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CVP notes.docx

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Department
Business
Course
BU121
Professor
Laura Allan
Semester
Winter

Description
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 NOT KNOW YOUR BUSINESS.,. 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 8x-3000 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  BUT at what level of volume would it make the most sense to invest in the new machinery?  At what point does your bottom line improve?  NOT necessarily at the breakeven point of the new machinery  Given that price is same regardless – makes sense at point where costs are equal… Let volume where new machinery is better be x: fixed + variable of old = fixed + variable of new 10 000 + 6x = 30 000 Proof: (volume above breakeven, below decision point) At 4,000 units = revenue $10 x 4,000 = $40,000 regardless Old = 40 000 - 10 000 - 6(4000) = 6000 income New = 40000-30000-2(4000) = 2000 income  Breakeven is where TR = TC  Let the breakeven units be ‘x’ Price x = FC + VC x (Price - VC) x= FC x = FC / (Price-VC) -  What is left over after covering variable costs that contributes toward covering fixed costs? Because that is what contributes on fixed…  Contribution Margin** - f  How many units do we have to sell at a contribution of (Price -VC) to cover FC? First thing you need to know Breakeven units = FC / Price-VC  Easier way to determine dec’n point… -forgot about stuff that doesn't change, where does the incremental fixed cost be covered… 20000 more to cover, but 4$ extra unit  Point where incremental (additional) fixed costs are covered by the incremental contribution = ($30,000 – 10,000) /(($10-2) – ($10-6)) =20000/(8-4)  =5000 units that you will cover the extra fix with variable, below that not making any money  Contribution Rate  Example:  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 costs $10,000 $30,000 variable costs $6,000 $2,000 sales $10,000 regardless of which
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