Chapter 3 : Cost-Volume-Profit Analysis

Q1: What is the Cost-Volume-Profit Analysis?

CVP analysis looks at the relationship between cost, Volume and profits to
determine the breakeven point.

Q2: What is the breakeven point?

The breakeven point (BEP) is where: Total revenue = total costs.
Net Income = Zero
Total Contribution Margin = Fixed Cost

Q3: Explain the CVP analysis using graphic form?

Q4: How is CVP Analysis Used?

CVP analysis can determine:
1- Breakeven point both in sales volume and sales dollars.
2- Volume and sales dollars required to achieve target profit.

Break Even Points Formulas

.
1. BEP (U) = = = ## units {C.M/U = SP V.C/U}
./

.
2. BEP ($) = = = $##
.%

() (./)
C.M% = 100 = #%
()

() (.)
C.M% = 100 = #%
()

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Chapter 3 : Cost-Volume-Profit Analysis

+ .+
3. Units Required to Earn Profit = =
./

+ .+
4. Sales Required to Earn Profit = =
.%

5. Safety Margin = Sales (U) BEP (U)

= Sales ($) BEP ($)

() ()
6. Safety Margin Ratio =
()

($) ($)
7. Safety Margin Ratio =
($)

8. Operating Leverage =

9. Percentage Change in Net Income = Percentage Change in Sales Operating Leverage

10. Change in Net Income (Contribution Margin) = Change in Sales CM%

Contribution Format Income Statement:

Total Per Unit Percentage

Sales Revenue (10,000 units) 100,000 SP/U $10 100%
(-) Variable Costs 40,000 V.C/U $4 V.C % 40%
(=) Total Contribution Margin 60,000 C.M/U $6 C.M% 60%
(-) Fixed Costs 20,000
(=) Net Income 40,000

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Chapter 3 : Cost-Volume-Profit Analysis

Breakeven Point For Multi Products

.
1. BEP (U) = = = ## units
./

.
2. BEP ($) = = = $ ##
.%

+
3. Units Required To Earn Profit = = ## units

+
4. Sales Required To Earn Profit = = $ ##

5. Change in Net Income (Contribution Margin) = Change in Sales Overall CM

Overall Units Contribution Margin

Products S.P/U V.C/U C.M/U Sales Mix Overall

A $10 $4 $6 40% $2.4
B $20 $12 $8 60% $4.8
Overall Contribution Margin $7.2

Overall Contribution Margin Ratio

Products S.P/U V.C/U C.M/U C.M % Sales Mix Overall

A $10 $4 $6 60% 40% 24%
B $20 $12 $8 40% 60% 24%
Overall Contribution Margin Ration 48%

A B Total
Sales $400,000 $600,000 $1,000,000
(-) Variable Costs 160,000 360,000 520,000
(=) Contribution Margin 240,000 240,000 480,000
(-) Fixed Costs 300,000
(=) Net Income 180,000

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Chapter 3 : Cost-Volume-Profit Analysis
Exercises:
1. NTQ Corporation produces and sells a single product with a price of $12 per unit and
variable costs of $8 per unit. Total fixed costs per month are $8,000.
a. Calculate NTQs contribution margin per unit.
b. How many units must NTQ sell monthly to break even?
c. If fixed costs increase by $500 per month, how many extra units must NTQ sell each
month to continue breaking even?

Solution:
a. Contribution margin per unit = Selling Price Variable cost per unit
= $12 - $8 = $4

$ 8,000
b. Breakeven point in units = = = 2,000 units
$4

$ 8,500
c. Breakeven point in units = = = 2,125 units
$4

Extra Units = 2,125 2,000 = 125 units

Another Solution:

$ 500
Extra Units = = = $125 units
$4

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Chapter 3 : Cost-Volume-Profit Analysis

2. Julies Jewels sells cubic zirconium (fake diamond) rings for $80 each. The projected
income statement for 2006 follows:
Sales $4,000,000
Variable costs (2,200,000)
Contribution Margin 1,800,000
Fixed costs (1,600,000)
Pretax profit $ 200,000

a. Compute the contribution margin per ring and the number of rings that must be sold to
break even.
b. Compute the contribution margin ratio and the breakeven point in total revenue.
c. Suppose the total revenues were $200,000 greater than expected. What is the total
pretax profit?
d. What is the margin of safety in number of rings?
e. Assume a tax rate of 25%. How many rings must be sold to earn an after-tax profit of
$300,000?

Solution:
. a. Contribution margin per ring = $1,800,000 50,000 units = $36

Breakeven point = $1,600,000/$36 per ring = 44,445 rings

b. Contribution margin ratio = ($1,800,000$4,000,000) 100 = 45%

Revenue at breakeven = $1,600,0000.45 = $3,555,556

c. Increase in Pretax profit = $200,000 x 0.45 = $90,000.

Add this to current profit of $200,000 to calculate new profit of $290,000.

d. Margin of safety in number of rings

= Current number of rings sold breakeven number of rings
= 50,000 44,445 = 5,555 rings

e. Pretax profit = $300,000 (1- 0.25) = $400,000

+
Units to meet target profit =

$1,600,000+$400,000
= = 55,556 rings
$36

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Chapter 3 : Cost-Volume-Profit Analysis

3. FTH Corporation produces and sells two products: regular scooters and electric scooters.
Last month, the company produced and sold 500 regular and 300 electric scooters. Last
months per-unit financial data for both models is presented below:
Regular Electric
Selling price $100 $150
Variable cost 30 40
Product line fixed cost 25 45
Corporate fixed cost 10 10
Product line fixed costs can be avoided if the product is dropped, but corporate fixed costs
can only be avoided if FTH goes out of business entirely. Calculate the following amounts:
a. Total fixed product line costs for each product
b. Total corporate fixed costs
c. Overall corporate breakeven point in sales dollars assuming a constant sales mix
d. Breakeven point in sales dollars for regular scooters, ignoring corporate fixed costs
e. Breakeven point in sales dollars for electric scooters, ignoring corporate fixed costs
Solution
a. Fixed Product line Costs = ($25 x 500) + ($45 x 300) = $26,000

b. Fixed Corporate Costs = ($10 x 500) + ($10 x 300) = $8,000

c. BEP ($) =

Weighted average CMR

Regular Electric Total

Sales Revenue $50,000 $45,000 $ 95,000
500$100 300$150
(-) Variable Costs $15,000 $12,000 $ 27,000
500$30 300$40
(=) Contribution Margin $ 68,000

$ 68,000
Then : Weighted Average CMR = 100 = 72%
$ 95,000

$,+$,
BEP ($) = = $47,222
%

d. Product line fixed cost = $25 x 500 = $12,500

CM Ratio = ($100 - $30) / $100 = 70%
$12,500 / 70% = $17,858 breakeven sales for regular scooters

e. Product line fixed cost = $45 x 300 = $13,500

CM Ratio = ($150 - $40) / $150 = 73% (rounded)
$13,500 / 73% = $18,410 breakeven sales for electric scooters

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