1. 1 Chapter 5- Cost-Volume-Profit-Analysis. Summer, 2011. Edited May 23, 2011. Copyright © 2011, Dr. Howard Godfrey This file contains illustrative problems that will be used in the lecture to illustrate important concepts and procedures. Copyright 2011. Dr. Howard Godfrey - M11-Chp-05-1A- Cost-Volume-Profit-Analysis -2011-0523

2. 2 After studying Chapter 5, you should be able to: LO1Explain how changes in activity affect contribution margin and net operating income. LO2Prepare and interpret a cost volume-profit (CVP) graph and a profit graph. LO3Use the contribution margin ratio (CM ratio) to compute changes in contribution margin and net operating income resulting from changes in sales volume. LO4Show the effects on net operating income of changes in variable costs, fixed costs, selling price, and volume. LO5Determine the level of sales needed for a desired target profit. LO6Determine the break-even point. LO7Compute the margin of safety and explain its significance. LO8Compute degree of operating leverage and explain how it can be used to predict changes in net operating income. LO9Compute the break-even point for a multiproduct company and explain the effects of shifts in the sales mix on contribution margin and the break-even point.

3. Introduction 3

4. American Motors-1 A company reported the following sales and earnings over a four-year period: Year Units Sold Pretax Earnings 1 194,000 $(16,700,000) 2 104,000 (30,000,000) 3 119,000 (11,000,000) 4 189,000 26,000,000 Does this seem to be a misprint? Unit sales were less in year 4, than in year 1, but pretax earnings were dramatically higher. 4

5. American Motors-2 Results of a company in trouble: American Motors Corp. In 1957, (year 3 above) the company had only 2% of the automobile market. The company bounced back, and by 1960, its market share had tripled, and it reported an operating profit of $105 million. 5

6. American Motors-3 Break-even analysis was an important part of the company's strategy. The company's 1956 annual report noted: "The primary automotive objective since the merger has been to reduce the automotive break-even point, and simultaneously, to develop new lines of cars needed to increase sales to profitable levels." 6

7. Your salespersons are paid a commission on their sales. Are you concerned when you find that you are paying more sales commissions. [Sales drives commissions.] Does an increase in sales also cause an increase in fuel costs for delivery trucks. Are fuel costs affected by the distance to customers? Does an increase in sales cause an increase in insurance premiums on the delivery trucks? 7

8. Break-Even Point-Question At break-even point, the contribution margin equals total: a. Variable Costs b. Sales revenues c. Selling and admin. Expenses d. Fixed costs 8

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13. Fruit Basket Revised Suppose Jan finds a supplier that charges less for the fruit. She reduces the total cost per basket and fruit to $5. What does that do to break-even? Suppose she also negotiates a reduction in the monthly rent, from $2,000 to $1,500. 13

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15. 1: CVP concepts 15

16. Concept Question The cost-volume-profit analysis for a breakeven chart does not assume that a. Price will remain fixed. b. Production will equal sales. c. Some costs vary inversely with volume. d. Costs are linear and continuous over the relevant range. 16

17. Concept Question The most important information to be derived form a break-even chart is: a. The volume of operations at which a company exactly breaks even b. The relationship between revenues and costs at various levels of output c. The amount of variable revenues needed to cover exactly the fixed costs of the company d. The amount of sales revenue needed to cover the variable costs incurred by the company 17

18. Concept Question At breakeven point of 400 units sold, variable costs were $400 and fixed costs were $200. What will the 401st unit sold contribute to profit before income taxes? a. $0 b. 0.50 c. $1.00 d.$1.50 18

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21. 2: CVP and profit graphs 21

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25. 3: CM ratio 25

26. Super Glue - Breakeven Super Glue sells for $2.00 per tube and has variable costs of $1.20 per tube. Fixed production expenses are $48,000 per month. How many tubes of Super Glue must be sold each month for the Super Glue Company to break even? (Ignore selling and administration costs.) a. 45,000 b. 60,000 c. 90,000 d. 135,000 26

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29. Kalik Co. sells radios for $60 each. Variable expenses are $40 per unit, while fixed expenses total $30,000. What total dollar amount must Kalik sell to break even? a. $40,000 b. $75,000 c. $90,000 d. $120,000 29

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32. Kalik Co. sells radios for $60 each. Variable expenses are $40 per unit, while fixed expenses total $30,000. How many radios must Kalik sell to earn an operating income of $70,000? a. 5,000 b. 3,500 c. 2,500 d. 1,500 32

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35. Koby Co. has sales of $200,000 with variable expenses of $150,000, fixed expenses of $60,000, and an operating loss of $10,000. (Variable costs are always 75% of sales.) By how much would Koby have to increase its sales in order to have operating income of 10% of sales? a. $400,000 b. $251,000 c. $231,000 d. $200,000 35

36. Koby Co. has sales of $200,000 with variable expenses of $150,000, fixed expenses of $60,000, and an operating loss of $10,000. (Variable costs are always 75% of sales.) By how much would Koby have to increase its sales in order to have operating income of 10% of sales? a. $400,000 b. $251,000 c. $231,000 d. $200,000 Increase 36

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39. Roxford Company - 1 Roxford Company had sales of $3,000,000, variable costs of $1,800,000 and fixed costs of $800,000 for a product. What are sales dollars at a level which generates net income of $160,000? a. $2,000,000 b. $2,400,000 c. $2,600,000 d. $2,760,000 e. none of these 39

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42. 4: Effects of changes in parameters 42

43. Kern Company prepared the following forecast concerning product A for 2010: Sales$500,000 Selling price per unit$ 5.00 Variable costs$300,000 Fixed costs$150,000 If the unit selling price is increased by 20%, volume is expected to decrease of only 10%. With these changes in its 2010 forecast, what will be the operating income from product A? a. $66,000 b. $90,000 c. $120,000 d. $145,000 43

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46. 5: Target profit analysis 46

47. Calculate sales volume in total dollars and total units for a target profit. 47

48. Sales to generate target profit Super Glue sells for $2.00 per tube and has variable costs of $1.20 per tube. Fixed production expenses are $48,000 per month. How many tubes of Super Glue must be sold each month for the Super Glue Company to have a monthly income (before income taxes) of $60,000? a. 45,000 b. 60,000 c. 90,000 d. 135,000 48

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51. 6: Break- even analysis 51

52. Koby Co. has sales of $200,000 with variable expenses of $150,000, fixed expenses of $60,000, and an operating loss of $10,000. (Variable costs are 75% of sales.) Compute break-even sales using a formula? a. $400,000 b. $240,000 c. $231,000 d. $200,000 52

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56. 7: Margin of safety 56

57. Big company has sales of $200,000, a contribution margin of 20%, and a margin of safety of $80,000. What is fixed cost? a. $16,000 c. $24,000 c. $80,000 d. $96.000 57

58. 8: Operating leverage 58

59. 9: Multiproduct CVP 59

60. Super Dinner serves dinner each day - 1 Company sells a total of 600 dinners per day: 300 large dinners - price of $10 each. 300 small dinners - price of $6 each. Large dinners have variable cost of $5 each. (Food, napkins, electricity, etc.) Small dinners have variable cost of $4 each. Fixed costs are $2,000 per day for salaries, rent, insurance, etc. What is the profit or loss per day? See next slide. 60

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63. Super Dinner - 4 What is break-even sales in dollars per day? See next slide. 63

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66. Super Dinner -6 Super Dinner is able to change the mix of 600 dinners per day to: 400 large and 200 small dinners. How does that affect profit? See next slide. (Chic-Fil-A began advertising its chicken salad sandwich along with other sandwiches on its product board. Sales of chicken salad sandwiches increased 300%.) 66

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69. Sales Mix Thomas sells products X, Y and Z. Thomas sells 3 units of X for each unit of Z and 2 units of Y for each unit of X. The contribution margins are $1.00 per unit for X, $1.50 per unit for Y, and $3.00 per unit for Z. Fixed costs are $600,000. How many units of X would Thomas sell at break-even point? a. 40,000 b. 120,000 c. 360,000 d. 400,000 69

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71. Compute cost- volume-profit relationships on an after-tax basis 71

72. Sticky Glue sells for $2.00 per tube and has related variable expenses of $1.50 per tube. Fixed expenses of producing Sticky Glue are $100,000 per month. Sticky Glue is in the 40% income tax bracket. How many tubes of Sticky Glue must be sold each month for the Sticky Glue Company to have a monthly income (after income taxes) of $60,000? a. 400,000 b. 300,000 c. 200,000 d. 135,000 e. 450,000 72

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76. Additional practice problems are provided in the following slides 76

77. Reliable Racket Co. makes tennis rackets. This year, fixed costs are expected to be $150,000. Each racket requires $10 of variable cost to produce and will be sold for $15. 1. What is the break-even point in units? a. 10,000 b. 15,000 c. 6,000 d. 30,000 e. 45,000 2. What is the break-even point in dollars? a. $300,000 b. $450,000 c. $150,000 d. $90,000 e. $675,000 3. How many rackets must be sold to earn an annual profit of $20,000? a. 4,000 b. 14,000 c. 24,000 d. 34,000 e. 44,000 77

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84. Reliable Racket Co. makes tennis rackets. This year, fixed costs are expected to be $150,000. Each racket requires $10 of variable cost to produce and will be sold for $15. Continued… 4. If 25,000 rackets are sold this year, and fixed costs are increased to $160,000, the overall profit or loss will be a. $25,000 profit b. $25,000 loss c. $35,000 loss. d. $45,000 loss. e. $45,000 profit. 84

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87. Zarlin Co. is considering an expansion program based on the following data: Expected sales$600,000 Variable costs400,000 Fixed expenses105,000 What are sales at break-even? a. $400,000 b. $420,000 c. $390,000 d. $315,000 e. none of these 87

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96. The most likely strategy to reduce break-even point would be to: a.Increase both fixed costs and the contribution margin. b.Decrease both fixed costs and the contribution margin. c.Decrease fixed costs and increase contribution margin. d.Increase fixed costs and decrease contribution margin. 96

97. Del Company has fixed costs of $100,000 and breakeven sales of $800,000. What is its projected profit at sales of $1,200,000? a. $50,000 b. $150,000 c. $200,000 d. $400,000 97

98. The End 98