2. MARKETING WANTS ANOTHER $50,000
What will they do with it?
How will it affect sales volume?
What is the impact on our bottom line?

4. WHAT DOES IT MEAN TO “BREAK EVEN”
Total revenues = total expenses
Profit = $0
There is one sales volume at which this relationship is true
This is called the “breakeven point”

5. TO CALCULATE THE BREAKEVEN POINT
Use the equation approach
Sales Revenue – Variable expenses – Fixed expenses = Operating income
(SP×units sold) – (VC×units sold) – FC = $0
[(SP – VC)×(units sold)] – FC = $0
(CM/unit×units sold) – FC = $0
Solve for units sold, which equals the breakeven point
Why is profit set to $0?

6. BREAKEVEN POINT FOR UNIVERSAL SPORTS EXCHANGE
Exhibit 3-1
$20x - $16x - $168,000 = 0
$4x - $168,000 = 0
x = 42,000 jerseys

7. SHORTCUTS… FC = Breakeven in units CM/Unit $168,000 $4
= 42,000 jerseys

8. SHORTCUTS… FC
CMR
= Breakeven in sales $
$168,000
0.2
= $840,000

9. LET’S LOOK AT BREAK EVEN GRAPHICALLY
Exhibit 3-2

10. MARGIN OF SAFETY Current sales – Breakeven sales What does this mean?
52,500 – 42,000 = 10,500 jerseys
$1,050,000 – $840,000 = $210,000
What does this mean?

11. PRACTICE BREAKING EVEN
Exercise 3-2
© Floortje/iStockphoto

12. EXERCISE 3-2 SOLUTION a. $.80 - $.45 = $.35
b. Contribution margin ratio =
c. $.80x – $.45x – $175,000 = $0
$.35x =
$175,000
x =
500,000 bars to breakeven
500,000 bars  $.80 per bar =
$400,000 to breakeven
d. The breakeven point will increase to:

14. LET’S REVIEW THE PROFIT EQUATION
SP(units sold) – VC(units sold) – FC = profit

15. HOW MUCH DO I HAVE TO SELL TO MAKE $X?
This is called the “target income” question
Use the breakeven formula and treat your target pretax income as additional fixed costs
FC + Target Income
CM / unit
= required sales
To find the sales dollars required to attain the target income, use the CMR rather than the CM / unit.

16. WHAT ABOUT TARGET NET INCOME?
You must adjust net income to pretax income
Divide target net income by (1 - tax rate)
Solve as before
Total FC +
= required sales
CM / unit
Target net income
1 – tax rate

17. TARGET PRACTICE (EXERCISE 3-10)
Wimpee’s Hamburger Stand sells one burger, the Super Tuesday Burger, for $3.00. If total variable expenses are $1.75 per hamburger and total monthly fixed expenses are $25,000, how many burgers would Wimpee have to sell each month:
To break even?
To earn a pretax operating income of $6,000?

18. WHAT IF…
Suppose Wimpee has never sold more than 21,000 Super Tuesday Burgers in a single month.
How likely is it that he will achieve the desired $6,000 target operating income?
What can he do to improve his chances of reaching his $6,000 target operating income?

19. CVP AND THE SUPPLY CHAIN
How do the CVP decisions of supply chain partners affect each other?
For example, consider the jerseys that Universal Sports Exchange purchases from C&C Sports.
What happens if C&C Sports increases the selling price?
What happens if Universal Sports Exchange decides to use a cheaper supplier?

20. CVP ANALYSIS Stands for cost-volume-profit
A tool to determine the impact of changes in sales volume, costs, or sales mix on net income
Useful for evaluating decision alternatives

21. THREE APPROACHES TO CVP
Prepare a contribution format income statement before and after implementing the changes
Prepare a partial contribution format income statement that includes only those items that change (called the “incremental approach”)
Compare the current total contribution margin with the proposed total contribution margin, then adjust for changes in fixed expenses

22. OPERATING LEVERAGE
Firms sometimes have the option to trade fixed costs for variable costs
Higher levels of fixed costs introduce higher levels of risk
Measures the magnitude of change in operating income for a given percentage change in sales revenue
Degree of operating leverage =
Contribution margin
Net operating income

23. WHY DO WE CARE ABOUT OPERATING LEVERAGE?
Exhibit 3-4

24. DO THE CVP
Exercise 3-6
© XAOC/iStockphoto

25. EXERCISE 3-6 SOLUTION a. Contribution margin ratio =
Variable cost ratio = = .35
b. Margin of safety = Current sales – Breakeven sales
Breakeven sales = =
$450,000
Margin of safety =
$600,000 – $450,000
$150,000
c. Net operating income would increase by the change in contribution margin: $100,000  .65 = $65,000

26. EXERCISE 3-6 SOLUTION (CONT.)
d. new variable cost =
$17.50  1.16 =
$20.30
new price =
$50  1.1
$55
current unit sales =
= 12,000
new unit sales =
12,000  .98 = 11,760
operating income =
[($55.00 – $20.30)  11,760] – $292,500 =
$115,572

28. MULTIPRODUCT CVP Rarely does a company produce a single product
Since not every product will have the same contribution margin, we have a problem when more than one product is produced

29. WHAT IS “SALES MIX”? The “bag” or “package” of goods sold For example:
For every dining room table sold, the company also sells 4 chairs
For every computer sold, the company also sells a monitor and a printer
For every pair of athletic shoes sold, Landon Sports sells 4 baseball jerseys

30. USE THE PROFIT EQUATION…WITH ADJUSTMENTS
Product
Price
Variable Cost
Contribution Margin
Jerseys
$20
$16.00
$4.00
Shoes
$45
$38.70
$6.30
CM(jerseys) + CM(shoes) – FC = OI

31. DETERMINE THE SALES MIX
Product
Contribution Margin
Sales Mix
Adjusted Contribution Margin
Jerseys
$4.00 4x
$16.00x
Shoes
$6.30 1x
$ 6.30x
$4.00(4x) + $6.30(x) – FC = OI
$16x + $6.30x – FC = OI

32. CALCULATING THE BREAKEVEN POINT
Product
Contribution Margin
Sales Mix
Adjusted Contribution Margin
Jerseys
$4.00 4x
$16.00x
Shoes
$6.30 1x
$ 6.30x
$16x + $6.30x– $178,400 = $0
$22.30x = $178,400
x = 8,000 shoes
4x = 32,000 jerseys

33. LIMITING ASSUMPTIONS OF CVP ANALYSIS
All costs can be divided into fixed and variable components
All cost and profit functions are linear throughout the relevant range
Sales mix will remain constant

34. CHANGES EXAMINED USING CVP
Change in sales price
Change in sales volume
Change in variable costs per unit
Change in fixed costs
Change in sales mix
Any combination of the above
Remember to always use “constant” forms – SP/unit, VC/unit, Total FC – when doing CVP analysis

35. TIME TO MIX IT UP
Exercise 3-14
© Danny Smythe/iStockphoto

36. EXERCISE 3-14 SOLUTION
a. Kitchenware’s sales mix is 14,000 plastic pitchers and 42,000 glass pitchers, or a sales mix of 1 to 3.
($30 – $15)x + ($45 – $24)3x – $982,800 =
$15x + $63x =
$982,800
x =
12,600
plastic pitchers = x = 12,600; glass pitchers = 3x = 37,800
b. ($30 – $13)x + ($45 – $24)3x – $982,800 =
$17x + $63x =
$982,800
x =
12,285
plastic pitchers = x = 12,285; glass pitchers = 3x = 36,855

38. ECONOMICS OF PRICE

39. WHAT WILL YOU PAY?
Pricing is based on what the customer is willing to pay, not on what the product costs to produce!

40. COST-PLUS PRICING Start with the cost to produce the product
Add a markup to the cost to arrive at price
Be clear about what cost you use in the markup calculation
Product Cost
+ Markup
= Sales Price

41. CALCULATING MARKUP PERCENTAGE
Sales price – Cost
Cost
= Markup %
$ $14.80
$14.80
= 35%

42. CALCULATING PRICE USING MARKUP %
Cost + (Cost × Markup %) = Price
$ ($36.00 × 35%) = Price
$ $12.60 = $48.60

43. ISSUES WITH COST-PLUS PRICING
What if customers are willing to pay more than the calculated price?
Cost-plus pricing does not recognize the value provided to the customer; it recognizes a return to the seller
The costs of the seller’s inefficiencies are borne by the customers

44. TARGET COSTING Start with an estimate of the price customers will pay
Subtract the desired markup
The result is the target, or maximum, product cost
If you can produce the product for the target cost, go forward
This is calculated before the product is designed and manufactured

45. LET’S PRICE
Exercise 3-18
© Chris Pethick/iStockphoto

46. EXERCISE 3-18 SOLUTION a. cost of original pet bed = $45 – $15 = $30
markup percentage =
price of high-end bed = $58 × 1.5 = $87
b. current gross margin =
= 1/3; COGS = 2/3
high-end bed target cost of goods sold = 2/3 × $78 = $52
c. Pet Designs could
redesign the high-end bed to reduce the cost to produce the bed;
accept a lower gross margin percentage; or,
not make the bed

47. ONE FINAL REVIEW
Problem 3-20
© Beverley Vycital/iStockphoto

48. PROBLEM 3-20(A) SOLUTION current sales volume:
new sales volume: 50,000 × .95 = 47,500 units
new sales price: $12.00 × 1.10 = $13.20
Total
Per unit
Sales
$627,000
$13.20
Less variable expenses
332,500
7.00
Contribution margin
294,500
$ 6.20
Less fixed expenses
175,000
Operating income
$119,500

49. PROBLEM 3-20(B) SOLUTION new sales price: $12.00 × 1.10 = $13.20
new variable cost per unit: $7.00 × 1.05 = $7.35
Total
Per unit
Sales
$660,000
$13.20
Less variable expenses
367,500
7.35
Contribution margin
292,500
$ 5.85
Less fixed expenses
175,000
Operating income
$117,500

50. PROBLEM 3-20(C) SOLUTION new sales price: $12.00 × .90 = $10.80
new sales volume: 50,000× 1.20 = 60,000 units
Total
Per unit
Sales
$648,000
$10.80
Less variable expenses
420,000
7.00
Contribution margin
228,000
$ 3.80
Less fixed expenses
175,000
Operating income
$ 53,500

51. PROBLEM 3-20(D) SOLUTION
new fixed expenses: $175,000 + $20,000 = $195,000
Total
Per unit
Sales
$648,000
$10.80
Less variable expenses
420,000
7.00
Contribution margin
228,000
$ 3.80
Less fixed expenses
175,000
Operating income
$ 53,500

52. PROBLEM 3-20(E) SOLUTION new sales price: $12.00 × 1.10 = $13.20
new variable cost per unit: $7.00 × 1.10 = $7.70
new fixed expenses: $175,000 + $25,000 = $200,000
new sales volume: 50,000 × .90 = 45,000 units
Total
Per unit
Sales
$594,000
$13.20
Less variable expenses
346,500
7.70
Contribution margin
247,500
$ 5.50
Less fixed expenses
200,000
Operating income
$ 47,500