Cost-Volume-Profit Analysis: A Managerial Planning Tool: Discussion Questions

CHAPTER 4
COST-VOLUME-PROFIT ANALYSIS:
A MANAGERIAL PLANNING TOOL
DISCUSSION QUESTIONS
1. CVP analysis allows managers to focus on 8. Packages of products, based on the
selling prices, volume, costs, profits, and expected sales mix, are defined as a single
sales mix. Many different “what-if” questions product. Selling price and cost information for
can be asked to assess the effect of changes this package can then be used to carry out
in key variables on profits. CVP analysis.
2. The units sold approach defines sales 9. This statement is wrong; break-even analysis
volume in terms of units of product and gives can be easily adjusted to focus on target
answers in these same terms. The unit profit.
contribution margin is needed to solve for the
10. The basic break-even equation is adjusted
break-even units. The sales revenue
for target profit by adding the desired target
approach defines sales volume in terms of
revenues and provides answers in these profit to the total fixed costs in the numerator.
same terms. The overall contribution margin The denominator remains the contribution
ratio can be used to solve for the break-even margin per unit.
sales dollars. 11. A change in sales mix will change the
3. Break-even point is the level of sales activity contribution margin of the package (defined
where total revenues equal total costs, or by the sales mix), and thus will change the
where zero profits are earned. units needed to break even.
4. At the break-even point, all fixed costs are 12. Margin of safety is the sales activity in excess
covered. Above the break-even point, only of that needed to break even. The higher the
variable costs need to be covered. Thus, margin of safety, the lower the risk.
contribution margin per unit is profit per unit,
provided that the unit selling price is greater 13. Operating leverage is the use of fixed costs to
than the unit variable cost (which it must be extract higher percentage changes in profits
for break even to be achieved). as sales activity changes. It is achieved by
increasing fixed costs while lowering variable
5. Variable cost ratio = Variable costs/Sales costs. Therefore, increased leverage implies
Contribution margin ratio increased risk, and vice versa.
= Contribution margin/Sales 14. Sensitivity analysis is a “what-if” technique
Contribution margin ratio that examines the impact of changes in
= 1 – Variable cost ratio underlying assumptions on an answer. A
company can input data on selling prices,
6. No. The increase in contribution is $9,000 (0.3 variable costs, fixed costs, and sales mix and
× $30,000), and the increase in advertising is set up formulas to calculate break-even
$10,000. If the contribution margin ratio is
points and expected profits. Then, the data
0.40, then the increased contribution is
can be varied as desired to see what impact
$12,000 (0.4 × $30,000). This is $2,000 above
the increased advertising expense, so the changes have on the expected profit.
increased advertising would be a good 15. A declining margin of safety means that sales
decision. are moving closer to the break-even point.
7. Sales mix is the relative proportion sold of Profit is going down, and the possibility of
each product. For example, a sales mix of 3:2 loss is greater. Managers should analyze the
means that three units of one product are reasons for the decreasing margin of safety
sold for every two of the second product. and look for ways to increase revenue and/or
decrease costs.
Copyright © 2018 by Nelson Education Ltd. 4-1

CORNERSTONE EXERCISES
Cornerstone Exercise 4–1
1. Variable cost per unit = Direct materials + Direct labour

+ Variable factory overhead + Variable selling expense
= $30 + $5 + $12 + $2
= $49
2. Total fixed expense = $14,000 + $15,400 = $29,400
3. Head-First Company
Contribution Margin Income Statement
For the Coming Year
Total Per Unit
Sales ($70 × 5,000 helmets).................................. $350,000 $70
Total variable expense ($49 × 5,000) ................... 245,000 49
Total contribution margin .................................... 105,000 $21
Total fixed expense............................................... 29,400
Operating income ................................................ $ 75,600
Total fixed cost

1. Break-even units =
(Price - Unit variable cost)
$29,400
=
($70 - $49)
= 1,400 helmets
At Break-Even
Total
Sales ($70 × 1,400 helmets)....................................................... $98,000
Total variable expense ($49 × 1,400) ........................................ 68,600
Total contribution margin ......................................................... 29,400
Total fixed expense.................................................................... 29,400
Operating income ...................................................................... $ 0
4-2 Copyright © 2018 by Nelson Education Ltd.

1. Variable cost ratio = Variable cost per unit

Price
= $49
$70
= 0.70, or 70%
2. Contribution margin ratio = (Price - Variable cost per unit)

Price
= ($ 7 0 - $ 4 9 )
$70
= 0.30, or 30%
For the Coming Year
Percent
of Sales
Sales ($70 × 5,000 helmets).................................. $350,000 100%
Total variable expense ($49 × 5,000) ................... 245,000 70
Total contribution margin .................................... 105,000 30
Total fixed expense............................................... 29,400
Operating income ................................................ $ 75,600
Total fixed cost

1. Break-even sales dollars =
Contribution margin ratio
$29,400
=
0.30
= $98,000

Cornerstone Exercise 4–4 (Continued)
At Break-Even
Total
Sales ........................................................................................... $98,000
Total variable expense ($98,000 × 0.70) ................................... 68,600
(Total fixed cost + Target income)

($29,400 + $81,900)
=
($70 - $49)
= 5,300 helmets
At 5,300 Helmets Sold
Total
Sales ($70 × 5,300 helmets)....................................................... $371,000
Total variable expense ($49 × 5,300) ........................................ 259,700
Operating income ...................................................................... $ 81,900
(Total fixed cost + Target income)

1. Sales for target income =
= ($29,400 + $81,900)
0.30
= $371,000

At Sales Revenue of $371,000
Total
Sales ........................................................................................... $371,000
Total variable expense ($371,000 × 0.70) ................................. 259,700
Operating income ...................................................................... $ 81,900
3. A contribution margin income statement helps managers make better decisions

in that it focuses their attention on those areas that are easiest to control.
Variable costs are usually more easily controlled than fixed costs.
1. Any package with 5 bicycle helmets for every 1 motorcycle helmet is fine; for
example, 5:1, or 10:2, or 30:6. Throughout the rest of this exercise, we will use
5:1.
Unit Unit Package Unit

Variable Contribution Sales Contribution
Product Price Cost Margin Mix Margin
Bicycle helmet $ 70 $ 49 $21 5 $105
Motorcycle helmet 220 143 77 1 77
Package total $182

Fixed cost
2. Break-even packages =
Package contribution margin
= $54,600
$182
= 300 packages
Break-even bicycle helmets = Number of packages × Sales mix amount

= 300 × 5
= 1,500
Break-even motorcycle helmets = Number of packages × Sales mix amount

= 300 × 1
= 300
At Break-Even
Total
Sales [($70 × 1,500) + ($220 × 300)] .......................................... $171,000
Total variable expense [($49 × 1,500) + ($143 × 300)] ............. 116,400
1. Contribution margin ratio = ($570,000 - $388,000)

$570,000
= 0.3193
Total fixed cost

Break-even sales dollars =
$54,600
=
0.3193
= $170,999

At Break-Even Sales Dollars
Total
Sales ........................................................................................... $170,999
Total variable expense ($170,999 × 0.6807) ............................. 116,399
1. Margin of safety in units = Budgeted units – Break-even units

= 5,000 – 1,400
= 3,600
2. Margin of safety in sales revenue = Budgeted sales – Break-even sales
= $350,000 – $98,000
= $252,000
Total contribution margin

Degree of operating leverage =
Operating income
$105,000*
= = 1.4
$75,600
* 5,000 × ($70 - $49)
1. Percent change in operating income = DOL × % Change in sales

= 1.4 × 15%
= 21%
2. Expected operating income = Original income + (% Change × Original income)
= $75,600 + (0.21 × $75,600) = $91,476

EXERCISES
Exercise 4–12
1. Direct materials .......................................................................... $ 5.85
Direct labour ............................................................................... 2.10
Variable overhead ...................................................................... 3.15
Variable selling and administrative expense ........................... 2.40
Unit variable cost ....................................................................... $13.50
Unit contribution margin = Price – Unit variable cost
= $24.00 – $13.50
= $10.50
2. Contribution margin ratio = $10.50 = 0.4375, or 43.75%

$24
Variable cost ratio = $13.50 = 0.5625, or 56.25%

$24
3. Break-even units ($78,000 + $56,925) / ($24 - $13.50) = 12,850
4. Sales ($24 × 12,850) ................................................................... $308,400

Variable costs ($13.50 × 12,850) ............................................... 173,475
Total contribution margin .................................................... 134,925
Less: Fixed expenses ($78,000 + $ 56,925).............................. 134,925
Operating income ................................................................. $ 0
Exercise 4–13
1. Unit variable cost = $19.00 × 0.60 = $11.40
Unit contribution margin = $19.00 – $11.40 = $7.60
2. Break-even units = $874,000 = 115,000

$7.60

Exercise 4–13 (Continued)
3. Break-even sales revenue = $19.00 × 115,000 = $2,185,000

OR
$874,000
Break-even sales revenue = = $2,185,000
0.40
4. Sales ........................................................................................... $2,185,000

Less: Variable costs (0.6 x $2,185,000) .................................... 1,311,000
Contribution margin .................................................................. 874,000
Less: Fixed costs ....................................................................... 874,000
5. Break-even operations always result in a profit of zero.
Exercise 4–14
1. Contribution margin ratio ($481,250/$875,000) = 55%
2. Variable cost ratio ($393,250/$4875,000) = 45%
3. Break-even sales revenue ($327,000/.55) = $594,546 (rounded up).

Exercise 4–15
1. Contribution Margin Income Statement
Starfirst Company
Sales $1,575,000
Variable costs 1,222,500
Contribution margin 352,500
Fixed costs 183,300
Operating income $ 169,200
2. Break-even point in units

Contribution margin per unit: $42 - $32.60 = $9.40
Break-even point in units: $183,300/$9.40 = 19,500 units
3. Units needed to generate $200,000 in operating income

Fixed costs + Target profit = $183,300 + $200,000 = $383,300
Units required = $383,300/$9.40 = 40,777 units (rounded)
Exercise 4–16
1. Unit variable cost includes all variable costs on a unit basis:

Direct materials..................................................................... $0.27
Direct labour ......................................................................... 0.58
Variable overhead................................................................. 0.63
Variable selling ..................................................................... 0.17
Unit variable cost.................................................................. $1.65
Unit variable manufacturing cost includes the variable costs of production on a
unit basis:
Direct materials..................................................................... $0.27
Direct labour ......................................................................... 0.58
Variable overhead................................................................. 0.63
Unit variable manufacturing cost ........................................ $1.48
Unit variable cost is used in CVP because it includes all variable costs, not just
manufacturing costs.

($131,650 + $18,350)
($2.45 - $1.65)
= $150,000
$0.80
= 187,500
($131,650 + $18,350 + $12,600)
3. Units to earn $12,600 =
($2.45 - $1.65)
= 203,250
4. Sales revenue to earn $12,600 = 203,250 × $2.45 = $497,962.50

or
$131,650 + $18,350 + $12,600 = $162,600 ÷ .3265* = $498,009
*contribution margin ratio = ($2.45 – $1.65) ÷ $2.45 = 0.3265 (rounded)
Exercise 4–17
1. Contribution margin = Sales – variable costs = $11.75 - $6.58 = $5.17

Break-even in units = Fixed costs/ CM per unit = $1,500,437/$5.17 =
290,220 *
2. Margin of safety = Sales volume – Break-even sales = 570,000 – 290,220

= 279,780 units
3. Contribution margin ratio = CM/Sales = $5.17/$11.75 = 44%

Break-even sales in dollars = Fixed costs / Contribution margin ratio
= $1,500,437/.44 = $3,410,084
Sales dollars = $11.75 x 570,000 = $6,697,500
Margin of safety = Sales dollars – Break-even dollars = $6,697,500 -
$3,410,084 = $3,287,416
*Rounded

Exercise 4–18
A B C D
Sales $15,000 $15,600* $16,250* $10,600
Total variable costs 5,000 11,700 9,750 5,300*
Total contribution margin 10,000 3,900 6,500* 5,300*
Total fixed costs 9,500* 4,000 6,136* 4,452
Operating income (loss) $ 500 $ (100)* $ 364 $ 848
Units sold 3,000* 1,300 125 1,000

Price per unit $5.00 $12* $130 $10.60*
Variable cost per unit $1.67* $9 $78* $5.30*
Contribution margin per unit $3.33* $3 $52* $5.30*
Contribution margin ratio 67%* 25%* 40% 50%*
Break-even in units 2,853* 1,333* 118* 840*
*Designates calculated amount.
(Note: Calculated break-even units that include a fractional amount have been
rounded to the nearest whole unit.)
Exercise 4–19
1. Variable cost ratio: Variable cost/Sales revenue = $303,885/$675,300 = 45%
Contribution margin ratio = CM/Sales = $371,415/$675,300 = 55%
2. If sales increase by $50,000, operating income increases by

$50,000 x CM ratio = $50,000 x 0.55 = $27,500
3. Sales revenue needed to break even:

Fixed costs/CM ratio = $247,610/0.55 = $450,200
Revenue $450,200
Variable expenses 202,590
Fixed expenses 247,610
Operating income 0
4. Expected margin of safety = Sales revenue – Break-even sales revenue

= $675,300 – $450,200 = $225,100
5. Margin of safety if sales are $500,000 = $500,000 – $450,200 = $49,800

Exercise 4–20
1. Sales mix is 2:1 (twice as many DVDs are sold as equipment sets).
2. Variable Sales Total

Product Price – Cost = CM × Mix = CM
DVDs $12 $4 $8 2 $16
Equipment sets 15 6 9 1 9
Total $25
Break-even packages = $70,000 = 2,800

$25
Break-even DVDs = 2 × 2,800 = 5,600
Break-even equipment sets = 1 × 2,800 = 2,800

Exercise 4–21
1. Sales mix is 2:1:4 (twice as many DVDs will be sold as equipment sets, and four
times as many yoga mats will be sold as equipment sets).

DVDs $12 $4 $8 2 $16
Equipment sets 15 6 9 1 9
Yoga mats 18 13 5 4 20
Total $45

$45
Break-even DVDs = 2 × 2,630 = 5,260
Break-even equipment sets = 1 × 2,630 = 2,630
Break-even yoga mats = 4 × 2,630 = 10,520
3. Switzer Company
Income Statement
For the Coming Year
Sales ........................................................................................... $555,000
Less: Total variable costs ......................................................... 330,000
Contribution margin ............................................................. 225,000
Less: Total fixed costs .............................................................. 118,350
Operating income ................................................................. $106,650
$225,000
Contribution margin ratio = = 0.405, or 40.5%
$555,000
Break-even revenue = $118,350 = $292,222

0.405
4. Margin of safety = $555,000 – $292,222 = $262,778

Exercise 4–22
1. Sales mix is 3:5:1 (three times as many small basics will be sold as carved
models and five times as many large basics will be sold as carved models).

Small basic $180 $105 $75 3 $225
Large basic 300 225 75 5 375
Carved 525 412 113 1 113
Total $713
Break-even packages = $669,750 = 940 (rounded up)

$713
Break-even small basic models = 3 × 940 = 2,820
Break-even large basic models = 5 × 940 = 4,700
Break-even carved models = 1 × 940 = 940
3. Sonora Company
Income Statement
For the Coming Year
Sales ........................................................................................... $25,650,000
Less: Total variable costs ......................................................... 18,520,000
Contribution margin ............................................................. 7,130,000
Less: Total fixed costs .............................................................. 669,750
Operating income ................................................................. $ 6,460,250
$7,130,000
Contribution margin ratio = = 0.2780, or 27.80%
$25,650,000
$669,750
Break-even revenue = = $2,409,173
0.2780
4. Margin of safety = $25,650,000 – $2,409,173 = $23,240,827

Exercise 4–23
35,000
30,000
Revenue and Cost ($)
25,000
X
20,000
15,000
10,000
X
5,000
0
0 500 1,000 1,500 2,000 2,500 3,000 3,500
Units Sold
Break-even point = 2,500 units; + line is total revenue, and X line is total cost.

2. a. Fixed costs increase by $5,000:
40,000
X
35,000
30,000
25,000
20,000
15,000 X
10,000
5,000
0
0 500 1,000 1,500 2,000 2,500 3,000 3,500 4,000
Units Sold
Break-even point = 3,750 units

2. b. Unit variable cost increases to $7:
50,000
40,000
X
30,000
20,000
X
10,000
0
0 500 1,000 1,500 2,000 2,500 3,000 3,500 4,000
Units Sold

2. c. Selling price increases to $12:
60,000
50,000
40,000
30,000
20,000 X
10,000
X
0
0 500 1,000 1,500 2,000 2,500 3,000 3,500 4,000
Units Sold

2. d. Both fixed costs and unit variable cost increase:
70,000
60,000
50,000 X
40,000
30,000
20,000 X
10,000
0
0 1,000 2,000 3,000 4,000 5,000 6,000 7,000
Units Sold
Exercise 4–24
1. Unit contribution margin: $75 - $24.75 = $50.25 per unit

Fixed costs $984,025
Break-even units: = = 19,583 units
Contribution margin $50.25
2. Sell 30,000 units above break-even

Operating income increases by the contribution margin.
Contribution margin for 30,000 units = 30,000 x $50.25= $1,507,500
Contribution margin $50.25

3. Contribution margin ratio = = = 67%
Sales $75
Fixed costs $984,025
Break-even in dollars = = = $1,468,694 *
CM ratio .67
Revenues up by $500,000 to $2,300,000, then
CM at new level = $2,300,000 x .67 = $1,541,000
New operating income = CM – fixed costs = $1,541,000 - $984,025 =
$556,975
*rounded up

Exercise 4–25
$1,833,300
1. Break-even sales dollars = = $3,160,862
0.58 *
$2,610,000
*Contribution margin ratio = = 0.58, or 58%
$4,500,000
2. Margin of safety = $4,500,000 – $3,160,862 = $1,339,138
Contribution margin
3. Degree of operating leverage =
Operating income
$2,610,000
=
$776,700
= 3.36
4. Percent change in operating income = 3.36 × 0.20 = 0.67

New operating income = $776,700 + (0.67 × $776,700) = $1,297,089
Exercise 4–26
1. Variable Sales Package

Vases $100 $75 $25 2 $ 50
Figurines 175 105 70 1 70
Total $120
Break-even packages = $75,000 = 625

$120
Break-even vases = 2 × 625 = 1,250
Break-even figurines = 1 × 625 = 625

2. The new sales mix is 3 vases to 2 figurines.

Variable Sales Package
Vases $100 $75 $25 3 $ 75
Figurines 175 105 70 2 140
Total $215
Break-even packages = $88,150 = 410

$215
Break-even vases = 3 × 410 = 1,230
Break-even figurines = 2 × 410 = 820
3. It is better to use contribution margin ratio in determining break-even for a

multi-product company because it makes the calculations easier when dealing
with sales mix.
Exercise 4–27
$6,720,000
1. a. Variable cost per unit = = $19.20
350,000
$1,680,000
b. Contribution margin per unit = = $4.80
350,000
c. Contribution margin ratio = $4.80 = 0.20, or 20%

$24.00
d. Break-even units = $1,512,000 = 315,000

$4.80
e. Break-even sales dollars = $1,512,000 = $7,560,000

0.20
OR
Break-even sales dollars = 315,000 × $24 = $7,560,000

2. Units for target income = ($1,512,000 + $300,000) = 377,500

$4.80
3. Additional operating income = $50,000 × 0.20 = $10,000
4. Margin of safety in units = 350,000 – 315,000 = 35,000 units

Margin of safety in sales dollars = $8,400,000 – $7,560,000 = $840,000
$1,680,000
5. Degree of operating leverage = = 10.0
$168,000
6. New operating income = $168,000 + [(10 × 0.10) ($168,000)] = $336,000

PROBLEMS
Problem 4–28
1. Break-even point in units = Fixed costs/Contribution margin per unit
= $3,213,924/$21 = 153,044 units
2. Units to sell to earn $2,700,000 = (Fixed costs + Target profit)/CM per

unit
= ($3,213,924 + $2,700,000)/$21 = 281,616*
3. Contribution margin ratio = CM/Sales = $21/$60 = 35%

Sales increase by $300,000; Additional operating income = Increased
sales * CM ratio = $300,000 x .35 = $105,000
4. Margin of safety = Sales – Break-even sales

Sales in units = $13,800,000/$60 = 230,000 units
Break-even sales in units = Fixed costs/CM per unit = $3,213,924/$21
= 153,044 units
Margin of safety = 230,000 units – 153,044 units = 76,956 units
*rounded up

Problem 4–29
Fixed cost
$96,000
=
($10 - $5)
= 19,200 units
($96,000 - $13,500)
($10 - $5)
= 16,500 units
3. The reduction in fixed costs reduces the break-even point because less
contribution margin is needed to cover the new, lower fixed costs. Operating
income goes up, and the margin of safety also goes up.
Problem 4–30
1. Unit contribution margin = $5,760,000 = $15

384,000
Break-even point = $3,000,000 = 200,000 units

$15
Contribution margin ratio = $15 = 0.3

$50
$3,000,000
Break-even sales = = $10,000,000
0.3
OR
= $50 × 200,000 = $10,000,000
2. Increased contribution margin ($3,000,000 × 0.3) ................... $900,000

Less: Increased advertising expense ...................................... 300,000
Increased profit..................................................................... $600,000

Problem 4–30 (Continued)
3. $945,000 × 0.3 = $283,500
4. We can simply focus on increased sales revenue to determine profitability

because any increase in profit will automatically add the gross margin of those
sales to profit. The fixed costs do not change.
5. Margin of safety = $19,200,000 – $10,000,000 = $9,200,000
$5,760,000
6. = 2.09 (operating leverage)
$2,760,000
20% × 2.09 = 41.8% (profit increase)
Problem 4–31
1. Sales mix:
Squares: $300,000 = 10,000 units
$30
Circles: $2,500,000 = 50,000 units

$50
Variable Contribution Sales Total

Product Price – Cost* = Margin × Mix = CM
Squares $30 $10 $20 1 $ 20
Circles 50 10 40 5 200
Package $220
$100,000
* = $10
10,000
$500,000
= $10
50,000
Break-even packages = $1,628,000 = 7,400 packages

$220
Break-even squares = 7,400 × 1 = 7,400
Break-even circles = 7,400 × 5 = 37,000

2. New mix:
Product Price – Cost = Margin × Mix = CM
Squares $30 $10 $20 3 $ 60
Circles 50 10 40 5 200
Package $260
Break-even packages = $1,628,000 = 6,262 packages
$260
Break-even squares = 6,262 × 3 = 18,786
Break-even circles = 6,262 × 5 = 31,310
3. Increase in contribution margin for squares (25,000 × $20)... $ 500,000

Decrease in contribution margin for circles (5,000 × $40)...... (200,000)
Increase in total contribution margin ................................. 300,000
Less: Additional fixed expenses .............................................. 245,000
Increase in income ............................................................... $ 55,000
Kenno would gain $55,000 by increasing advertising for the squares. This is
a good strategy.
Problem 4–32
1. Break-even point in units = Fixed costs / Unit contribution margin per
unit
Contribution margin per unit = $0.90 - $0.63 = $0.27
Break-even = $210,600 / $0.27 = 780,000 bottles
Margin of safety = Sales volume – Break-even volume
830,000 bottles – 780,000 bottles = 50,000 bottles
2. Revenue $747,000 ($0.90 x 830,000)

Variable costs 522,900 ($0.63 x 830,000)
Fixed costs 210,600

3. Units to generate $40,500 in profit = (Fixed costs + Target profit)/CM

($210,600 + $40,500)/$0.27 = 930,000 bottles
4. Sales dollars to earn operating income of 20% of sales

(Fixed costs + 0.2 × Sales)/Contribution margin% = Sales
CM% = ($0.90 – $0.63)/$0.90 = 30%
(210,600 + 0.2X)/CM% = X
702,000 + 0.6667X = X
0.3333X = 702,000
X = $2,106,211
Problem 4–33
$302,616
1. Contribution margin ratio = = 0.54, or 54%
$560,400
2. Break-even revenue = $150,000 = $277,778

0.54
3. $560,400 × 110% = $616,440

$257,784 × 110% = 283,562
$332,878
$332,878
Contribution margin ratio = = 0.54
$616,440
The contribution margin ratio remains at 0.54.
4. Additional variable expense: $560,400 × 0.03 = $16,812

New contribution margin = $302,616 – $16,812 = $285,804
$285,804
New contribution margin ratio = = 0.51
$560,400
Break-even revenue = $150,000 = $294,118

0.51
The effect is to increase the break-even revenue.

5. Present contribution margin ..................................................... $302,616
Projected contribution margin* ................................................ 326,604
Increase in contribution margin/profit ..................................... $ 23,988
*($560,400 + $80,000) × 0.51 = $326,604
Operating leverage will decrease from 1.98 ($302,616/$152,616) to 1.85

($326,604/$176,604) because the increase in the contribution margin of $23,988
is exactly equal to the increase in the operating income, which results in a
decrease in the operating leverage.
Alonzo should pay the commission because profit would increase by $23,988.
Problem 4–34
Fixed cost
1. Revenue =
(1 - Variable rate)
$150,000
=
(1/3)
= $450,000
2. Of total sales revenue, 60 percent is produced by floor lamps and 40 percent

by desk lamps.
$360,000 = 12,000 units

$30
$240,000 = 12,000 units

$20
Thus, the sales mix is 1:1.


Floor lamps $30 $20.00 $10.00 1 $10.00
Desk lamps 20 13.33 6.67 1 6.67
Package $16.67
Fixed cost
Number of packages =
(Package contribution margin)
= $150,000
$16.67
= 8,998 packages
Floor lamps: 1 × 8,998 = 8,998

Desk lamps: 1 × 8,998 = 8,998
Contribution margin
3. Operating leverage =
Operating income
$200,000
=
$50,000
= 4.0
Percentage change in profits = 4.0 × 40% = 160%

4. The theory behind the operating leverage concept is that a company will
increase its profits in direct relationship to the relationship between its fixed
costs and its variable costs. The more fixed costs a company has the more
impact an increase in revenues will have on profit because its fixed costs have
been covered.

Problem 4–35
1. Door Handles Trim Kits

CM $12 – $9 = $3 $8 – $5 = $3
CM ratio $3/$12 = 0.25 $3/$8 = 0.375
2. Contribution margin:
($3 × 20,000) + ($3 × 40,000) $180,000
Less: Fixed costs 146,000
3. Sales mix (from Requirement 2): 1 door handle to 2 trim kits
Price – V = CM × Sales Mix = Total CM

Door handle $12 $9 $3 1 $3
Trim kit 8 5 3 2 6
Package $9
$9
Door handles = 1 × 16,222 = 16,222
Trim kits = 2 × 16,222 = 32,444
4. Revenue (70,000 × $8) ............................................................... $560,000

Variable cost (70,000 × $5) ........................................................ 350,000
Fixed costs ................................................................................. 111,000
Operating income ................................................................. $ 99,000
Yes, operating income is $65,000 higher than when both door handles and trim
kits are sold.

Problem 4–36
Fixed costs
1. Break-even in units =
Contribution margin per unit
$604,800
Contribution margin per unit = = $16.80
36,000
$504,000
Break-even in units= = 30,000 units
$16.80
Fixed costs
Break-even in dollars =
CM%
$604,800
CM = = 40%
$1,512,000
$504,000
Break-even in dollars = = $1,260,000
.4
$1,260,000
Proof: = 30,000 units
$42
2. Margin of safety = Actual units – Break-even units =

36,000 – 30,000 = 6,000 units
3. Fixed costs go up by $250,000 to $754,000; Variable costs are lowered to 45%

of sales.
Revenue $1,512,000
Variable costs (45%) 680,400
Fixed costs 754,000
Fixed costs
Break-even in units =
CM/unit
$831,600
CM per unit = = $23.10
36,000
$754,000
Break-even in units = = 32,641 units *
$23.10
$754,000
Break-even in dollars = = $1,370,909 *rounded up
.55

Problem 4–37
Steven Kissick, Lawyer
Contribution Income Statement
Revenue $180,000
Variable costs
Direct 66,000
Indirect 17,500
Fixed costs
Direct 88,000
Indirect 110,000
Operating income/(Loss) (101,500)
Income tax (27.5%) 0
Net loss $(101,500)
Fixed costs
1. Break-even revenue =
Contribution margin
Contribution margin ratio =
Revenue
$96,500
= 53.61%
$180,000
($88,000 + $110,000)
= $369,334 *rounded
0.5361
2. To generate $150,000 after tax income, the pre-tax income

$150,000
must be =
(1 - Tax rate)
Pre-tax income is = $206,897
(Fixed cost + Target profit)
Target revenue =
CM%
($198,000 + $206,897)
= $755,264 *rounded up
0.5361
3. At $350 per hour, it would appear that this target is not reasonable. Based
on a 40-hour week and 50 working weeks of the year, there are 2,000
hours in a normal work year. Kissick would have to bill 2,158 hours per
year to achieve his objective. If he raised his rate to $380, his goal would
be realized.

Problem 4–38
1. Revenue – Variable costs – Fixed costs = Operating profit
At break-even, profit = 0
27,500X = 22,500 + 62,400
27,500X = 84,900
X = $3.09 rounded up
2. Revenue – Variable costs – Fixed costs = Operating income

(Fixed costs + Operating income)
= Revenue
(X + $33,000)
= $228,000
0.35
X  $33,000 
= $228,000 –  
.35  0.35 
X = (228,000 – $94,286) × 0.35
X = $46,800
3. Revenue – Variable cost – Fixed cost = Operating income

$800,000 – (X*$800,000) – $220,000 = 0
(X*$800,000) = $800,000 – $220,000
$580,000
X= = 72.5%
$800,000

Problem 4–39
1. Contribution margin per unit = $5.60 – $4.20*

= $1.40
*Variable costs per unit:
$0.70 + $0.35 + $1.85 + $0.34 + $0.76 + $0.20 = $4.20
Contribution margin ratio = $1.40 = 0.25
$5.60
2. Break-even in units = ($32,300 + $12,500) = 32,000 boxes

$1.40
Break-even in sales = 32,000 × $5.60 = $179,200
OR
= ($32,300 + $12,500) = $179,200
0.25
3. Sales ($5.60 × 35,000) ................................................................ $196,000

Variable costs ($4.20 × 35,000) ................................................. 147,000
Fixed cost ................................................................................... 44,800
Operating income ................................................................. $ 4,200
4. Margin of safety = $196,000 – $179,200 = $16,800
$44,800
5. Break-even in units = = 22,400 boxes
($6.20 - $4.20)
New operating income = $6.20(31,500) – $4.20(31,500) – $44,800
= $195,300 – $132,300 – $44,800 = $18,200
Yes, because operating income will increase by $14,000 ($18,200 – $4,200).
Problem 4–40
$100,000
1. Company A: =2
$50,000
$300,000
Company B: =6
$50,000

2. Company A Company B
$50,000 $250,000
X= X=
(1 - 0.8) (1 - 0.4)
X = $50,000 X = $250,000
0.2 0.6
X = $250,000 X = $416,667
Company B must sell much more than Company A to break even because it
must cover $200,000 more in fixed costs (it is more highly leveraged).
3. Company A: 2 × 50% = 100%

Company B: 6 × 50% = 300%
The percentage increase in profits for Company B is much higher than

Company A’s increase because Company B has a much higher degree of
operating leverage (i.e., it has a larger amount of fixed costs in proportion to
variable costs as compared to Company A). Once fixed costs are covered,
additional revenue must cover only variable costs, and 60 percent of Company
B’s revenue above break even is profit, whereas only 20 percent of Company
A’s revenue above break even is profit.
Problem 4-41
1. Total sales = $500,000 + $1,080,000 + $2,760,000 + $3,600,000 = $7,940,000
Total variable costs = $300,000 + $630,000 + $1,650,000 + $2,350,000 + $25,000

+ $150,000 + $240,000 + $213,000 = $5,558,000
Contribution margin = $7,940,000 - $5,558,000 = $2,382,000
Contribution margin % = $2,382,000 / $7,940,000 = 30%
Total fixed costs = $25,000 + $220,000 + $300,000 + $300,000 + $64,200 + $50,000

+ $50,000 + $150,000 + $270,000 = $1,429,200
Revenue needed to break-even = $1,429,200 /.30 = $4,764,000

Problem 4-41 (Continued)
2. Contribution Margin Per Product
Product A Product B Product C Product D

Revenue $500 $1,800 $9,200 $36,000
Variable
Product 300 1,050 5,500 23,500
Sell/Admin 25 250 800 2,130
Contribution $175 $ 500 $2,900 $10,370
Package of products: A= 10; B= 6; C= 3; D= 1
Contribution per package: (10 x 175) + (6 x 500) + (3 x 2,900) + (1 x 10,370) =

$23,820
Packages required to break-even:
Fixed costs ($1,429,200) divided by contribution per package ($23,820) = 60.
Quantity of each product: A=60 x 10 = 600; B= 60 x 6 = 360; C= 60 x 3 = 180; D=

60 x 1 = 60.
Calculation to check: Revenue = (600 x $500) + (360 x $1,800) + (180 x $9,200) +

(60 x $36,000) = $300,000 + $648,000 + $1,656,000 + $2,160,000) = $4,764,000.
3. After-tax profit of $1,625,000 is pre-tax profit of ($1,625,000 divided by (1 - .35))

or $2,500,000.
Fixed costs plus target profit = $1,429,200 + $2,500,000 = $3,929,200.
Target revenues = $3,929,200 divided by contribution margin ratio of .30 or

$13,097,333.

Problem 4-41 (Continued)
4. After-tax profit of $1,300,000 is pre-tax profit of $2,000,000.
Target units are calculated by taking the fixed costs plus the target pre-tax profit
divided by the contribution margin per package and then calculating the number
of each unit in a package.
Fixed costs ($1,429,200) plus target profit ($2,000,000) = $3,429,200
Target packages: $3,429,200 / $23,820 = 144 packages (rounded)
By product: A: 10 x 144 = 1,440; B: 6 x 144 = 864; C: 3 x 144 = 432; D: 1 x 144 =

144.

Problem 4–42
1. Contribution margin calculated in Problem 4-41 was:
Revenue $7,940,000
Less: Variable costs 5,558,000
Contribution $2,382,000
Revised contribution margin

Revenue $7,940,000
Less: Variable costs 6,113,800
Contribution $1,826,200
Contribution margin % 23%
Revised contribution margin by product
Product A: $500 – [1.1 ($300 + $25)] = $ 142.50

Product B: $1,800 – [1.1 ($1,050 + $250)] = $ 370
Product C: $9,200 – [1.1 ($5,500 + $800)] = $2,270
Product D: $36,000 – [1.1 ($23,500 + $2,130)] = $7,807
Revised contribution by package
Product A: 10 x $142.50 = $ 1,425

Product B: 6 x $370 = $ 2,220
Product C: 3 x $2,270 = $ 6,810
Product D: 1 x $7,807 = $ 7,807
Total revised package contribution $18,262
Revised fixed costs $1,429,200 + $1,000,000 = $2,429,200
$2,429,200
Revised break-even in revenues: = $10,561,739
.23
$2,429,200
Revised packages to break even: = 133 packages (rounded)
$18,262
Per product: A: 133 x 10 = 1,330; B: 133 x 6 =798; C: 133 x 3 =399; D: 133 x 1 =

133.

2. Revised sales revenue = ($500 x 900) + ($1,800 x 400) + ( $9,200 x 500) + ($36,000
x 200) = $12,970,000
Revised contribution
Product A $142.50 x 900 = $128,250
Product B $370 x 400 = $148,000
Product C $2,270 x 500 = $1,135,000
Product D $7,807 x 200 = $1,561,400
Total revised contribution $2,972,650
Revised contribution margin % = $2,972,650 / $12,970,000 = 22.92%
New break even in revenue: $2,429,200 / 22.92% = $10,598,604
Revised sales mix is: A; 9; B: 4; C: 5; D: 2
Revised package contribution: (9 x $142.50) + (4 x $370) + (5 x $2,270) + (2

$7,807) = $29,727 (rounded)
Revised packages to break even: $2,429,200 / $29,727 = 82 packages (rounded)
Revised units to break even: A: 82 x 9 = 738; B: 82 x 4 = 328; C: 82 x 5 = 410; D:

82 x 2 = 164.
3. Using the changes outlined in Requirement 1:
Pre-tax net income is: $2,470,000 / .65 = $3,800,000
Fixed cost plus target income = $2,429,200 + $3,800,000 = $6,229,200
Revenue to meet new target: $6,229,200 / .23 (from 1 above) = $27,083,478
Using changes outlined in Requirement 2:
Fixed costs plus target pre-tax income = $6,229,200
New contribution margin % (from 2 above) = 22.92%
Revenues needed to meet target: $6,229,200 / .2292 = $27,178,010

Problem 4–43
1. Contribution margin ratios:
$23,910
May of current year = = 0.549, or 54.9%
$43,560
$23,400
May of prior year = = 0.561, or 56.1%
$41,700
2. Break-even point in sales dollars (in thousands):
May of current year = $20,330 = $37,031

0.549
May of prior year = $13,800 = $24,599

0.561
3. Margin of safety (in thousands):

May of current year = $43,560 – $37,031 = $6,529
May of prior year = $41,700 – $24,599 = $17,101
4. Clearly, the sharp rise in fixed costs from the prior year to the current year has
had a large impact on the break-even point and the margin of safety. Bissonette
will need to ensure that tight cost control is exercised since the margin of safety
is much slimmer. Still, the decision to go with the OEM investment program
could pay large dividends in the future. Note that the margin of safety and break-
even point give the company important information on the potential risk of the
venture but do not tell it the upside potential.

PROFESSIONAL EXAMINATION PROBLEM*
Professional Examination Problem 4–44
1. CM/unit = $4 - $2.40 = $1.60

After-tax net income = [(390,000 × 1.60) - $440,000].6
= ($624,000 – $440,000).6
= $110,400
2. $440,000 / $1.60
= 275,000 boxes
3. Current CM ratio = $1.60 / $4 = 40%

New variable costs = $2 × 1.15 + $0.40 = $2.70
Let SP = new selling price

(SP - $2.70) / SP = 0.4
SP - $2.70 = 0.4SP
SP – 0.4SP = $2.70
0.6SP = $2.70
SP = $4.50
4. CM = $4 - $2.70 = $1.30
CM ratio = $1.30 / $4 = 32.5%
Desired operating income = $110,400 / .6 = $184,000
Desired sales volume = ($184,000 + $440,000) / 0.325

= $1,920,000
5. Let X = volume of boxes
$1.30X – $440,000 = $4X(0.10) / 0.60

$1.30X – $440,000 = $0.6667X
$0.6333X = $440,000
X = $440,000 / $0.6333
= 694,737 boxes
* © CPA Ontario.

CASES
Case 4–45
1. Let X be a package of 3 Grade I cabinets and 7 Grade II cabinets.
0.3X($3,400) + 0.7X($1,600) = $1,600,000
X = 748 packages
Grade I: 0.3 × 748 = 224 units
Grade II: 0.7 × 748 = 524 units
2. Variable Contribution Sales Total

I $ 3,400 $ 2,686 $714 3 $2,142
II 1,600 1,328 272 7 1,904
Package 21,400 17,354 $4,046
Direct fixed costs — I $ 95,000

Direct fixed costs — II 95,000
Common fixed costs 35,000
Total fixed costs $225,000
$225,000
= 56 packages
$4,046
Grade I: 3 × 56 = 168 units
Grade II: 7 × 56 = 392 units

Case 4–45 (Continued)

I $ 3,400 $ 2,444 $956 3 $2,868
II 1,600 1,208 392 7 2,744
Package 21,400 15,788 $5,612
$21,400X = $1,600,000 – $600,000
X = 47 packages remaining
Grade I: 3 × 47 = 141
Grade II: 7 × 47 = 329
Additional contribution margin:
141($956 – $714) + 329($392 – $272) = $73,602
Increase in fixed expenses 44,000
Increase in operating income $29,602
Break-even point for the year: ($225,000 + $75,430) = 54 packages
$5,612
Grade I: 3 × 54 = 162
Grade II: 7 × 54 = 378
If the new break-even point is the revised break-even point for the current year,
therefore total fixed costs must be reduced by the contribution margin already
earned (through the first five months) to obtain the units that must be sold for
the last seven months. These units would then be added to those sold during
the first five months:
Contribution margin earned = $600,000 – (83* × $2,686) – (195* × $1,328)
= $118,102
*224 – 141 = 83; 524 – 329 = 195
X = ($225,000 + $44,000 - $118,102) = 27 packages
$5,612
From the first five months, 28 packages were sold (83/3 or 195/7). Thus, the
revised break-even point is 55 packages (27 + 28)—in units, 165 of I and 385 of
II.


I $3,400 $2,686 $714 1 $714
II 1,600 1,328 272 1 272
Package 5,000 4,014 $986
New 7-month sales revenue $1,000,000 × 130% = $1,300,000
$5,000X = $1,300,000
X = 260 packages
Thus, 260 units of each cabinet will be sold during the rest of the year.
Effect on profits:
Change in contribution margin:
$714(260 – 141) – $272(329 – 260) $66,198
Increase in fixed costs:
$70,000(7/12) 40,833
Increase in operating income $25,365
Fixed cost
X =
(Price - Variable cost)
= $295,000
$986
= 299 packages (or 299 of each cabinet)
The break-even point is computed as follows:
X = ($ 2 9 5 ,0 0 0 - $ 1 1 8 ,1 0 2 )
$986
= $176,898
$986
= 179 packages (179 of each)
To this, add the units already sold, yielding the revised break-even point:
I: 83 + 179 = 262
II: 195 + 179 = 374

Case 4–46
Per-unit product contribution analysis
T-shirts Sweatshirts Fleece
Jackets
Revenue $6.50 $16.00 $38.50
Materials 1.50 3.00 12.00
Direct labour 2.50 3.00 8.00
Variable selling 0.65 1.60 3.85
Contribution 1.85 8.40 14.65
Product per package 5 3 2
Contribution per package $9.25 $25.20 $29.30
Package revenues = ($6.50 x 5) + ($16.00 x 3) + ($38.50 x 2) = $157.50
Total contribution per package = $9.25 + $25.20 + $29.30 = $63.75
Contribution margin % = $63.75 / $157.50 = 40.48%
Fixed costs: $300,000 + $150,000 + $250,000 = $700,000
Break-even revenues = Fixed costs / contribution margin %
Break-even revenues = $700,000 / .4048 = $1,729,249
Target profit of $140,000 after tax is ($140,000 /.6) = $233,333 pre-tax
Revenue to achieve target = profit fixed costs plus pre-tax target / Contribution
margin %
Revenue is ($700,000 + $233,333) / .4048 = $2,305.665
Packages to achieve break-even $700,000 / $63.75 = 10,981 (rounded up)

Units: 54,905 t-shirts (10,981 x 5); 32,943 sweatshirts (10,981 x 3); 21,962 fleece
jackets (10,981 x 2)
Packages to achieve target profit: $933,333 / $63.75 = 14,641
Units: 73,205 t-shirts (14,641 x 5); 43,923 sweatshirts (14,641 x 3); 29,282 fleece
jackets (14,641 x 2)
Case 4–47
Fixed expense
1. Break-even point =
(Price - Variable cost)
$100,000
First process: = 5,000 cases
($30 - $10)
$200,000
Second process: = 8,333 cases
($30 - $6)
2. Income = X(Price – Variable cost) – Fixed cost

X($30 – $10) – $100,000 = X($30 – $6) – $200,000
$20X – $100,000 = $24X – $200,000
$100,000 = $4X
X = 25,000 cases
The manual process is more profitable if sales are less than 25,000 cases; the
automated process is more profitable at a level greater than 25,000 cases. It is
important for the manager to have a sales forecast to help in deciding which
process should be chosen.

3. The right to decide which process should be chosen belongs to the divisional
manager. Donna has an ethical obligation to report the correct information to
her superior. By altering the sales forecast, Donna would unfairly and
unethically influence the decision-making process. Managers certainly have a
moral obligation to assess the impact of their decisions on employees, and
every effort should be taken to be fair and honest with employees. Donna’s
behaviour, however, is not justified by the fact that it would help a number of
employees retain their employment. First, Donna has no right to make that
decision. Donna certainly has the right to voice her concerns about the impact
of automation on the employees’ well-being. In so doing, perhaps the divisional
manager would come to the same conclusion, even though the automated
system appears to be more profitable. Second, the choice to select the manual
system may not be the best for the employees anyway. The divisional manager
may possess more information, making the selection of the automated system
the best alternative for all concerned, provided the sales volume justifies its
selection. For example, if the automated system is viable, the divisional
manager may have plans to retrain and relocate the displaced workers in better
jobs within the company. Third, her motivation for altering the forecast seems
more driven by her friendship with Hussan Khalil than any legitimate concerns
for the layoff of other employees. Donna should examine her reasoning
carefully to assess the real reasons for her behaviour. Perhaps in so doing, the
conflict of interest that underlies her decision will become apparent.

Cost-Volume-Profit Analysis: A Managerial Planning Tool: Discussion Questions

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CHAPTER 4

Copyright © 2018 by Nelson Education Ltd. 4-1

Cornerstone Exercise 4–1

1. Variable cost per unit = Direct materials + Direct labour

2. Total fixed expense = $14,000 + $15,400 = $29,400

Cornerstone Exercise 4–2

Total fixed cost

4-2 Copyright © 2018 by Nelson Education Ltd.

1. Variable cost ratio = Variable cost per unit

2. Contribution margin ratio = (Price - Variable cost per unit)

Cornerstone Exercise 4–4

Total fixed cost

Copyright © 2018 by Nelson Education Ltd. 4-3

Cornerstone Exercise 4–5

(Total fixed cost + Target income)

Cornerstone Exercise 4–6

(Total fixed cost + Target income)

4-4 Copyright © 2018 by Nelson Education Ltd.

3. A contribution margin income statement helps managers make better decisions

Cornerstone Exercise 4–7

Unit Unit Package Unit

Copyright © 2018 by Nelson Education Ltd. 4-5

Break-even bicycle helmets = Number of packages × Sales mix amount

Break-even motorcycle helmets = Number of packages × Sales mix amount

Cornerstone Exercise 4–8

1. Contribution margin ratio = ($570,000 - $388,000)

Total fixed cost

4-6 Copyright © 2018 by Nelson Education Ltd.

Cornerstone Exercise 4–9

1. Margin of safety in units = Budgeted units – Break-even units

Cornerstone Exercise 4–10

Total contribution margin

Cornerstone Exercise 4–11

1. Percent change in operating income = DOL × % Change in sales

Copyright © 2018 by Nelson Education Ltd. 4-7

2. Contribution margin ratio = $10.50 = 0.4375, or 43.75%

Variable cost ratio = $13.50 = 0.5625, or 56.25%

3. Break-even units ($78,000 + $56,925) / ($24 - $13.50) = 12,850

4. Sales ($24 × 12,850) ................................................................... $308,400

1. Unit variable cost = $19.00 × 0.60 = $11.40

Unit contribution margin = $19.00 – $11.40 = $7.60

2. Break-even units = $874,000 = 115,000

4-8 Copyright © 2018 by Nelson Education Ltd.

3. Break-even sales revenue = $19.00 × 115,000 = $2,185,000

4. Sales ........................................................................................... $2,185,000

5. Break-even operations always result in a profit of zero.

1. Contribution margin ratio ($481,250/$875,000) = 55%

2. Variable cost ratio ($393,250/$4875,000) = 45%

3. Break-even sales revenue ($327,000/.55) = $594,546 (rounded up).

Copyright © 2018 by Nelson Education Ltd. 4-9

2. Break-even point in units

3. Units needed to generate $200,000 in operating income

1. Unit variable cost includes all variable costs on a unit basis:

4-10 Copyright © 2018 by Nelson Education Ltd.

4. Sales revenue to earn $12,600 = 203,250 × $2.45 = $497,962.50

1. Contribution margin = Sales – variable costs = $11.75 - $6.58 = $5.17

2. Margin of safety = Sales volume – Break-even sales = 570,000 – 290,220

3. Contribution margin ratio = CM/Sales = $5.17/$11.75 = 44%

Copyright © 2018 by Nelson Education Ltd. 4-11

Units sold 3,000* 1,300 125 1,000

2. If sales increase by $50,000, operating income increases by

3. Sales revenue needed to break even:

4. Expected margin of safety = Sales revenue – Break-even sales revenue