Contemporary Engineering Economics, 4 th edition, © 2007 Cost-Volume-Profit Analysis Lecture No. 30 Chapter 8 Contemporary Engineering Economics Copyright © 2006

Contemporary Engineering Economics, 4 th edition, © 2007 Illustration of Full Cost Concept Direct Material Cost = Direct Labor Cost Prime Cost Overhead Cost = Selling Cost General and Administrative Cost Full Production Cost (or Inventory Cost) Full Cost

Contemporary Engineering Economics, 4 th edition, © 2007 Break-Even Chart (Fixed Manufacturing Overhead)- (Depreciation) Fixed Selling and Administrative Expense Variable Selling and Administrative Expense Variable Mfg., Overhead Direct Labor $ Point of Desired Profit Total Cost Line Cash Cost Line Direct Material Desired Profit (Fixed Manufacturing Overhead)- (Depreciation) DEPRECIATION Fixed Selling and Admins Expense Variable Selling and Admins Expense Variable Mfg., Overhead Direct Labor Units of Product (in thousands) Dollars (in thousands)

Contemporary Engineering Economics, 4 th edition, © 2007 Cost Data for Break-Even Chart Unit Variable Costs Direct Materials$2.00 Direct Labor1.00 Variable Manufacturing Overhead1.00 Variable Selling and Administrative Expenses 1.00 Total Unit Variable Cost$5.00  Fixed manufacturing overhead (including Depreciation of $10,000) = $70,000  Fixed Selling and Administrative Expenses = $30,000  Selling Price/Unit = $10  Desired Profit before Taxes = $100,000

Contemporary Engineering Economics, 4 th edition, © 2007 Def: Difference between the unit sales price and the unit variable cost MC = Sales price – Variable cost Application: Break- even volume analysis: Unit Marginal Contribution

Contemporary Engineering Economics, 4 th edition, © 2007 Break-Even Analysis Formulas

Contemporary Engineering Economics, 4 th edition, © 2007 Useful Break-even Sales Formulas

Contemporary Engineering Economics, 4 th edition, © 2007 Profit-Volume Graph PROFITS ($000’s) LOSSES ($000’s) $100 0 $200 $100$200$300$400$500$600 Point of Desired Profit Profit Line Slope of profit line is the marginal contribution $200 UNITS OF PRODUCT (000’s) SAME COST DATA AS USED FOR BREAK-EVEN CHART Fixed cost

Contemporary Engineering Economics, 4 th edition, © 2007 Effect of Variable Costs on Sales Company 1Company 2Company 3 Number of Units Sold70,000 Unit Selling Price$10.00 Unit Variable Cost Unit Marginal Contribution % Marginal Contribution30%35%20% Total Marginal Contribution$210,000$245,000$140,000 Fixed Costs150,000 Net Profit (loss) before taxes$60,000$95,000($10,000) The Profit/Volume Graph shows profits (losses) at different operating levels for the three companies.

Contemporary Engineering Economics, 4 th edition, © 2007 $200 $100 0 $100 $ % MCR30% MCR 20% MCR Units of Product Sold (000’s) An increase in the selling price with variable costs fixed has the same analysis Break-even Chart

Contemporary Engineering Economics, 4 th edition, © 2007 Effect of Fixed Costs  Selling price per unit= $6.00  Variable cost per unit= $3.00  Unit marginal Contribution= $3.00  Current fixed costs= $600,000  Desired profit level = $150,000  Required sales units = (600, ,000)/3 = 250,000 unit  Fixed costs increase = $60,000 (ex. addtl. advertising expenditure)  Reqd. Sales units to maintain profits = 810,000/3 = 270,000 units

Contemporary Engineering Economics, 4 th edition, © , ,000 Increase in sales units required to maintain the same level of profit Effects of Fixed Costs Profit and Loss

Contemporary Engineering Economics, 4 th edition, © 2007 Present Operation Variable Cost Increase Selling Price Decrease Unit Selling Price $10.00 $9.00 Unit variable Cost $7.50$8.25$7.50 Unit marginal contribution $2.50 (25%)$1.75 (17.5%)$1.50 (16.6%) Fixed Costs$150,000 Price Reduction and Increase in Variable Costs

Contemporary Engineering Economics, 4 th edition, © 2007 Price Reductions and Increase in Variable Cost 10% reduction in sales price PRESENT 10% increase in variable cost Profits (000’s) Losses (000’s)

Contemporary Engineering Economics, 4 th edition, © 2007 Option 1: Adding overtime or Saturday operations: 36Q Option 2: Second- shift operation: $13, Q Break-even volume: 36Q = $13, Q Q = 3,000 units Example 8.4 Break-Even Analysis

Contemporary Engineering Economics, 4 th edition, © 2007 Example 8.7 Profit-Maximization Problem

Contemporary Engineering Economics, 4 th edition, © 2007 Net Profit Calculation as a Function of Production Volume

Contemporary Engineering Economics, 4 th edition, © 2007 Weekly Profits as a Function of Time