Cost Volume Profit Analysis (CVP)

Q1. Pointdextre Ltd, which manufactures and sells a single product, is currently producing and selling 102,000 units per month, which represents 85% of its full capacity. Total monthly costs are 619,000 but at full capacity these would be 700,000. Total fixed costs would remain unchanged at all activity levels up to full capacity. The normal selling price of the product results in a contribution to sales ratio of 40%. A new customer has offered to take a monthly delivery of 15,000 units at a price per unit 20% below the normal selling price. If this new business is accepted, existing sales are expected to fall by one unit for every six units sold to this new customer. Required: (a) For the current production and sales level, calculate: (i) the variable cost per unit; (ii) the total monthly fixed costs; (iii) the selling price per unit; (iv) the contribution per unit. (6 marks) (b) Calculate the net increase or decrease in monthly profit which would result from acceptance of the new business. (4 marks) (c) In the context of decision making, explain the term opportunity cost and illustrate your answer by reference to Pointdextre Ltd. (2 marks) Q2. Hughes plc has recently developed a personal music player and is now considering what price to charge for the new product. A market research company has produced the following forecasts of demand at three potential selling prices: Selling price 250 350 450 Sales units per annum 10,000 8,000 6,000 Fixed costs per annum 800,000 500,000 200,000 Variable costs are forecast at 220 per unit at any activity level. Required: (a) Calculate, for each potential selling price, the budgeted profit, the break-even point in units and the margin of safety ratio (b) Using the graph paper provided, draw and label a break-even chart for a selling price of 350 for activity levels between 0 and 8,000 units. Q3. Z Ltd manufactures and sells three products with the following selling prices and variable costs: Product A Product B Product C (/unit) (/unit) (/unit) Selling price 3.00 2.45 4.00 Variable cost 1.20 1.67 2.60 The company is considering expenditure on advertising and promotion of Product A. It is hoped that such expenditure, together with a reduction in the selling price of the product, would increase sales. Existing annual sales volume of the three products is: Product A 460,000 units Product B 1,000,000 units Product C 380,000 units Page 1 of 6

If 60,000 per annum was to be invested in advertising and sales promotion, sales of Product A at reduced selling prices would be expected to be: 590,000 units at 2.75 per unit or 650,000 units at 2.55 per unit Annual fixed costs are currently 1 710 000 per annum. Required: (a) Calculate the current break-even sales revenue of the business. (8 marks) (b) On the basis of incremental profits, advise the management of Z Ltd as to whether the expenditure on advertising and promotion, together with selling price reduction, should be introduced on Product A. (6 marks) (c) Calculate the required unit sales of Product A, at a selling price of 2.55 per unit, in order to justify the expenditure on advertising and promotion. (5 marks) Q4. Motor Co has recently developed a new environmentally friendly motor home. It has prepared two sets of figures for its forecast for the next year since it is currently undecided on its production level and selling price. The company is trying to decide whether it is more profitable to produce 400 or 500 motor homes, since a clear link between price and demand has been identified. An extract from the coming years forecast is as follows: Units produced and sold 400 500 $000 $000 Revenue 34,000 37,500 Materials 13,600 17,000 Labour 8,400 10,500 Overheads (1) 9,000 10,500 Note (1) Overheads include both a fixed and a variable element which can be calculated from the above data. Required: (a) Calculate the contribution per unit at each sales level. (4 marks) (b) Calculate the break-even point in units at each sales level. (3 marks) (c) Calculate the margin of safety as a percentage at each sales level and explain what the margin of safety is. (3 marks) (d) Calculate the budgeted profit at each sales level. (2 marks) (e) Using the graph paper provided, draw and label a break-even chart for the motor homes at a sales level of 400 units, showing activity levels between 0 and 400 units. (f) State four assumptions on which break-even analysis is based. (2 marks) Q5. A building company constructs a standard unit which sells for 30 000. The companys costs can be readily identifiable between fixed and variable costs. Budgeted data for the coming six months includes the following:

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You are told that the fixed costs for the six months have been spread evenly over the period under review to arrive at the monthly profit projections. Required: (a) Prepare a graph for total sales, costs and output for the six months under review that shows: (i) The break-even point in units and revenue. (ii) Total fixed costs. (iii) The variable cost line. (iv) The margin of safety for the total budgeted sales. (14 marks) (b) The company is worried about the low level of sales. The sales director says that if the selling price of the unit was reduced by 5000 the company would be able to sell 10% more units. All other costs would remain the same you are told. Determine whether the company should reduce the selling price to attract new sales in order to maximize profit. Clearly show any workings. Q6. Taylor Ltd manufactures a single product using a labour intensive production process. Its quality control department tests the final product before it leaves the factory and at present 20% of its pre-inspection output is rejected and scrapped. Scrap units have no value and cannot be reworked. Taylor builds the cost of scrapped units into the cost of good production. A standard cost card for Taylors product under its current production method is given below per unit Direct material 3 kgs at 5 per kg 1500 Direct labour (variable) 1000 Variable overhead 500 Cost pre-inspection per unit produced 3000 Cost of rejects 750 Variable cost per good unit 3750 Selling price per good unit 6000 Contribution per good unit 2250 Total fixed overheads are budgeted at 148,500 per month. Taylor currently sells 9,000 units per month. Negligible stocks are held. A proposal is being considered to reduce the reject rate: To automate the process by hiring a machine for 120,000 per month. This would lead to a 50% reduction in labour cost per unit and the quality of the manufacturing process would improve so that reject rates would fall to 5% of pre-inspection output. Variable overhead and material cost per unit (pre-inspection) would be unchanged. Existing fixed overheads would be unchanged. Required:

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(a) Calculate the break even point in good units per month for the current manufacturing process. (2 marks) (b) Calculate the break even point in good units per month for the automated process under the proposal. (5 marks) (c) Calculate the output level in good units per month at which proposal 1 and the current manufacturing process would have the same total cost. Comment briefly on your result.

Q7. Click Co is a photographic printing company. It prints photographs for customers, mainly the general public, generating sales revenue of $1,800,000 per annum. All of the companys printing machines are hired rather than owned outright. The current rate of rejects (i.e. prints of unacceptable quality) is 10%. Click Co is now considering replacing the machines with more technically advanced ones, which would eliminate rejects altogether. The companys standard costs for one photograph are as follows: $ $ Direct materials Paper: 004 Ink: 003 007 Direct labour 001 Variable overheads 002 Cost per unit produced 010 Cost of rejects 001 Variable cost per unit sold (good units) 011 Currently, the company sells 12,000,000 photos per annum. The companys fi xed overheads are $35,000 per month. If the new machines were hired to replace the old machines, machine rental costs would increase by $5,000 per month. However, the new machines would reduce variable overheads by 30%. The ink used by the new machines is 10% cheaper than the ink being currently used. Required: (a) Calculate the current annual break-even point in good units. (3 marks) (b) Calculate the annual break-even sales revenue if the new machines are hired. (5 marks) (c) Calculate the annual level of good quality photos that would have to be demanded and sold for Click Co to become indifferent about using the old or the new machines. Briefly explain the basis of your calculation. (6 marks) (d) Briefly outline THREE advantages and THREE disadvantages of using marginal costing, as compared to absorption costing. (6 marks) (20 marks)

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Maximisation of profits with limiting factor

Q6. Shilton Ltd produces three chemicals X, Y and Z. The selling price and cost per litre for each of these products are budgeted as follows: X Y Z /litre /litre /litre Selling price 100 120 120 Direct materials 20 16 21 Direct labour (12 per hour) 18 24 27 Other direct expenses 3 Variable overhead 12 16 18 Fixed overhead 6 8 9 Notes 1. The fixed overhead is absorbed on the basis of labour hours, based on a budget of 440 hours per month. 2. Maximum demand for each product for month 4 is as follows: X 150 litres Y 40 litres Z 60 litres 3. Included in the maximum demand totals is an unavoidable commitment to a major customer to supply 15 litres per month of each of the three products. 4. During month 4 there is a shortage of labour hours that will restrict production. The total number of labour hours available is 375 hours. 5. Shilton is able to produce and sell fractions of a litre.

Required:
(a) Determine the production mix that will maximise profit in month 4 and calculate the resulting profit. (12 marks) (b) After completing the production plan you are informed that new environmental controls on pollution are to be introduced from the beginning of month 4. These controls relate to the production of product Z only, and will incur an additional fixed cost of 1,000 per month for each month that Z is manufactured. In addition you also learn that an overseas supplier will supply as many litres of chemical Z as Shilton Ltd needs at a cost of 100 per litre. Importation of Z will not incur the additional fixed pollution control costs.

Required:
Using the above information calculate how much chemical Z (if any) should be purchased by Shilton Ltd from the overseas supplier in month 4. (4 marks) (c) Briefly explain TWO factors, other than costs or selling price, which should be taken into consideration when deciding whether to subcontract the manufacture of chemical Z. Page 5 of 6

(4 marks)

Make or buy with and without limiting factor

Q7. Mabbutt plc makes four types of electrical sub-assembly: A, B, C and D. Demand and costs per unit in the coming period are estimated to be as follows: Sub-assembly A B C D Demand (units) 10,000 50,000 120,000 60,000 Unit variable costs per unit per unit per unit per unit Direct labour (400 per hour) 4 6 8 6 Direct material 2 5 2 11 Variable overhead 2 3 4 3 Total variable cost per unit 8 14 14 20 Absorbed fixed overhead 8 12 16 12 Total production cost 16 26 30 32 Fixed overheads are absorbed on the basis of direct labour hours and represent apportioned general factory overhead. The direct labour used to build the subassemblies is highly skilled and Mabbutt plc sometimes has difficulties in recruitment, resulting in shortages of labour. Due to rapid technological change, stocks of completed sub-assemblies are never carried. The finance director of Mabbutt plc considers the costs of the sub-assemblies to be too high and is considering subcontracting their manufacture. A supplier has offered to supply any quantity of A, B, C or D for 10, 16, 13 and 25 per unit respectively. Mabbutt plc seeks to satisfy demand at minimum cost.

Required:
(a) On a purely financial basis, determine how many of each sub-assembly should be made by Mabbutt plc and how many should be bought in from the supplier, if Mabbutt plc expects direct labour hours in the coming period to be: (i) in unlimited supply; (4 marks) (ii) restricted to 145,000 hours. (8 marks)

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