and require you to relate and apply the content to various

d by their level of difficulty. Solutions to review problems that

ided in a separate section at the end of the book. Solutions to Lim,  2014  
vided in the Instructor’s Manual accompanying this book that
ital support Lesson
resources.
1 and Additional review problems
2: Cost-Volume-Profit Analysis and with
Other fully
Related Topics
nt Manual that accompanies this book.
For those who are not familiar with my types of exercises, they are broken down into theoretical, simple
ncludes oversolving,
30 and
case studysolving
moderate problems.
/ case type Several cases
questions. The answerare
keys are at the end.
xamples include Dumbellow Ltd, Hardhat Ltd and Merrion
Warm-Up

1) Explain why the break-even point changes when there is a change in sales mix.

2) Define the term ‘operating leverage’ and explain how the degree of operating leverage can
influence future profits.

3) How can sensitivity analysis be used in conjunction with cost–volume–profit analysis?

analysis can 8.7 Explain why the break-even point changes when there is a
4) A company has established a budgeted sales revenue for the forthcoming period of £500 000 with
changecontribution
an associated in sales mix. (pp. 000.
of £275 179–80)
Fixed production costs are £137 500 and fixed selling
ange’. 8.8costs are £27 500.
Describe the assumptions underlying cost–volume–profit
analysis. (pp. 183–84)
) 8.9What isDefine
the break-even sales revenue?
the term ‘operating leverage’ and explain how
ain how it can the degree of operating leverage can influence future
(a) £75,625
173–74) (b) £90,750
profits. (pp. 180–81)
ifferent (c)
8.10 £250,000
How can sensitivity analysis be used in conjunction with
(d) £300,000
relationships cost–volume–profit analysis? (p. 184)
5) Z plc currently sells products Aye, Bee and Cee in equal quantities and at the same selling price
se per unit. The contribution to sales ratio for product Aye is 40 per cent; for product Bee it is 50 per
cent and the total is 48 per cent. If fixed costs are unaffected by mix and are currently 20 per cent
of sales, the effect of changing the product mix to:

Aye 40%, Bee 25%, Cee 35% s that the total contribution/total sales ratio changes to:

(a) 27.4%
(b) 45.3%
(c) 47.4%
ales revenue 8.13 48.4% The following information is required for sub-questions
(d) Basic.
iated (a)(e)
and68.4%
(b).
£137 500 and W Ltd makes leather purses. It has drawn up the following
6) The following information is required for sub-questions (a) and (b). W Ltd makes leather purses.
budget
It hasfor its next
drawn up thefinancial
followingperiod:
budget for its next financial period:
Selling price per unit $11.60
Variable production cost per unit $3.40
Sales commission 5% of selling price
Fixed production costs $430 500
Fixed selling and administration costs $198 150
Management Sales 90 000 units
6a)
(a)The
Themargin
margin of safety represents:
of safety represents:
(i) 5.6% of budgeted sales
d Cee in equal (i) (ii)5.6%
8.3% of
of budgeted
budgetedsales
sales
contribution (ii)(iii)8.3%
11.6%ofofbudgeted
budgeted sales
sales
(iv) 14.8% of budgeted sales
uct Bee it is (iii) 11.6% of budgeted sales
are unaffected (iv)marketing
6b) The 14.8% of budgeted
manager sales that an increase in the selling price to $12.25 per unit
has indicated
ct of would not marketing
(b) The affect the number
managerof units sold, provided
has indicated thatthat the sales commission
an increase in the is increased to 8
per cent of the selling price.
selling price to $12.25 per unit would not affect the number
of units sold, provided that the sales commission is
  increased to 8 per cent of the selling price. 1  
These changes will cause the break-even point (to the
to: nearest whole number) to be:
 (d) Z plc is now considering opening another retail outlet ending 31 December 2011.
selling the same products. Z plc plans to use the same
profit margins in both outlets and has estimated that the Tweed Ltd profit and loss accou
specific fixed costs of the second outlet will be £100 000
per annum. Lim,  2014  
Z plc also expects that 10 per cent of its annual sales
Sales revenue
from its existing outlet would transfer to this second outlet if
(100 000 sweaters at
it were to be opened.
These changes will cause the break-even
Calculate point value
the annual (to the
of nearest whole from
sales required number)
the to be:
£10)
(i) 71,033 unitsnew outlet in order to achieve the same annual profit as Factory cost of goods sold:
(ii) 76,016 unitspreviously obtained from the single outlet. (5 marks)
Direct materials
(iii) 79,879 units Direct labour
(e) Briefly describe the cost accounting requirements of
(iv) 87,070 units Variable factory overheads
organizations of this type. (4 marks)
Fixed factory overheads
Chartered Institute of Management Accountants Operational
Administration overhead
Cost Accounting Stage 2
7) RT plc sells three products. Product R has a contribution margin of $30. Product S has aSelling and distribution
contribution margin of $20. Product T has a contribution margin of $25. Assume they all sell for
overhead
$100 each. 8.20 Intermediate: Preparation of a break-even chart with step Sales commission (2% of
fixed costs. Toowomba manufactures various products and uses sales)
Monthly fixed costs
CVPare $100,000.
analysis If thethe
to establish products
minimum arelevel
soldofinproduction
the ratio:to ensure Delivery costs (variable
R:2 S:5 T:3 profitability. per unit sold)
Fixed costs of £50 000 have been allocated to a specific product Fixed costs
The monthly break-even sales revenue,
but are expected to the
to increase nearest
to £100 000 $1,once
is: production exceeds
Profit
30 000 units, as a new factory will need to be rented in order to
a) £400 000 produce the extra units. Variable costs per unit are stable at £5 per
(b) £411 107 unit over all levels of activity. Revenue from this product will be
(c) £425 532 £7.50 per unit. The information to be submitted
(d) impossible toRequired:
calculate without further the following three proposals:
8) S plc produces and sells three products,
(a) Formulate X, Y and
the equations for Z.
theIttotal cost at: to supply products X(i)andToY,proceed on the basis
has contracts
which will utilize all of the
(i) less than or equal to 30 000 units; to make these two products during
specific materials that are available studies which indicate th
the next period. The revenue these contracts
(ii) more than 30 000 units. will generate and the information
(2 marks) of products X and that a 10 per cent
such
Y are as follows: increase demand by 40
(b) Prepare a break-even chart and clearly identify the break- (ii) To proceed with an enqu
Product X = $10,000,000 eveninpoint or points.
revenue, 85% of revenue are variable costs (6 marks) had from a mail order co
(c) Discuss
Product Y = $20,000,000 the implications
in revenue, of the results
10% of revenue from your
are variable graph in (b)
costs purchasing 50 000 units
with regard to Toowomba’s production plans. (2 marks) The mail order company
Product Z’s variable costs are ACCA75% of total
Paper 1.2 –revenues.
Financial The total fixed
Information costs of S plc are £5.5 million
for Management Tweed Ltd to its own war
during the next period and management have budgeted to earn a profit of £1 million. Calculate would be paid on these s
the revenue that 8.21
needsIntermediate:
to be generated by Product
Changes in salesZmix.
for SXYZ
plcLtd
to achieve
producesthe
twobudgeted profit. acceptable price can be
products and the following budget applies for 20 × 2: expected to contribute £6
9) XYZ Ltd produces two products and the following budget applies: of producing the mail ord
Product X Product Y necessary for Tweed Ltd
(£) (£) packaging at a cost of £
director considers that in
Selling price 6 12
business would remain u
Variable costs 2 4
on a selling price of £10
Contribution margin 4 8
undertaken.
Fixed costs apportioned 100 000 200 000
(iii) To proceed on the basis
Units sold 70 000 30 000
that a 10 per cent price
advertising campaign cos
You are requiredYouto calculate
are requiredthetobreak-even
calculate thepoints for each
break-even product
points andproduct
for each the company as a whole
to the maximum capacity
and comment onand yourthefindings.
company as a whole and comment on your findings.
Required:
8.22 Advanced: Non-graphical CVP behaviour. Tweed Ltd is a (a) The calculation of break-e
10) Toowomba manufactures various products and uses CVP analysis to establish the minimum level
company engaged solely in the manufacture of sweaters, which are accounts.
of production to ensure profitability.
bought mainly for sporting activities. Present sales are direct to (b) A financial evaluation of p
retailers,
Fixed costs of £50 000 havebut been
in recent years there
allocated has been
to a specific a steady
product decline
but in
are expected to increasenumber
to of units Tweed Ltd
£100 000 once production exceeds 30 000 units, as a new factory will need to be rented in order target profit of £
output because of increased foreign competition. In the last trading earn the
year units.
to produce the extra (2011)Variable
the accounting report
costs per unitindicated thatatthe
are stable £5company of A calculation of the minim
per unit over all levels(c)
activity. Revenue from this product will be £7.50 per unit.
produced the lowest profit for 10 years. The forecast for 2012 quoted to the mail order c
indicates that the present deterioration in profits is likely to Ltd would, at least, break
continue. The company considers that a profit of £80 000 should be second, to ensure that th
achieved to provide an adequate return on capital. The managing proposal (i) and, third, to
director has asked that a review be made of the present pricing and is earned.
  marketing policies. The marketing director has completed this 2   evaluation of p
(d) A financial
 Lim,  2014  

a) Formulate the equations for the total cost at:

(i) less than or equal to 30 000 units;
(ii) more than 30 000 units.
b) Prepare a break-even chart and clearly identify the break- even point or points.
(c) Discuss the implications of the results from your graph in (b) with regard to Toowomba’s
production plans.

Getting Serious:

11) Tweed Ltd is a company engaged solely in the manufacture of sweaters, which are bought mainly
for sporting activities. Present sales are direct to retailers, but in recent years there has been a
steady decline in output because of increased foreign competition. In the last trading year (2011)
the accounting report indicated that the company produced the lowest profit for 10 years. The
ASSESSMENT MATERIAL 189
forecast for 2012 indicates that the present deterioration in profits is likely to continue. The
company considers that a profit of £80 000 should be achieved to provide an adequate return on
o 30 per cent of the capital. review,
The managing director has asked that a review be made of the present pricing and
and passes the proposals on to you for evaluation and
marketing policies. The marketing director has completed this review, and passes the proposals
annual profit. (2 marks)on to yourecommendation,
for evaluation andtogether with the profit
recommendation, andwith
together lossthe
account for year
profit and loss account for year
nother retail outlet ending
ending 31 31 December
December 2011. 2011.
ans to use the same
has estimated that the Tweed Ltd profit and loss account for year ending 31 December 2011
outlet will be £100 000
(£) (£) (£)
ent of its annual sales
Sales revenue
r to this second outlet if
(100 000 sweaters at 1 000 000
£10)
les required from the
Factory cost of goods sold:
ame annual profit as
Direct materials 100 000
outlet. (5 marks)
Direct labour 350 000
requirements of
Variable factory overheads 60 000
(4 marks)
Fixed factory overheads 220 000 730 000
Accountants Operational
Administration overhead 140 000
Cost Accounting Stage 2
Selling and distribution
overhead
even chart with step Sales commission (2% of 20 000
us products and uses sales)
l of production to ensure Delivery costs (variable 50 000
per unit sold)
ted to a specific product Fixed costs 40 000 110 000 980 000
once production exceeds Profit 20 000
be rented in order to
unit are stable at £5 perThe information to be submitted to the managing director includes the following three proposals:
this product will be
(i) To proceed on the basis of analyses of market research studies which indicate that the demand
The information
for the sweaters to be
is such that submitted
a 10 to the managing
per cent reduction in sellingdirector includes
price would increase demand by 40
the
per cent. following three proposals:
l cost at: (i) To proceed on the basis of analyses of market research
(ii) To proceed with an enquiry that the marketing director has had from a mail order company
nits; studies which indicate that the demand for the sweaters is
about the possibility of purchasing 50 000 units annually if the selling price is right. The mail
such that
(2 marks)order company would a 10 the
transport persweaters
cent reduction in selling
from Tweed Ltd toprice would
its own warehouse, and no sales
commission would be paiddemand
increase on theseby
sales
40by Tweed
per cent.Ltd. However, if an acceptable price can be
rly identify the break- negotiated, (ii)
TweedToLtd wouldwith
proceed be expected to contribute
an enquiry £60 000 per
that the marketing annumhas
director towards the cost of
(6 marks) had from a mail order company about the possibility of
lts from your graph in (b) purchasing 50 000 units annually if the selling price is right.
on plans. (2   marks) The mail order company would transport the sweaters from
3  
mation for Management Tweed Ltd to its own warehouse, and no sales commission
would be paid on these sales by Tweed Ltd. However, if an
 Lim,  2014  

producing the mail order catalogue. It would also be necessary for Tweed Ltd to provide special
additional packaging at a cost of £0.50 per sweater. The marketing director considers that in 2012
the sales from existing business would remain unchanged at 100 000 units, based on a selling
price of £10 if the mail order contract is undertaken.

(iii) To proceed on the basis of a view by the marketing director that a 10 per cent price reduction,
together with a national advertising campaign costing £30 000 may increase sales to the
maximum capacity of 160 000 sweaters.

Required:
(a) The calculation of break-even sales value based on the 2011 accounts.
(b) A financial evaluation of proposal (i) and a calculation of the number of units Tweed Ltd
would require to sell at £9 each to earn the target profit of £80 000.
(c) A calculation of the minimum prices that would have to be quoted to the mail order company,
first, to ensure that Tweed Ltd would, at least, break-even on the mail order contract, second, to
ensure that the same overall profit is earned as proposal (i) and, third, to ensure that the overall
target profit is earned.
(d) A financial evaluation of proposal (iii).

12) A local government authority owns and operates a leisure centre with numerous sporting
facilities, residential accommodation, a cafeteria and a sports shop. The summer season lasts for
20 weeks including a peak period of six weeks corresponding to the school holidays. The following
budgets have been prepared for the next summer season:

Accommodation
60 single rooms let on a daily basis.
35 double rooms let on a daily basis at 160 per cent of the single room rate.
Fixed costs £29 900.
Variable costs £4 per single room per day and £6.40 per double room per day.

Sports Centre
Residential guests each pay £2 per day and casual visitors £3 per day for the use of facilities.
Fixed costs £15 500

Sports Shop
Estimated contribution £1 per person per day.
Fixed costs £8250

Cafeteria
Estimated contribution £1.50 per person per day. Fixed costs £12 750

During the summer season the centre is open seven days a week and the following activity levels
are anticipated:
Double rooms fully booked for the whole season.
Single rooms fully booked for the peak period but at only 80 per cent of capacity during the rest of
the season.
30 casual visitors per day on average.

You are required to:

(a) calculate the charges for single and double rooms assuming that the authority wishes to make
a £10 000 profit on accommodation;
(b) calculate the anticipated total profit for the leisure centre as a whole for the season;
(c) advise the authority whether an offer of £250 000 from a private leisure company to operate
the centre for five years is worthwhile, assuming that the authority uses a 10 per cent cost of
capital and operations continue as outlined above.

  4  
 Required
What is the optimal production level in number of square yards for each product?

Problems Lim,  2014  

LO 3 3-49 Cost classification and target profit Walt’s Woodwork Company makes
and sells wooden shelves. Walt’s carpenters make the shelves in the
13) Walt’s Woodwork Company
company’s rentedmakes andWalt
building. sells has
wooden shelves.
a separate Walt’s
office carpenters
at another makethat
location the shelves
in the company’s
also includes a showroom where customers can view sample shelves and ask includes
rented building. Walt has a separate office at another location that also
a showroom where customers can view sample shelves and ask questions of salespeople. The
questions of salespeople. The company sells all the shelves it produces each
company sells all the shelves it produces each year and keeps no inventories. The following
year and keeps no inventories. The following information pertains to Walt’s
information pertains to Walt’s Woodwork Company for the past year:
Woodwork Company for the past year:
a. Units produced and sold 50,000
b. Sales price per unit $70
c. Carpenter labor to make shelves 600,000
d. Wood to make the shelves 450,000
e. Sales staff salaries 80,000
f. Office and showroom rental expenses 150,000
g. Depreciation on carpentry equipment 50,000
h. Advertising 200,000
i. Sales commissions based on number of units sold 180,000
j. Miscellaneous fixed manufacturing overhead 150,000
k. Rent for the building where the shelves are made 300,000
l. Miscellaneous variable manufacturing overhead 350,000
m. Depreciation for office equipment 10,000

Make appropriate assumptions about cost behavior and assume that direct labor costs vary
Requireddirectly with the number of units produced. How many units must the company sell in order to
earn a pre- tax profit of $500,000?
Make appropriate assumptions about cost behavior and assume that direct labor costs vary directly
with the
14) number
JohnsonofCompany
units produced. How
and Smith many units
Company are must the company
competing selloffer
firms that in order to earnservice
limousine a pre- from the
salaries.
tax profit of Information
$500,000? about the selling prices per ride and cost structures
Charlesburg airport. While Johnson pays most of its employees on a per-ride basis, Smith prefers
of
LO 2, to
the two
3 pay3-50
firms isfixed
its employees
Introducing
given
a new
below.
salaries. Information
product, about the
profitability selling
Santos prices per
Company is ride and cost
considering
structures of the two firms is given below.
introducing a new compact disc player model at a price of $105 per unit.
COST CATEGORY
Santos’s controller has compiledJOHNSON COMPANY
the following incremental costSMITH COMPANY

Selling price per ride $30 $30

Variable cost per ride 24 15
106 Chapter Contribution
3 Using Costs margin
in Decision
perMaking
ride 6 15
Fixed costs per year $300,000 $1,500,000

(a) Calculate the breakeven point in the number of rides for both firms.
quired (b) Draw two graphs plotting profit as a function of the number of rides for the two firms.
(c) Explain which firm’s cost structure is more profitable.
Calculate the breakeven point
(d) Explain whichinfirm’s
the number of rides
cost structure for both firms.
is riskier.
(e) What is the indifference point?
Draw two graphs plotting profit as a function of the number of rides for the two firms.
Explain which firm’s
Answer cost structure is more profitable.
Key:
Explain which firm’s cost structure is riskier.
1)The break-even point changes when the sales mix changes because there is a change in the
LO 3 3-54 weightedbreakeven
Multiple average contribution
points margin. You may be
Last month, able to sell
Capetini products with
Capacitor higher or lower
Company
contribution margins, which lessens/ increases the units needed to breakeven.
sold capacitors to its distributors for $250 per capacitor. The sales level of 3,000
2)capacitors
Operating per month
leverage is thewas less than
sensitivity the relative
of profits single-shift capacity
to growth in sales,of 4,400
and capacitors
can be at
measured via
the proportion of fixed costs relative to variable costs. It enhances profits significantly like a
itsmultiplier
plant located in San Diego. Variable production costs were $100 per capacitor,
because high operating leverage has high fixed costs, so profits go up faster relative to
and fixed production
revenues. However, it hascosts were $200,000
a downside perlosses
of multiplying month. In addition, variable selling
as well.
and distribution costs are $20 per capacitor, and fixed selling and distribution
costs are $62,500 per month. At the suggestion of the marketing department, this
month Capetini reduced the sales price to $200 and increased the monthly
  5  
advertising budget by $17,500. Sales are expected to increase to 6,800 capacitors
per month. If the demand exceeds the single-shift capacity of 4,400 capacitors,
 Lim,  2014  

3) Sensitivity analysis can be used with CVP analysis to measure changes in margin of safety,
breakeven, profit, and the like relative to changes in contribution margins and fixed costs.

4) D. Remember that for CVP analysis, it does not matter if a cost is COGS or in operating expenses
under the formal income statement, only that it is variable or fixed. In this particular problem,
the per unit variable cost is not given, so you may be surprised. However, note that the question is
asking breakeven on a monetary measure.

Breakeven in Sales in Volume = (137,500 + 27,500) / Contribution Margin Per Unit

Breakeven Sales in Dollar = (165,000 / Contribution Margin Per Unit) x Selling Price Per Unit

Breakeven Sales in Dollar = 165,000/ (Contribution Margin Per Unit/ Selling Price Per Unit

Contribution Margin Ratio = Proportion contributed to paying for fixed costs relative to $1
earnings, or contribution margin per unit / selling price per unit. Since this is a ratio, it’s the same
if we use total contribution margin / total revnue

Contribution Margin Ratio = 275,000 / 500,000 = 55% Each $1 gives 0.55 in contribution.

Breakeven Sales in Dollar = 165,000 / 55% = $300,000

5) B. This is a classic of encountering an unfamiliar term, but the solution is similar to other
problems. Contribution to sales ratio is basically contribution margin ratio, and all it is asking you
for is getting the weighted average contribution margin ratio, similar to multiple product CVP
analysis.

40% x 40% + 25% x 50 % + 35% x 48% = 45.3%

6) 6a) III. The margin of safety requires both budgeted sales and breakeven sales in terms of units.
Breakeven sales in units is computed as Fixed Costs / Contribution Margin Per Unit

Be warned that sales commission is a variable cost, which we can convert into a per unit basis.

Sales Commission = 5% of Selling Price

Sales Commission per unit = 5% x 11.60 = .58

Breakeven Sales = ($430,500 + 198,150) / (11.60 – 0.58 – 3.40)

Breakeven Sales = 628,650 / 7.62 = 82,500

Margin of Safety = 90,000 – 82,500 = 7,500

As % of Budget = 7,500 / 90,000 =8.3%

Be careful to read what the problem is asking for!

6b) III. Recompute but changing the CM. Remember to use the new inputs forcommission and
selling price!

Sales Commission = 8% of Selling Price

Sales Commission per unit = 8% x 12.25 = .98

Breakeven Sales = ($430,500 + 198,150) / (12.25– 0.58 – 3.40)

Breakeven Sales = 628,650 / 7.87 = 79,879

7) C. First do the weighted average contribution margin:

20% x 30 + 50% x 20 + 30% x 25 = 23.5

Breakeven in units = 100000 / 23.5 = 4,255.32

  6  
 Lim,  2014  

Breakeven in sales = 4,255.32 x 100 = 425,532

Note: If you are given the contribution margin ratio, this can be solved as well. For example, if
contribution margin ratio is 30%, 20%, and 25% for A B and C respectively, you can get the
weighted average contribution margin ratio and divide the fixed costs with it, without needing to
multiply by the selling price.

8) ) You are not given volume, but you do not need it. First solve for the hurdle / target: $5,500,000
+ 1,000,000 = 6,500,000

Next, determine the portion already covered by product x and product y.

Product X Contribution Margin = 10,000,000 x 15% = 1,500,000

Product Y Contribution Margin = 20,000,000 x 10% = 2,000,000

Fixed Costs and Profit Left to Cover = 6,500,000 – 1,500,000 – 2,000,000 = 3,000,000

Product Z Contribution Margin = 25% of Revenues

3,000,000 = 25% x Product Z Revenues

Product Z Revenues = 3,000,000 / 25% = 12,000,000

9) Stand-Alone Breakeven:

Product X = 100,000 / 4 = 25,000 units

Product Y = 200,000 / 8 = 25,000 units

Company Breakeven:
Weighted Average Contribution: 1/3 x 4 + 2/3 x 8 = 5.2
Company Breakeven = 300,000 / 5.2 = 57,692

Why the difference? When you do stand-alone breakeven, 1/3 of the fixed costs are allocate to
product X, which has a lower margin. When you do combined, 7/10 of the fixed costs are allocated
to product X effectively, meaning that it takes more to cover these fixed costs.

Which do you use? You have do stand-alone first to see if the products are profitable by itself. The
company breakeven is so you have some flexibility to cover for the losses of other products from
time-to-time.

10) a) This is a step function / piece-wise cost equation.

Where X = Volume

If X <= 30,000: Total Cost = 50,000 + 5X

If X > 30,000: Total Cost = 100,000 + 5X

b) Breakeven point is at 20,000 if < 30,000 and at 40,000 for > 30,000

  7  
 Lim,  2014  

140,000  
120,000  
100,000  
80,000  
Total  Fixed  
60,000   Cost  
40,000  
20,000  
Contribution  
0   Margin  
 -­‐        
 5,000    
 10,000    
 15,000    
 20,000    
 25,000    
 30,000    
 35,000    
 40,000    
 45,000    
 50,000    
c) If Toowomba is planning on expansion, then it better makes sure it can sell at least 40,000 to
breakeven. Otherwise, it will just lose money. And even then, Toowomba must make sure the
profit gained from ramping up capacity is exceeds the profit from not ramping up capacity.

At 30,000 units, total profit is 30,000 x 7.5 – 100,000 – 5 x 30,000 = $25,000. So effectively, not
only must you produce 40,000 to breakeven, you actually need to produce at this to earn a better
return:

7.5 X – 100,000 - 5X > 25,000

X > 50000. In other words, volume must actually be 50,000 for expansion to be worth it.

To summarize:
If potential sales < 20,000 = Don’t bother producing
If potential sales is between 20,000 to 50,000, producing at 30,000 is still better even if you
breakeven at 40,000 with the new fixed costs
If potential sales is > 50,000, then producing at >50,000 is still better

11) a) Again, we calculate breakeven based on variable and fixed costs (cost behaviors relative to
volume) regardless of whether they are COGS, admin, or selling expenses:

You can do this directly via sales revenue and contribution margin ratio, or the long cut (less
confusing way).

First, determine the fixed costs. Total fixed costs include: 1) Fixed Factory Overhead, 2)
Administration Overhead, 3) Fixed sales overhead

Total fixed costs = 220,000 + 140,000 + 40,000 = 400,000

Total Revenue = 1,000,000

Total Variable Costs = 100,000 + 350,000 +60,000 + 20,000 + 50,000 = 580,000

Contribution Margin Ratio = (1,000,000 – 580,000) / 1,000,000

Contribution Margin Ratio = 42%

Breakeven Sales Revenue = 400,000 / 42% = $952,381

If you don’t want to memorize the contribution margin ratio formula (though I encourage you to
understand it), here is another way:

Unit Selling Price: $10 / sweater

Direct Materials: $1 / sweater (100,000 / 100,000)
Direct Labour: $3.5 / sweater (350,000 /100,000)
Variable Overhead: $0.6 / sweater ( 60,000 / 100,000)

  8  
 Lim,  2014  

Commission: $0.2 / sweater (2% of $10)

Delivery Costs: $0.5 / sweater (50,000 / 100,000)

Total Variable Costs Per Unit: $5.8

Total Contribution Margin Per Unit = $10 – 5.8 = $4.2

Breakeven Sales in Units = 400,000 / 4.2 = 95,238 units

Breakeven Sales in Dollars = 95,238 units x $10 / sweater = 952,381

b) Proposal (i) asks you do actually do a sensitivity / scenario analysis

You can manipulate this on a total revenue or on a per unit basis.

Let us say the variable costs remain steady at $5.8, but selling price goes down to $9. Your
contribution margin per unit becomes $3.2.

Your sales go up by 40%, or by 40,000 sweaters to become 140,000 sweaters.

Total Profit = 140,000 x ( 9 – 5.8) – 400,000

Total Profit = $48,000

Better effect than the base case, but still not hitting the $80,000 target. How much do you need to
sell in order to reach 80,000? This is a target profit analysis

Target Profit + Fixed Costs = 480,000

480,000 / 3.2 = 150,000 units

c) Assuming that the decision will not affect the existing production capacity. This should be
assessed as an independent decision. We will asses the INCREMENTAL costs and
INCREMENTAL revenues of the contract.

Additional Fixed Cost = $60,000

Variable Cost = Old Variable Cost – Commission + Special Fee
Variable Cost = $5.8 + 0.5 – 0.2 = $6.1
Volume = 50,000 units

1) To breakeven
Fixed Cost = Contribution Margin -> Breakeven
60,000 = 50,000 (Selling Price – Variable Cost )
60,000 = 50,000 (Selling Price - $6.1)
$1.2 = Selling Price – 6.1
$7.3 = Minimum Selling Price

2) Same as proposal (i)

Proposal (i) has a net profit of 48,000. With the existing 100,000 earning 20,000, the new
proposal has to earn $28,000

Target Profit + Fixed Cost = Contribution Margin

20,000 + 60,000 = 50,000 (Selling Price - $6.1)

80,000 = 50,000 (SP – 6.1)
1.60 = SP – 6.1
Minimum Selling Price: $7.7

3) Target Profit of 80,000

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With the existing production earning 20,000, you need to earn 60,000 on the new proposal.

80,000 + 60,000 = 50,000 (SP – 6.1)

140,000 = 50,000 (SP – 6.1)
2.8 = SP – 6.1
Minimum Selling Price = $8.9

d) Selling Price – Variable Cost = Margin Contribution

10 – 5.80 = 4.20
Margin Contribution = $4.20

Total Margin Contribution = $4.20 x 160,000 = $672,000

Fixed Cost = 430,000
Profit = 672,000 – 430,000 = $242,000

12) a) Assuming that you want to make 10,000 on accommodation, this is a target profit analysis
problem, wherein fixed costs + target profit

= 29,900 + 10,000 = 39,900

While this is an atypical cost formula, all you have to do is translate the sentence into a formula.
You are looking for the charge of the single room (X) and the double room (Y), but Y = 1.6x
because it is 160% of the single room rate. (woah algebra ☺) To not get confused, frame the
timeline of the problem first. This is 20 weeks budget (140 days).

Let us solve for the volume first.

Double rooms are booked for the whole season. So 35 x 140 = 4,900 double rooms booked in the
season

Single rooms are booked at 100% for 6 weeks (42 days) and 80% for the remaining 14 weeks (98
days).

60 x 42 + 60 x 80% X 98 = 7,224 single rooms booked in the season

7,224 (x-4) + 4,900 (1.6x – 6.4) = 39,900

7,224x – 28,896 + 7840x – 31,360 = 39,900

15,064x = 100,156

Single Room Rate = 6.65 / night

Double Room Rate = 10.64 / night

b) Let us use the rates that we solved in A for accommodation. Furthermore, let us count the
number of guests. How do we do this? Look at the rooms booked. Remember that single rooms
are one person and double rooms are two persons. The way to do this is a sum of the parts
analysis (just solve individually and put them together). This is how companies with very diverse
products do it.

7,224 + 4900 x 2 = 17,024 guests

30 x 140 = 4,200 casual visitors

Accommodation = $10,000 profit (as given)

Sports Center

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Contribution Margin = 2 x 17,024 + 3 x 4,200 = 46,648

Profit = 46,648 – 15,500
Profit = $31,148

Sports Shop

The word used is persons, meaning all the people who go to the resort. This number is the guest
plus casual visitors.

Contribution Margin = (17,024 + 4,200) x 1 = 21,224

Profit = 21,224 – 8,250
Profit = 12,974

Cafeteria

Contribution Margin = (17,024 + 4,200) x 1.5 = 31,836

Profit = 31,836 – 12,750
Profit = 19,086

Total Profit = 73,208 / summer

c) At 73,208 profit per summer, the government would be better off operating it on its own and
getting $366,040 after 5 years. Assuming we even get the present value using a 10% discount rate,
you will still get 277,515.92. The offer is too low.

13) The first thing you have to do is separate the fixed and variable costs through sound judgment.

Variable costs should include, carpenter labor, wood, sales commissions, and miscellaneous
variable manufacturing overhead.

Depreciation on carpentry equipment, arguably, can be a variable cost if we can allocate this
based on volume (like units-of-production method). However, let us not include it for now.

Fixed Costs: Depreciation for Carpentry, Sales Staff Salaries, Rental expenses, Advertising, Rent
for Factory Building, Depreciation for Office

Total Variable Cost = 600,000 + 450,000 + 180,000 + 150,000 + 350,000 = 1,730,000

# of Units Sold = 50,000

Variable Cost per Unit = 1,730,000 / 50,000 = $34.6 / shelf

Total Fixed Cost = 80,000 + 50,000 + 150,000 + 200,000 + 300,000 + 350,000 + 10,000
=1,140,000

Target Profit = 500,000

Target Profit and Fixed Costs = 1,140,000 + 500,000
Target Profit and Fixed Costs = 1,640,000

Selling Price Per Unit = $70

Variable Cost Per Unit = $34.60
Contribution Margin = 35.4

Units to Sell = 1,640,000 / 35.4 = 46,328 units

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14) Breakeven Point for Johnson:

300,000 / 6 = 50,000 rides

Breakeven Point for Smith:

1,500,000 / 15 = 100,000 rides

b)

 2,000,000    
 1,500,000    
 1,000,000    
 500,000    
 -­‐         Johnson  
 (500,000)  
Smith  
 (1,000,000)  
 (1,500,000)  
 (2,000,000)  

(c) There is no absolute answer for this. Johnson’s business is more profitable if you are riding
under 133,333 cars. After this Smith’s business is more profitable.

(d) Smith’s cost structure is riskier due to its higher operating leverage, at any level below
100,000, Smith will lose money. For Johnson’s case, it takes a lower volume to breakeven.

e) Indifference point is the point of intersection, which is 133,333. You can do systems for this.

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