Chapter 7 – Cost-Volume-Profit Analysis
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107. Paranormal Company is considering the development of two products: no. 65 or no. 66.
Manufacturing cost information follows.
No. 65
No. 66
Annual fixed costs
$220,000
$340,000
Variable cost per unit
33
25
Regardless of which product is introduced, the anticipated selling price will be $50 and the
company will pay a 10% sales commission on gross dollar sales. Paranormal will not carry an
inventory of these items.
Required:
A. What is the break-even sales volume (in dollars) on product no. 66?
B. Which of the two products will be more profitable at a sales level of 25,000 units?
C. At what unit-volume level will the profit/loss on product no. 65 equal the profit/loss on
product no. 66?
Solution:
A.
Selling price
Less: Variable cost [$25 + ($50 x 10%)]
Unit Contribution margin
Break-even sales: 17,000 x $50 = $850,000
No. 65
Sales *
Less: Variable costs**
Contribution margin
$300,000
Less: Fixed costs
Operating income
** No. 65: 25,000 x [$33 + ($50 x 10%)]; No. 66: 25,000 x [$25 + ($50 x10%)]
108. Downtown Industries recently sold 70,000 units, generating sales revenue of $4,900,000.
The company’s variable cost per unit and total fixed cost amounted to $20 and $2,800,000,
respectively. Management is in the process of studying the dollar impact of various
transactions and events, and desires answers to the following independent cases:
Case no. 1: Management wants to lower the firm’s break-even point to 52,000 units. If all
other costs remain constant, what must happen to fixed costs to achieve this objective?
Case no. 2: The company anticipates a $2 hike in the variable cost per unit. If all other costs
remain constant and management desires to maintain the firm’s current break-even point, what
must happen to Downtown’s selling price? If selling price remains constant, what must
happen to the firm’s total fixed costs?
Required:
A. Answer the two cases raised by management.
B. Determine the impact (increase, decrease, or no effect) of the following operating changes
on the items cited:
1. An increase in variable selling costs on income.
2. A decrease in direct material cost on the unit contribution margin.
3. A decrease in the number of units sold on the break-even point.
Solution:
109. Calle Company is studying the impact of the following:
1. An increase in sales price.
2. An increase in the variable cost per unit.
3. An increase in the number of units sold (note: each unit produces a $6 contribution
margin).
4. A decrease in fixed costs.
5. A proposed change in the method of compensation for salespeople, away from
commissions based on gross sales dollars and toward higher monthly salaries.
Required:
Determine the impact of each of these operating changes on Calle’s per-unit contribution
margin and break-even point by completing the chart that follows. Your responses should be
Increase (INC), Decrease (DEC), No Effect (NE), or Insufficient Information to Judge (II).
Per-Unit
Contribution
Margin
Break-Even
Point
1.
2.
3.
4.
5.
Solution:
Per-Unit
Margin
Point
1.
INC
DEC
2.
DEC
INC
3.
4.
DEC
5.
INC
110. Pfitz Company is studying the impact of the following:
An increase in sales price on the break-even point.
2. A decrease in fixed costs on the contribution margin.
3. An increase in the contribution margin on the break-even point.
4. A decrease in the variable cost per unit on the sales volume needed to achieve Pfitz’s
$68,000 target profit.
5. An increase in sales commissions on the contribution margin and the break-even point.
6. A decrease in anticipated advertising outlays on fixed cost and the break-even point.
Required:
Determine the impact of these operating changes (increase, decrease, no effect) on the item(s)
noted.
Solution:
111. Falcon Environmental Services, Inc. provides consulting services to power plants . The
consulting firm’s contribution-margin ratio is 15 percent, and its annual fixed expenses are
$135,000. The firm’s income-tax rate is 35 percent.
Required:
1. Calculate the firm’s break-even volume of service revenue.
2. How much before-tax income must the firm earn to make an after-tax net income of
$65,000?
3. What level of revenue for consulting services must the firm generate to earn an after-
tax net income of $65,000?
4. Suppose the firm’s income-tax rate rises to 45 percent. Explain what will happen to
the break-even level of consulting service revenue.
112. The PowerClean Company manufactures an engine for carpet cleaners called the
“Snooper.” Budgeted cost and revenue data for the “Snooper” are given below, based on sales
of 40,000 units.
Sales revenue
$1,600,000
Less: Cost of goods sold
1,120,000
Gross margin
$480,000
Less: Operating expenses
100,000
Income
$380,000
Cost of goods sold consists of $810,000 of variable costs and $310,000 of fixed costs.
Operating expenses consist of $30,000 of variable costs and $70,000 of fixed costs.
Required:
A. Calculate the break-even point in units and sales dollars.
B. Calculate the safety margin (in dollars).
C. PowerClean received an order for 6,000 units at a price of $25.00. There will be no
increase in fixed costs, but variable costs will be reduced by $0.54 per unit because of cheaper
packaging. Determine the projected increase or decrease in profit from the order, assuming
there are no opportunity costs.
Solution:
Sales
Less: Variable costs ($810,000 + $30,000)
Contribution margin
Sales (6,000 x $25)
Less: Variable costs at $20.46*
Increase in profit
113. Max Company manufactures and sells three products: Good, Better, and Best. Annual
fixed costs are $3,315,000, and data about the three products follow.
Good
Better
Best
Sales mix in units
30%
50%
20%
Selling price
$250
$350
$500
Variable cost
100
150
250
Required:
A. Determine the weighted-average unit contribution margin.
B. Determine the break-even volume in units for each product.
C. Determine the total number of units that must be sold to obtain a profit for the company of
$234,000.
D. Assume that the sales mix for Good, Better, and Best is changed to 50%, 30%, and 20%,
respectively. Will the number of units required to break-even increase or decrease? Explain.
Hint: Detailed calculations are not needed to obtain the proper solution.
Solution:
Contribution margin
Good: $150 x 30%
Better: $200 x 50%
Best: $250 x 20%
Weighted-average CM
114. Shotz Corporation sells three products: J, K, and L. The following information was taken
from a recent budget:
J
K
L
Unit sales
40,000
130,000
30,000
Selling price
$60
$80
$75
Variable cost
40
65
50
Total fixed costs are anticipated to be $2,450,000.
Required:
A. Determine Shotz’s sales mix.
B. Determine the weighted-average contribution margin.
C. Calculate the number of units of J, K, and L that must be sold to break even.
D. If Shotz desires to increase company profitability, should it attempt to increase or decrease
the sales of product K relative to those of J and L? Briefly explain.
J
K
L
Selling price
$80
$75
Variable cost
65
50
Contribution margin
$15
$25
J: $20 x 20%
K: $15 x 65%
L: $25 x 15%
Weighted-average CM
$17.50
7-65
115. Bolton Publications, Inc. produces and sells business books. The results of the company’s
operations for the year ended December 31, 20×1, are given below.
Sales Revenue
$400,000
Cost of goods sold (manufacturing costs):
Fixed
100,000
Variable
200,000
Selling costs:
Fixed
10,000
Variable
20,000
Administrative costs:
Fixed
24,000
Variable
6,000
Required:
A. Prepare a traditional income statement for the company.
B. Prepare a contribution income statement for the company.
C. Which income statement (traditional or contribution) would an operating manager most
likely use to study changes in operating income that are caused by changes in sales? Why?
Solution:
Sales
$400,000
Less: Cost of goods sold
Gross margin
$100,000
Less operating expenses:
Selling
Administrative
Net income
Sales
Less: Variable expenses:
Manufacturing
$200,000
Selling
Administrative
Contribution margin
Less: Fixed expenses:
Manufacturing
$100,000
Selling
Administrative
Net income
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116. Flavol Corporation reported sales revenues of $1,850,000 for the period just ended. Cost
of goods sold, selling expenses, and administrative expenses totaled $1,200,000, $280,000,
and $170,000, respectively. A detailed analysis of the latter three amounts revealed respective
fixed cost components of $780,000, $60,000, and $130,000.
Required:
A. Determine the amounts, if any, that Flavol would report on a traditional income statement
for (1) gross margin, (2) contribution margin, and (3) income.
B. Determine the amounts, if any, that Flavol would report on a contribution income
statement for (1) gross margin, (2) contribution margin, and (3) income.
C. Which of the two income statements (traditional or contribution) is more useful for
studying a company’s cost-volume-profit relationships?
117. Techtronics Software, Inc. specializes in customized spreadsheet software. The results of
the company’s operations during the prior year (20xx) are given in the following table. All
units produced during the year were sold. (Ignore income taxes.)
Sales revenue
$ 3,000,000
Manufacturing costs:
Fixed
500,000
Variable
1,000,000
Selling costs:
Fixed
50,000
Variable
100,000
Administrative costs:
Fixed
120,000
Variable
30,000
Required:
1. Prepare a traditional income statement and a contribution income statement for the
company.
2. What is the firm’s operating leverage for the sales volume generated during the prior
year?
3. Suppose sales revenue increases by 20 percent. What will be the percentage increase
in net income?
4. Which income statement would an operating manager use to answer requirement (3)?
Why?
Chapter 7 – Cost-Volume-Profit Analysis
7-68
Solution:
7-69
118. Clarkson Enterprises is studying the addition of a new product that would have an
expected selling price of $180 and expected variable cost of $120. Anticipated demand is
9,000 units.
A new salesperson must be hired because the company’s current sales force is working at
capacity. Two compensation plans are under consideration:
Plan 1: An annual salary of $38,000 plus 10% commission based on gross sales dollars
Plan 2: An annual salary of $180,000 and no commission
Required:
A. What is meant by the term “operating leverage”?
B. Calculate the contribution margin and income of the two plans at 9,000 units.
C. Compute the operating leverage factor of the two plans at 9,000 units. Which of the two
plans is more highly leveraged? Why?
D. Assume that a general economic downturn occurred during year no. 2, with product
demand falling from 9,000 to 7,200 units. By using the operating leverage factors, determine
and show which plan would produce a larger percentage decrease in income.
Solution:
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119. Two brothers (Baylor and Lamar) dreamt about owning and operating companies in the
same line of business. Baylor believed in maintaining a very large, highly efficient manual
labor force; Lamar, on the other hand, favored automated-production processes. One business
was located in Omaha and the other was located in Tulsa. Recent data follow.
Omaha
Tulsa
Sales
$2,000,000
$2,000,000
Contribution margin
1,500,000
450,000
Income
150,000
150,000
Required:
A. Which of the two businesses, Omaha or Tulsa, has the higher level of (1) variable cost and
(2) higher level of fixed cost? Explain how you determined your answer.
B. Determine the probable owner of the firm located in (1) Omaha and (2) Tulsa. Briefly
explain your logic.
C. Compute the operating leverage factor for Omaha and Tulsa.
D. Suppose that both Omaha and Tulsa had the opportunity to increase sales by 10%. Which
of the two locations would experience a larger percentage change in net income? Why?
Solution:
120. Operating leverage is an important concept for many companies.
Required:
A. Define operating leverage.
B. Assume that a firm pays no income taxes and is planning to increase its selling price. If
sales volume in units does not change, what will be the effect on the operating leverage
factor? Explain.
C. Assume that another firm that pays no income taxes is planning to increase total fixed
manufacturing costs and decrease variable manufacturing costs per unit. At the present
volume of production, the total manufacturing costs will be unchanged. What will this change
do to the operating leverage factor? Explain.
Solution:
121. Many firms are moving toward flexible manufacturing systems and adopting the just–in–
time (JIT) philosophy.
Required:
A. How is cost behavior altered in the typical flexible manufacturing environment as
compared to a traditional manufacturing system? What is the impact on the break-even point?
Explain.
B. One of the assumptions underlying cost-volume profit analysis is that sales volume and
production volume are equal. Stated another way, inventories are assumed to remain constant.
Is this assumption likely to be violated under an ongoing JIT philosophy? Explain.
Solution: