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Lecture

# BU121 Week 9 Lecture 1.docx

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Department
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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