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Lecture

BU121 Week 9 Lecture 1.docx

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Department
Business
Course
BU121
Professor
Laura Allan
Semester
Winter

Description
BU121 Week 9 Lecture 1 CVP - Recap  Tool to: o Assess risk in decision when doing something new  Breakeven – above become profitable  When fixed costs covered by contribution from sales - = FC / contribution per unit or % margin  Compare to market – realistic?  Decide when to change strategy – start new approach ○ Determine decision point – above become more profitable  When incremental fixed costs cover incremental contribution  Make decisions that affect costs and/or volume – fine-tuning a strategy ○ Positive impact on profit  Total incremental contribution > incremental fixed and negligible negative qualitative impact Application Assume:  ABC Company currently sells 400 units of a product at $250/unit and variable costs are $150/unit…  contribution per unit = $250 - $150 = $100/unit  total $ contribution = $100/unit x 400 units = $40,000  contribution margin = $150/$250 = 40% Process:  What is the additional/incremental contribution?  Compare to the additional/incremental fixed cost  Better off? o Quantitatively o Qualitatively o $30,000 x 40% contribution = $12,000 additional contribution o Vs $10,000 increase in fixed costs o YES it is better  Quantitatively contribution is higher than fixed Next Problem:  If you could decrease variable costs by $25/unit, but it would mean that quality would also decrease and as a result sales would drop to 350 units, would you do it?  $250 - $125 = $125 contribution per unit  X 350 units = $43,750 total contribution  Vs $40,000 – additional contribution of $3,750  YES, quantitatively  Qualitative issues: may have long term repercussions, may affect value proposition, quality that people perceive of your product Next Question:  If by paying your sales people a commission of $15/unit you could reduce salaries by $6,000 and increase sales by 15%, would you do it?  $250 - $165 = $85 contribution per unit  X 460 units = $39,100 total contribution  vs. $40,000 = $900 decrease in contribution  BUT $6,000 drop in FC  YES, quantitatively  Quantitatively $5100 better off due to the drop in FC  Qualitative issues: depends on the people, some may be happy with this but others may not Next Question:  If by dropping price by $20, and increasing advertising by $15,000, you could expect sales to increase by 50%, would you do it?  $230 - $150 = $80 contribution per unit  X 600 units = $48,000 total contribution  Vs. $40,000 = $8,000 additional contribution  Vs $15,000 increase in FC  NO total contribution drops $7,000  Qualitative issues can’t override unless long term benefit Next Question:  If you were covering your fixed costs now, and you had the opportunity to make a bulk sale of
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