1. COST-VOLUME-PROFIT ANALYSIS AND PRICING DECISIONS3
CHAPTER
photo: © Tischenko Irina/Shutterstock
COST-VOLUME-PROFIT ANALYSIS AND PRICING DECISIONS

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?

3. 3 1 . BREAKEVEN ANALYSIS Unit 3.1 Unit 3.2 Unit 3.3 Unit 3.4
© Tomwang112 / iStockphoto 3 1 .
BREAKEVEN ANALYSIS
Unit 3.1
Unit 3.2
Unit 3.3
Unit 3.4

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
$168,000

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. 3 2 . C-V-P ANALYSIS Unit 3.1 Unit 3.2 Unit 3.3 Unit 3.4
© Tomwang112 / iStockphoto 3 2 .
C-V-P ANALYSIS
Unit 3.1
Unit 3.2
Unit 3.3
Unit 3.4

12. LET’S REVIEW THE PROFIT EQUATION
SP×(units sold)
– VC×(units sold)
– FC
= OI

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

14. 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 volume
CM / unit
Target net income
1 – tax rate

15. 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

16. 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

17. 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?

18. 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

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

20. MULTIPRODUCT C-V-P ANALYSIS
© Tomwang112 / iStockphoto 3 .
MULTIPRODUCT C-V-P ANALYSIS
Unit 3.1
Unit 3.2
Unit 3.3
Unit 3.4

21. 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

22. 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

23. 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

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

25. 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 = 4(8,000) = 32,000 jerseys

26. 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

27. 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

28. 3 4 . PRICING DECISIONS Unit 3.1 Unit 3.2 Unit 3.3 Unit 3.4
© Tomwang112 / iStockphoto 3 4 .
PRICING DECISIONS
Unit 3.1
Unit 3.2
Unit 3.3
Unit 3.4

29. ECONOMICS OF PRICE
Market equilibrium

30. 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

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

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

33. 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

34. 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
This is calculated before the product is designed and manufactured
If you can produce the product for the target cost, go forward