BU121 Lecture Notes - Variable Cost, European Cooperation In Science And Technology, Operating Leverage

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31 Jan 2013

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Cost-Volume-Profit Analysis
tool used for decision-making - anything that involves cost
shows effect of changes in Costs or Volumes on Profits CVP Analysis - these decisions are made all the time
shows impact of Operating Leverage - something we do that might incurred risk but it'll bring back something
degree to which locked into fixed operating costs
o must sell more to cover fixed costs (RISK)
o but once covered - leveraged effect on profit (RETURN) MAGNIFY RETURN
also used for ‘Breakeven’ Analysis
where Revenues = Expenses OR Rev-Exp=0
most important concept is contribution * - what important info is, easier to analysis, if you do not know this then YOU DO
Things to Know:
Fixed costs -
constant regardless of level of production and sales - like an overhead cost, only constant in normal activity
assuming operating in ‘relevant range’ - e.g certain amount of rent within a space.. But if expand then more space
needed, then fixed nature OC changes, only constant in range of activity
o normal range of operating activity
Variable costs - varies, like the material put in for the product
total depends on level of production and sales
Example operating leverage
The ABC Company is considering buying a new, more highly automated piece of machinery to increase productivity
The following costs would apply:
Old Machinery New Machinery
Fixed $10,000 $30,000
Variable $6/unit $2/unit - all fixed changes are shown in variable cost, where leverage impact of our product
Price $10/unit regardless of machine used - doesn't matter.. But when you compare to variable cost, then it can
increase profit, but always keep in mind the fixed cost
Breakeven is where TR = TC
Let the breakeven units be ‘x’
Price x = FC + VC x
(Price - VC) x = FC
x = FC / (Price-VC)
10x=30 000 + 2x
x=3750 - break even, doesn't say if you should, but says what you need to sell for it to be okay
Better to increase operating leverage as long as the risk (of not meeting breakeven volume) is not too high
above breakeven contribution is higher
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