MANAGEMENT SCIENCE MODULE

Chapter 4:  In discussing CVP, we can use the following formula below:

Cost-Volume-Profit Analysis
Selling Price P xxx Sales (SP*Q) P xxx
Chapter Objectives: Less: VC/u xxx Less: VC (VC/u * Q) xxx
This chapter should enable you to know and understand: CM per unit P xxx Total CM (CM/u * Q) P xxx
 The uses, assumptions and limitations of CVP analysis. Sales in units xxx Less: FxC xxx
 The different assumptions underlying cost-volume-profit and Total CM P xxx Net Income P xxx
break-even analyses. Less: FxC xxx
 The break-even point in unit sales and peso sales Net Income P xxx
 The required selling price, unit, peso sales to achieve a target
profit
 How to determine break-even point when multiple products are Assumptions of Cost-Volume-Profit Analysis:
sold in combination. 1. Changes in the level of revenues and costs arise only because of
 The concepts of margin of safety and degree of operating changes in the number of product (or service) units produced and
leverage. sold.
2. Total costs can be separated into a fixed component that does not
vary with the output level and a component that is variable with
USES, ASSUMPTIONS AND LIMITATIONS OF CVP ANALYSIS respect to the output level.
3. When represented graphically, the behavior of total revenues and
 CVP Analysis
total costs are linear in relation to output level within a relevant
- Examines the behavior of total revenues, total costs and operating
range and time period.
income as changes occur in the output level, selling price, variable
4. The selling price, variable cost per unit, and fixed costs are known
cost per unit or fixed costs of a product. and constant.
5. The analysis either covers a single product or assumes that the sales
- A useful management tool that helps managers in planning for profit mix, when multiple products are sold, will remain constant as the
by way of a systematic analysis of the interrelationship among costs, level of total units sold changes.
volume and profit. 6. All revenues and costs can be added and compared without taking
into account the time value of money.
 Factors affecting profit
CVP Related Terminologies
If there is an increase in: Then profit will 1. Contribution Margin (CM) –the difference between sales and
1. Selling price Increase variable cost. It can either be expressed I a per unit basis or in a total
2. Unit variable cost Decrease basis. It is otherwise known as marginal income, profit contribution,
3. Fixed cost Decrease contribution to fixed cost or incremental contribution.
4. Unit sales (volume) Increase

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 MANAGEMENT SCIENCE MODULE
2. Contribution Margin Ratio (CMR) – there are several ways of
computing for the CMR and it all depends on the information BREAKEVEN POINT IN UNIT SALES AND PESO SALES
provided in the given problem. The formulas are as follows: BREAK-EVEN SALES- that point of activity level (sales volume) where total
revenue equal total costs.
The computations for either BEP in units or BEP in Peso sales are:
Per unit basis: Total basis: ¿ Cost
BEP in Peso = or BEP in units x Selling Price per unit
CM per unit CMR
Selling Price
Total Contribution Margin ¿ Cost
Sales Revenue BEP in units =
CM /u

Change basis In re: VC ratio Required Selling Price, Unit and Peso Sales to Achieve a Target Profit
Change∈CM The following formulas are used to compute for the required sales in peso or
1- VC Ratio
Change∈Sales in units.

Sample Problem:
1. Summer Company incurred the following costs in the production and
sale of 10,000 units of its main product, Product F:

Direct materials P 15
Direct labor 12
Variable overhead 10
Variable selling and admin expenses 18
Fixed overhead P220,000
Fixed selling and admin expenses 88,000

The company sells Product F for P100 per unit.

Required: Sample Problem:
1. Determine the contribution margin. P450,000 Presented below are the cost incurred by Summer Corporation during
2. Determine the CM ratio. 45% production:

2. Summer Company budgets that its total revenue will decrease by Direct materials P 50
P432,000 in the next year because of the decline in its product demand Direct labor 30
during the last quarter of the current year. In relation to this, total Variable overhead 40
contribution margin would also decrease by P64,800. Determine the CM Variable selling and admin expenses 30
ratio. 15% Fixed overhead P400,000
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 MANAGEMENT SCIENCE MODULE
Fixed selling and admin expenses 280,000 machine were purchased and labor were downsized, variable cost per unit
would decrease to P40 per unit and fixed costs would increase by P270,000.
The product sell for P200 per unit. Required:
Required: 1. Determine the number of units to be sold were Toby Company would be
1. Determine the breakeven point in units. 13,600 units indifferent whether it should purchase the new machine or not. 27,000
2. Determine the breakeven point in peso sales. P2,720,000 units – 3,000 units
3. Assume that the company wants to earn a profit of P220,000, how many 2. Assuming that the maximum number of units that the Company could
units must it sell in order to earn this profit? 18,000 units sell is 25,000 units, should the Company purchase the new machine?
4. Determine the revenue needed in order for the corporation to have a NO.
profit of P184,000. P3,456,000 3. Assuming that the Company can sell up to 30,000 units, should the
5. If a wealthy donor gives P150,000 for the production of Product F, how Company purchase the new machine? YES.
many units must the Corporation sell in order to breakeven. 10,600
units MULTIPLE PRODUCT ANALYSIS
6. If the Corporation wishes to have a return on sales of 12.5%, determine When CVP analysis is used for a multiple product firm, the product is
the target sales. P5,440,000 defined as a package of products. For example, if the sales mix is 3:1 for
7. Determine the number of units to be sold in order for the Corporation to Products A and B, the package would consist of 3 units of Product A and 1 unit
have a profit after tax of P128,800. Assume that the Corporation is of Product B.
subject to 30% income tax rate. 17,280 units
Break-even in packages for a multiple product firm is then calculated as:
SENSITIVITY ANALYSIS ¿ Cost Total CM
 BEP in Peso= ;where WaCMR =
Indifference Point- the level of volume at which two alternatives being WaCMR Total Sales
analyzed would yield equal amount of total costs or profits. It is at this point
where the decision maker would be indifferent as to what alternative to ¿ Cost Total CM
take.  BEP in units= ;where WaUCM = Total Units
WaUCM

Alternative A Alternative B Sales Mix

(Unit CM * Qty) – Fixed Costs = Unit CM * Qty) – Fixed Costs - The composition of total sales in terms of various products, i.e., the
Or Or percentage of each product included in total sales. It is used to
Fixed costs + (Unit VC * Qty) = Fixed costs + (Unit VC * Qty) compute for the breakeven point in case there is more than one unit
that the company is producing and subsequently selling.
Sample Problem:
Francis Company is deciding whether it should purchase a new machine. The Using the Weighted Average CM per unit
new machine would result to the decrease in labor as much as what is Product 1 Product 2
currently needed but with a corresponding increase in fixed factory Selling Price P xxx P xxx
overhead. The Company sells its units at P150 per unit with variable cost per Less: Variable cost/u (xxx) (xxx)
unit amounted to P50. Total fixed cost amounted to P240,000. If the CM/unit P xxx P xxx

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 MANAGEMENT SCIENCE MODULE
Multiply: PRODUCT Mix xx% xx% Less: Variable cost/u (3.50) (1.50)
WaUCM Xxx xxx CM/unit P 0.50 P 1.00
x Product Sales Mix 80% 20%
WaUCM WaUCM 0.40 0.20

Using the Weighted Average CM Ratio WaUCM= 0.60

Product 1 Product 2
Selling Price P xxx P xxx Step 2: Use the WaUCM to get the total BEP in units.
Less: Variable cost/u (xxx) (xxx) ¿ Cost P 18,000
CM/unit P xxx P xxx
BEP in units=
WaUCM
= 0.60
= 30,000 units
Multiply: PRODUCT Mix xx% xx%
WaUCM Xxx xxx Step 3: Allocate the BEPu using the Product mix.
Product A Product B
WaCMR Total BEPu 30,000 30,000
Multiply: Product Mix 80% 20%
Sample Problem: BEPu per Product 24,000 6,000
Summer Company produces and sells two products, A and B. The following
is the income budget for next month: Alternative Solution (using Composite Contribution Margin)
Product A Product B Total Note that sometimes, the problem will not provide the number of units sold
Sales in Units 60,000 15,000 75,000 for each product but would give you the ratio of units sold for one product
Sales Revenue P240,000 P37,500 P277,500 over the other. The problem may be solved by the composite breakeven
Variable costs 210,000 22,500 232,500 method.
Contribution Margin P 30,000 P15,000 P 45,000
Fixed Costs 18,000 Step 1:
Profit P 27,000 Product A Product B
Selling Price P 4.00 P 2.50
Required: Less: Variable cost/u (3.50) (1.50)
1. Determine the number of units of Product A to be sold in order to CM/unit P 0.50 P 1.00
breakeven. 24,000 units x Ratio of the Product 4 1
2. Determine the number of units of Product B to be sold in order to WaUCM 2.00 1.00
breakeven. 6,000 units
Composite Breakeven Ratio = 3.00
Suggested Solution:
Step 1: Compute for the WaCMu or WaUCM Step 2:
Product A Product B
Selling Price P 4.00 P 2.50
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 MANAGEMENT SCIENCE MODULE
¿ Cost P 18,000
Composite units= = =
Composite Breakeven Ratio 3
6,000 units

Step 3:
Product A Product B
Composite units 6,000 6,000
Multiply: Product Ratio 4 1
BEPu per Product 24,000 6,000

3. Determine the weighted average contribution margin ratio. 16.21622%

4. Determine the amount of revenue needed in order to breakeven.
P111,000

Suggested Solution:
Step 1: Compute for the WaCMR. CONCEPTS OF MARGIN OF SAFETY AND DEGREE OF OPERATING LEVERAGE
 MARGIN OF SAFETY
Total CM P 45,000 - Indicates the amount by which actual or planned sales may be
WaCMR = = = 16.21622%
Total Sales P 277,500 reduced without incurring a loss. It is the difference between actual
or planned sales volume and break-even sales.
Step 2: Use the WaCMR to get the total BEP in Peso.
MS P = Sales in Peso – BEP in Peso
¿ Cost P 18,000 MS ∈Peso
BEP in Peso= = 16.21622 % = P111,000 MS U = Sales in units – BEP in Units or
WaCMR Selling Price
MS ∈ Peso MS ∈Units
MSR= or
Step 3: Allocate the BEPu using the PESO mix. Sales∈Peso Sales∈Units
Product A Product B
Total BEPp P111,000 P111,000 Sample Problem:
Multiply: Peso Mix 240/277.5 37.5/277.5 Christian Company is in the business of manufacturing cheap body bags. In
BEPu per Product P 96,000 P 15,000 planning its operations for 2020 based on sales forecast of P2,400,000.
Variable Costs Fixed Costs
5. Determine the number of units of Product B to be sold in order to earn a Direct Materials P 312,000
profit of P42,000. 20,000 units Direct Labor 468,000
Factory Overhead 156,000 P196,000
Selling expenses 234,000 224,000
Administrative expenses 390,000 140,000
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 MANAGEMENT SCIENCE MODULE
1. Speedy Mouse Inc. makes a special mouse for computers. Each mouse
Required: sells for P25 and annual production and sales are 120,000 units. Costs
1. Determine the breakeven point in peso. P1,600,000 for each mouse are as follows:
2. Determine the margin of safety. P800,000 Direct materials P6.00
3. Determine the margin of safety ratio. 33.33% Direct labor 3.00
Variable overhead 0.80
 OPERATING LEVERAGE Variable selling expenses 2.20
- The extent to which a company uses fixed costs in its cost structure. Total variable cost P12.00
It is achieved by increasing fixed costs while lowering variable costs.
Total fixed overhead P589,550
 Operating Leverage Factor (OLF) or Degree of Operating Leverage (DOL)
- used to measure the extent of the change in profit before tax a. Calculate the unit contribution margin in pesos and the contribution
resulting from the change in sales. margin ratio for the product.
b. Determine the break-even point in number of mice.
Total CM c. Calculate the peso break-even point using the contribution margin
DOL or OLF= or
Profit before Tax ratio.
Percentage change∈ Profit d. How many mice must the company sell if it desires to earn P996,450
Percentage change∈Sales in before-tax profits?
e. If Speedy Mouse Inc. wants to earn P657,800 after tax and is subject
to a 20 percent tax rate, how many units must be sold?
Sample Problem: f. How much peso sales must be generated to earn before tax profit of
Christine Company sells its products at P100 per unit. The variable cost per P203,450?
unit is P40 per unit. The Company expects to sell 20,000 units for 2020. g. If Speedy Mouse Inc. wants to earn P242,515 after tax and is subject
Fixed costs amounted to P720,000. The Company is subject to an income tax to a 30 percent tax rate, how much should peso sales be?
rate of 30%. h. How many units would the company need to sell to break even if its
fixed costs increased by P7,865?(Use original data.)
Required: i. Speedy Mouse Inc. has receive an offer to provide a one-time sale of
1. Determine the degree of operating leverage. 2.5 4,000 mice to a network of computer superstores. This sale would
2. Determine the increase in net income before taxes, when the Company not affect other sales or their costs, but the variable cost of the
expects a 20% increase in sales. 50% increase or P240,000 increase additional units will increase by P0.60 for shipping and fixed costs
3. Determine the decrease in net income before taxes, when the Company will increase by P18,000. The selling price for each unit in this order
expects a 10% decrease in sales. 25% decrease or P120,000 decrease would be P20. Based on quantitative measurement, should the
company accept this offer. Show your calculations.
j. Determine Speedy Mouse Inc.’s margin of safety in units, in sales
-End of Discussion- pesos, and as a percentage.

SELF-CHECK TEST:
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 MANAGEMENT SCIENCE MODULE
k. Compute Speedy Mouse Inc.’s degree of operating leverage. If sales 0 5
increase by 25 percent, by what percentage would before tax 0
income increase? 2
Variable 0 0. .0
2. Racine Tire Co. manufactures tires for all terrain bicycles. The tires sell selling . 2 0
for P60 and the variable cost per tire is P45; monthly fixed cost is expenses 5 5
P450,000. 0
REQUIRED: 0
a. Calculate the firm’s break-even point in sales pesos. Variable 0 0. .3
b. If the company is currently selling 40,000 tires monthly, wht is the admin . 1 0
degree of operating leverage? expenses 2 0
c. If the company can increase sales volume by 15% above the current 0
level, what will be the increase in net income? What will be the new
net income? Fixed P7
overhead 60
3. Philippine Flooring makes three types of flooring products: tile, carpet, ,0
and parquet. Cost analysis reveals the following costs (expressed on a 00
per-square-foot basis) are expected for 2019: Fixed selling 24
T C Pa expenses 0,
il a rq 00
e r u 0
p et Fixed 20
e administrativ 0,
t e expenses 00
P P P 0
Direct 5 3. 8.
Material . 2 80 Per foot expected selling price are as follows: tile P16.40; carpet P8.00; and
2 5 parquet P25. In 2018, sales were 18,000 square feet for tile; 144,000 sq. feet
0 for carpet and 12,000 sq. feet for parquet.
6
Direct Labor 1 0. .4 Review of recent tax returns reveals an expected tax rate of 40 percent.
. 4 0
8 0 a. Calculate the break-even point in 2019?
0 b. How many square feet each product are expected to be sold at the
1 break-even point?
Variable 1 0. .7
overhead . 1 5
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 MANAGEMENT SCIENCE MODULE
c. Assume that the company desires a pre-tax profit of P800,000. How
many square feet of each type of product would need to be sold to
generate this profit level? How much revenue would be required?
d. Assume that the company desires an after-tax profit of P680,000.
Use the contribution margin percentage approach to determine the
revenue needed.
e. If the company actually achieves the revenue determined in part (d),
what is Philippine Flooring’s margin of safety in pesos and
percentage?

4. Samsonyt sells one of its products, a piece of soft-sided luggage, for

P600. Variable cost per unit is P340, and monthly fixed costs are
P600,000. A combination of changes in the way Samsonyt produces and
sells this product could reduce variable cost per unit by P40 but increase
monthly fixed cost to P1,000,000.

REQUIRED: Determine the indifference point of the two alternatives.

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