Presentation Chapter 4 Profit Planning

Marginal Analysis Income Statement To reach earnings before interest and taxes (Operating Income) Revenues 10000 Variable costs 60% 6000 Marginal contribution 4000 Fixed costs 1200 EBIT 4800

Break-even Analysis The minimum position that allows continued operations. Key terms: Break-even Point. The level of operations with neither a profit or loss. Variable Cost. The cost of producing goods or delivering services. Fixed Cost. Cost that does not vary with the level of activity.

Marginal Contribution The direct profit from operations. In Dollars. Revenues – variable costs. As a Percent. Revenues – variable costs Revenues or (Rev – VC)/Rev

B/E Dollars or Units The break-even point may be calculated in dollars or units: B/E_$ = level of revenues needed to cover fixed costs. B/E_units = number of units sold needed to cover fixed costs

Break-even Formula -- Dollars The break-even point in dollars is calculated by the formula: B/E_$ = FC/(MC%) where B/E_$ = Revenues at the break-even point. MC% = marginal contribution as a percent [(Rev-VC)/Rev]

Break-even Formula -- Units The break-even point in units sold is calculated: B/E_units = FC/(MC$) where MC$ = Rev-VC

Profit-volume Analysis This is a modification of break-even analysis. Profits are added to fixed costs. B/E_Revs = (FC + Profit)/MC% B/E_Revs equals the dollars of sales needed to achieve a desired profit.

Marginal Analysis This is the application of profit-volume analysis: Varying the Level of Revenues. Forecasting profits at different sales levels while holding selling price and costs constant. Varying Price. Forecasting profits at different prices. Varying Fixed and Variable Costs. Trading one category of cost for another.

Profit Planning and Stock Price Investors link a firm’s profits to the market price of its stock. Key terms: Earnings per Share (EPS). Net income divided by outstanding shares of stock. Price-earnings Ratio (P/E). Market price divided by EPS.

Normal P/E Multiple A normal P/E multiple exists when EPS meets two conditions: A firm has a satisfactory return on its capital. Investors are not disturbed by unusual psychological or economic factors.

Estimating Normal P/E The normal P/E for a company or industry is estimated by analyzing: Historical data. Similar firms. Industry norms. National markets Common sense.

Question How do know when we have found the normal P/E?

Answer Nobody knows.