inappropriate for answering mostof of
thethe
Annotated Instructors
questions asked by investors and bankers? Be specific.
Edition for general suggesc. If you were deciding whether to invest in RBC, how would you quickly check the reasonabletions related to the chapters
ness of RBCs projected operating profit?
in Part One.
d. Why is the question How much does a pint of beer cost to produce? difficult to answer?
e. Perform sensitivity analysis by answering the following questions.
1.
2.
3.
4.
cor50782_ch01_001-072.indd 1
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What is the break-even point in sales dollars for RBC?

What is the margin of safety for RBC?
Why cant RBC find the break-even point in units?
What sales dollars would be required to achieve an operating profit of $200,000?
$500,000? What assumptions are made in this calculation?
( Kurt Heisinger, 2009)
10/5/09 11:09:29 PM
10/22/09 10:34:04 PM
REVISED PAGES
Chapter 3
Solutions to Self-Study Questions

1.
P A R T
a. Operating profit:
Profit PX VX F
$360,000 $240,000 $60,000
$60,000
b.
109
Orientation
Break-even point:
F
X ______
PV
$60,000 ($90 $55 $5) $60,000 $30 2,000 units

c.
Target volume in units: Profit $120,000

F Target profit
X _______________
PV

($60,000 $120,000) $30 6,000 units

d. Target volume in sales dollars: Profit $20,000
Contribution margin ratio $30 $90 .333 (rounded)
F Target profit
PX _____________________
($60,000 $20,000) .333 $240,000
e. Number of units sold in March
X $360,000 $90 4,000 units
f. Number of units sold to produce an operating profit of 20 percent of sales C
H A P T E R S
I N
P A R T
O N E
PX VX F 20%PX
$90X $60X (20%)($90)X $60,000
($90 $60 $18)X $60,000
X $60,000 $12 5,000 units 2 Approaching College Reading and

After-tax profits [(P V)X F](1 t)
$48,750 [($15 $7)X $60,000](1 .35)
$48,750 ($8X $60,000)(.65)
($48,750 .65) $8X $60,000
$75,000 $60,000 $8X
$8X $135,000
X $135,000 $8
X 16,875 units
2.
3.
Based on the current mix of tent spaces and RV spaces, the sales mix at HDC is 40% ( 6,000
15,000) tent spaces and 60% ( 9,000 15,000) RV spaces. The weighted-average contribution
margin for HDC is:
.40 ($6 $3) .60 ($15 $7) $6
The multiple-product break-even point can be determined by the break-even formula:
X Fixed costs Weighted-average contribution margin per unit
$60,000 $6 10,000 units
At the current sales mix, this would be 4,000 tent spaces (40% of 10,000 units) and 6,000 RV
spaces (60% of 10,000 units).
cor50782_ch01_001-072.indd 1
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Related Resources
in Part One.
1
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L.O.5 Understand the assumptions and limitations of CVP analysis.

Making Yourself Successful in College

Approaching College Reading and

Approaching College Assignments:

read that managers can calculate the price they need

Jamaal Kidd was discussing the photo-finishing store that

Preparing and Organizing Yourself

Approaching College Assignments:

Cost-Volume-Profit Analysis and Airline Pricing

The Sabre study showed that when planes are

Cost Analysis and Estimation

TC VX 2 F Approaching College Reading and

Developing a College-Level Vocabulary

Profit 3PX Approaching

Reading Textbooks and Following Directions

Collecting terms gives

Profit (Price Variable costs) Units of output Fixed costs

We defined contribution margin in Chapter 2 as the difference between the sales