CVP is a powerfulanalytical tool that informs managers for business decision making.By the use of this tool, relationships between production orservice costs, volume, and profit can be modeled to determine salesvolume needed at a certain price to break even or earn a targetprofit level or amount.
What are the keycomponent of CVP Analysis? Discuss the basic assumptions of CVPanalysis. Define the terms Unit Contribution Margin andContribution Margin ratio.
CVP is a powerfulanalytical tool that informs managers for business decision making.By the use of this tool, relationships between production orservice costs, volume, and profit can be modeled to determine salesvolume needed at a certain price to break even or earn a targetprofit level or amount.
What are the keycomponent of CVP Analysis? Discuss the basic assumptions of CVPanalysis. Define the terms Unit Contribution Margin andContribution Margin ratio.
Related questions
Contribution Margin Analysis:
We calculatecontribution margin by taking our sales revenue less our variablecosts. This basically tells us the portion of our sales that areavailable to cover the fixed cost of the business.
Contribution marginper unit is especially useful. We compute this by taking our salesrevenues per unit less our variable cost per unit. With this, wecan easily compute our break-even point.
Dog Day Care
Pricing at $18 per dog per day, you can expect to have 22 dogsper day
Pricing at $20 per dog per day, you can expect to have 15 dogsper day
Pricing at $25 per dog per day, you can expect to have 10 dogsper day
· Overnight Boarding
Pricing at $25 per dog per day, you can expect to have 12 dogsper day
Pricing at $28 per dog per day, you can expect to have 10 dogsper day
Pricing at $430 per dog per day, you can expect to have 7 dogsper day
Basic Groom
Pricing at $25 per dog per day, you can expect to have 5 dogsper day
Pricing at $30 per dog per day, you can expect to have 4 dogsper day
Pricing at $35 per dog per day, you can expect to have 3 dogsper day
Break-Even Analysis:
Break-even analysis isa key element of cost-volume-profit analysis. The technique ishelpful for new and small businesses to assess the viability oftheir start-up. However, it can also be quite beneficial forestablished businesses when evaluating new and existing productlines.
In this exercise, weare computing not only the break-even point but also the number ofunits that must be sold in order to earn given levels of targetprofit.
The break-even formulais:
Fixed Costs /Contribution Margin per Unit
The formula to computethe level required for a target profit is:
(Fixed Costs + TargetProfit) / Contribution Margin per Unit
We have alreadycomputed fixed costs for each area in our Milestone One. We will beusing these figures as follows:
Grooming, fixed costs:2,367.92
Daycare, fixed costs:859.39
Boarding, fixed costs:1,378.99
Our computations wouldthen be as follows:
Grooming
Sales Price $25
Break-even: 158
$1,000 Profit: 225
$1,500 Profit: 258
Sales Price $30
Break-even: 119
$1,000 Profit: 169
$1,500 Profit: 194
Sales Price $35
Break-even: 95
$1,000 Profit: 135
$1,500 Profit: 155
Daycare
Sales Price $18
Break-even: 65
$417 Profit: 97
$667 Profit: 116
Sales Price $20
Break-even: 57
$417 Profit: 84
$667 Profit: 101
Sales Price $25
Break-even: 43
$417 Profit: 64
$667 Profit: 76
Boarding
Sales Price $25
Break-even: 79
$583 Profit: 112
$909 Profit: 130
Sales Price $28
Break-even: 67
$583 Profit: 96
$909 Profit: 111
Sales Price $30
Break-even: 61
$583 Profit: 87
$909 Profit: 102
| Break-EvenAnalysis | ||||||||||||||||||
| Instructions - Showall steps and calculations to determine the break-even, as well asthe break-even for the target profit levels as outlined in theinstructions. Round all decimals UP to next wholenumber | ||||||||||||||||||
| Grooming | Day Care | Boarding | ||||||||||||||||
| Break-even Units= | Break-even Units= | Break-even Units= | ||||||||||||||||
| Fixed Costs | Fixed Costs | Fixed Costs | ||||||||||||||||
| Cont. Margin | Cont. Margin | Cont. Margin | ||||||||||||||||
The Hampshire Company manufactures umbrellas that sell for$12.50 each. In 2014, the company made and sold 60,000 umbrellas.The company had fixed manufacturing costs of $216,000. It also hadfixed costs for administration of $79,525. The per-unit costs ofeach umbrella are as follows:
Direct Materials: $3.00
Direct Labor: $1.50
Variable Manufacturing Overhead: $0.40
Variable Selling Expenses: $1.10
Using the information above, perform a cost-volume-profit (CVP)analysis by completing the steps below.
1. Compute net income before tax.
2. Compute the unit contribution margin in dollars and thecontribution margin ratio for one umbrella.
3. Calculate the break-even point in units and dollars ofrevenue.
4. Calculate the margin of safety:
In units
In sales dollars
As a percentage
5. Calculate the degree of operating leverage.
6. Assume that sales will increase by 20% in 2015. Calculate thepercentage of before-tax income for this increase. Providecalculations to prove that your percentage increase is correctbased on the operating leverage calculated in step 5.
7. Compute the number of umbrellas that Hampshire is required tosell if it plans to earn $150,000 in income before taxes by usingthe target income formula. Proof your calculation.
8. A company that specializes in tours in England has offered topurchase 5,000 umbrellas at $11 each from Hampshire. The variableselling costs of these additional units will be $1.30 as opposed to$1.10 per unit. Also, this production activity will incur another$15,000 of fixed administrative costs. Should Hampshire agree tosell these additional 5,000 umbrellas to the touring business?Provide calculations to support your decision.
| Requirement 1 | ||||
| Units | Price | Totals | ||
| Sales | X | $ | $ | |
| Variable Costs | X | $ | $ | |
| Fixed Costs | $ | |||
| Net Income | $ | |||
| Requirement 2 | ||||
| Contribution Margin per Unitin Dollars = Selling Price â Variable Costs | ||||
| Selling Price | Variable Costs | Contribution Margin per Unit | ||
| Contribution Margin Ratio =Contribution Margin/Selling Price | ||||
| Contribution Margin | Selling Price | Contribution Margin Ratio | ||
| Requirement 3 | ||||
| Break-Even Point = Fixed Costs/ Contribution Margin | ||||
| Fixed Costs | Contribution Margin | Break-Even Point in Units (Rounded) | ||
| Break-Even Point in Units XSelling Price per Unit = Break-Even Point Sales | ||||
| Break-Even Point in Units | Selling Price per Unit | Break-Even Point in Sales (Rounded) | ||
| Requirement 4A | ||||
| Margin of Safety in Units =Current Unit Sales â Break-Even Point in Unit Sales | ||||
| Current Unit Sales | Break-Even Point in Sales | Margin of Safety in Units | ||
| Requirement 4B | ||||
| Margin of Safety in Dollars =Current Sales in Dollars â Break-Even Point Sales in Dollars | ||||
| Current Sales in Dollars | Break-Even Point in Dollars | Margin of Safety in Dollars | ||
| Requirement 4C | ||||
| Margin of Safety as aPercentage = Margin of Sales in Units / Current Unit Sales | ||||
| Margin of Safety in Units | Current Unit Sales | Margin of Safety Percentage | ||
| Requirement 5 | ||||
| Degree of Operating Leverage =Contribution Margin / Operating Income | ||||
| Contribution Margin | Operating Income | Operating Leverage | ||
| Requirement 6 | ||||
| Units | $ Per Unit | Totals | ||
| Sales | X | $ | $ | |
| Variable Costs | X | $ | $ | |
| Fixed Costs | $ | |||
| Net Income | $ | |||
| Operating Leverage | Times % Increase | Increase would be XX% | ||
| Prior Income | $ | From Part 1 | ||
| Increase | $ | Prior Income X XX% Above | ||
| Total | $ | |||
| Requirement 7 | ||||
| Targeted Income = (Fixed Costs+ Target Income) / Contribution Margin | ||||
| Fixed Costs + Target Income | Divided by Contribution Margin | # of Units (Rounded) | ||
| Fixed Costs | $ | |||
| Target Income | $ | |||
| Total | $ | $ | X | |
| # of Units Above X $ Per Unit | ||||
| Proof | Revenue | XX,XXX X $XX.XX | $ | |
| Variable Costs | XX,XXX X $X.XX | $ | ||
| Contribution Margin | $ | |||
| Fixed Costs | $ | |||
| Net Income | $ | |||
| Requirement 8 | ||||
| Sales Mix | ||||
| Current | Specialty | Total | ||
| Expected Sales Units | X | X | ||
| Revenue = Sales X Price | $ | $ | $ | |
| Variable Costs X Units | $ | $ | $ | |
| Contribution Margin | $ | $ | $ | |
| Fixed Costs | $ | $ | $ | |
| Operating Income | $ | |||
| Prior Net Income FromRequirement 1 | $ | |||
| Additional Operating Income | (Operating Income Above Less Prior Income) | $ | ||
| Decision With Explanation | ||||
Case 9-6: Profit PlanningâChoice of CostStructure
The owner of a package delivery business is currently evaluatingthe choice between two different cost structures, based on how thedelivery personnel are paid. One option (hereafter, âAlternative#1â) has relatively higher short-term fixed costs, while the otheroption (hereafter, âAlternative #2â) has the reverseâthat is,relatively higher variable costs in its cost structure. (Forsimplicity in this example we hold the delivery cost per package,that is, the selling price per unit is constant. Selling price isindependent of the cost-structure choice.) The following tablecontains pertinent information for creating the CVP model for eachdecision alternative:
Decision Inputs (Data) | Cost Structure Alternative #1 | Cost Structure Alternative #2 |
Delivery price (i.e., revenue) per package | $60 | $60 |
Variable cost per package delivered | $48 | $30 |
Contribution margin per unit | $12 | $30 |
Fixed costs (per year) | $600,000 | $3,000,000 |
Requirements
1. What is meant by the term âshort-term profit-planningâ model,and how can such a model be used by management? (That is, in whatsense can this model be used to facilitate planning, control, ordecision-making by managers of an organization?)
2. What are the definitions of fixed costs, variable costs,contribution margin ratio, contribution margin per unit, andrelevant range?
3. What is the break-even point, in terms of number ofdeliveries per year (or per month), for Alternative #1? ForAlternative #2?
4. How many deliveries would have to be made under Alternative#1 to generate a pre-tax profit, ÏB, of $25,000per year?
5. How many deliveries (per month or per year) would have to bemade under Alternative #1 to generate a pre-tax profit,ÏB, equal to 15% of sales revenue?
6. How many deliveries would have to be made under Alternative#2 to generate an after-tax profit, ÏA, of$100,0000 per year, assuming a tax rate of, say, 45%?
7. Assume that for the coming year total fixed costs areexpected to increase by 10% for each of the two alternatives. Whatis the new break-even point, in terms of number of deliveries, foreach decision alternative? By what percentage did the break-evenpoint change for each case? How do these figures compare to thepercentage increase in budgeted fixed costs?
8. Assume an average income-tax rate of 40%. What volume (numberof deliveries) would be needed to generate an after-taxprofit, ÏA, of 5% of sales for each alternative?
