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REVIEW 6-17
(a)
NAYLOR MANUFACTURING INC.
CVP Income Statement
For the Month ended January 31, 2012
Total
Per Unit
Sales (8,000 units)
$400,000
$50
Variable costs
240,000
30
Contribution margin
160,000
$20
Fixed expenses
Operating income

140,000
$ 20,000

(b) $160,000 8,000 = $20 Contribution margin per unit

(c) $20 $50 = 40% Contribution margin ratio

EXERCISE 6-23
(a)

(1) Contribution margin per room =

Contribution margin per room =
Contribution margin ratio
=

$50 ($5 + $25)

$20
$20 $50 = 40%

Fixed costs = $10,000 + $2,000 + $1,000 + $500 = $13,500

Break-even point in rooms = $13,500 $20 = 675
(2) Break-even point in dollars

=
=

675 rooms $50 per room

$33,750 per month

OR
Fixed costs Contribution margin ratio = $13,500 0.40
= $33,750 per month
(b)

(1) Margin of safety in dollars:

Planned activity = 30 rooms per day 30 days
= 900 rooms per month
Expected rental revenue = 900 rooms $50 = $45,000
Margin of safety in dollars = $45,000 $33,750 = $11,250
(2) Margin of safety ratio: $11,250
$45,000

= 25%

EXERCISE 6-31
(a)

(1) Old-Fashioned:
Operating leverage = $120,000 $100,000 = 1.2
Contribution margin ratio = $120,000 $400,000 = 30%
(2) Mech-Apple:
Operating leverage = $260,000 $100,000 = 2.6
Contribution margin ratio = $260,000 $400,000 = 65%
Mech-Apple will be more sensitive to changes in sales volume,
because after reaching their break-even point, 65 cents from every
sales dollar goes to profit. Old-Fashioned will only receive 30
cents from every sales dollar towards profit.

(b)

(1) Old-Fashioned: 10% 1.2 = 12% decrease, or $12,000

Mech-Apple: 10% 2.6 = 26% decrease, or $26,000
(2) Old-Fashioned: 5% 1.2 = 6% increase, or $6,000
Mech-Apple: 5% 2.6 = 13% increase, or $13,000

(c) The investment banker should not make her decision solely on the
information provided.
Other factors, such as the market
situation, should be considered, because this will impact the
profitability of the companies.
For example, Mech-Apple will benefit from its high degree of
operating leverage, but only if it is above break-even. With its
current cost structure, it has a much higher break-even point
than Old-Fashioned has, and carries a much higher risk in an
unstable market. Profitability will not be as great for OldFashioned, with an operating leverage of only 1.2, but with a
lower break-even point it will achieve profitability much faster.

EXERCISE 6-35
(a) Weighted average contribution margin per unit:
(40% $40) + (50% $20) + (10% $70) = $33
Break-even in units = $660,000 $33 = 20,000 units
(b) Shoes: 20,000 40% = 8,000 units
Gloves: 20,000 50% = 10,000 units
Range-Finder: 20,000 10% = 2,000 units
(c) Operating income = total contribution margin fixed costs
[(8,000 $40) + (10,000 $20) + (2,000 $70)] $660,000 = $0

PROBLEM 6-46A
(a)

(1) Contribution margin

Sales ($16 per unit)
Less: variable costs
Direct materials ($5.11 per unit)
Direct labour ($2.85 per unit)
Manufacturing overhead (70% $360,000)
Selling expenses (40% $240,000)
Administrative expenses (20% $280,000)
Contribution margin
Contribution margin
Sales (100,000 110% $16)
Less: variable costs
Direct materials(110,000 $5.11)
Direct labour (110,000 $2.85)
Manufacturing overhead (110,000 $2.52)
Selling expenses (110,000 $0.96)
Administrative expenses (110,000 $0.56)
Contribution margin

Current Year
$1,600,00
$511,000
285,000
252,000
96,000
56,000

Projected Year
$1,760,000
$562,100
313,500
277,200
105,600
61,600

(2) Fixed costsCurrent Year

Manufacturing overhead (30% $360,000)
Selling expenses (60% $240,000)
Administrative expenses (80% $280,000)

1,200,000
$400,000

$108,000
144,000
224,000
$476,000

(b) Contribution margin per unit = $400,000 100,000 = $4

Break-even in units = $476,000 $4 = 119,000 units
Break-even in dollars = 119,000 $16 = $1,904,000

1,320,000
$440,000

PROBLEM 6-46A (Continued)

(c)

Contribution margin ratio: $400,000 $1,600,000 = 25%

Target income = ($476,000 + $310,000) 0.25 = $3,144,000

(d) Safety of margin ratio = ($3,144,000 $1,904,000) $3,144,000

Safety of margin ratio = 39.44%
(e)

(1) Contribution margin

Sales
Less: variable costs
Direct materials
Direct labour
Manufacturing overhead (30% $360,000)
Selling expenses (90% $240,000)
Administrative expenses
Contribution margin
(2)

With changes
$1,600,000
$511,000
181,000
108,000
216,000
56,000

Contribution margin ratio = $528,000 $1,600,000 = 33%

(3) Fixed costswith changes

Manufacturing overhead
Selling expenses
Administrative expenses

$252,000
24,000
224,000
$500,000

Break-even in sales = $500,000 0.33 = $1,515,151

1,072,000
$528,000

PROBLEM 6-46A (Continued)

By incorporating the changes, the break-even sales declinedwhich
means the companys overall risk is decreased. It will not take them
as long to reach break-even as before, so they will show profits
sooner.
However, the changes actually had opposing effects. Reducing
variable costs increases the contribution margin ratio, but also leads
to a higher break-even point because of higher fixed costs (purchase
of equipment). On the other hand, moving to commissioned sales
increases variable costs and lowers fixed costs resulting in a lower
contribution margin ratio and a lower break-even point.

PROBLEM 6-49A
(a) Reformat the income statement to CVP format.
All amounts are in $000s.
Sales
$78,000
Variable costs ($36,660 + $14,040)
50,700
Contribution margin
27,300
Less: Fixed costs ($7,940 + $10,260)
18,200
Operating income
$9,100
Contribution margin ratio = $27,300 $78,000 = 35%
Break-even point = $18,200 0.35 = $52,000
(b) If a hired workforce replaces sales agents, commissions will
be reduced to 10% of sales, or $7,800; but fixed costs will
increase by $6,240. All amount are in $000s.
Sales
$78,000
Variable costs ($36,660 + $7,800)
44,460
Contribution margin
33,540
Less: Fixed costs ($18,200 + $6,240)
24,440
Operating income
$9,100
Contribution margin ratio = $33,540 $78,000 = 43%
Break-even point = $24,440 0.43 = $56,837 (rounded)
(c) Operating leverage = contribution margin operating income
Current situation: from part (a)
$27,300,000 $9,100,000 = 3.00
Proposed situation: from part (b)
$33,540,000 $9,100,000 = 3.69 (rounded)

PROBLEM 6-49A (Continued)

The calculations indicate that at a sales level of $78 million, a
percentage change in sales and contribution margin will result in
3.00 times that percentage change in operating income if Olin
continues to use sales agents. If they choose to employ their
own, the change in operating income will be 3.69 times the
percentage change in sales.
The higher contribution margin per dollar of sales and higher
fixed costs from Olin employing their own agents gives them
more operating leverage. This will result in greater benefits
(increases in operating income) if revenues increase, but greater
risks (decreases in operating income) if revenues decline. It will
also increase their break-even point, which could be risky in an
unstable market.
(d) The sales level at which operating incomes will be identical is
called the point of indifference. This would be when the cost of
the network of agents (18% of sales) is exactly equal to the cost
of paying employees 10% commission along with additional fixed
costs of $6.24 million. None of the other costs are relevant,
because they will not change between alternatives.
Let the sales volume = S
18% S = (8% S) + 7,800,000
0.18S = 0.08S + $7,800,000
0.10S = $7,800,000
S = $78,000,000
This confirms what is shown in parts (a) and (b) of this question
the operating income under both scenarios is $9,100,000 and the
sales are $78 million.

*PROBLEM 6-51A
Contribution margin ratio:
Old Company: $220,000 $400,000 = 55%
New Company: $320,000 $400,000 = 80%
(a) Break-even point in dollars:
Old Company: $170,000 0.55 = $309,090
New Company: $270,000 0.80 = $337,500
Margin of safety ratio:
Old Company: ($400,000 $309,090) $400,000 = 22.73%
New Company: ($400,000 $337,500)
$400,000 = 15.63%
(b) Degree of operating leverage:
Old Company: $220,000 $50,000 = 4.4
New Company: $320,000 $50,000 = 6.4
Operating leverage measures the impact any increase or
decrease in sales will have on a companys operating income. In
this situation, any percentage increase in sales for Old Company
will result in an increase in operating income equal to 4.4 times
that percentage. For New Company, it would be equal to 6.4
times that percentage. In the current situation, New Company
stands to gain much more from sales increases than Old
Company.
The opposite effect will occur with any declines in sales. In this
case, Old Company is in a better position because its income will
decrease by a smaller amount in relation to any decreases in
sales.

PROBLEM 6-51A (Continued)

(c) New income statements with a 20% increase in sales:

Sales
Variable costs
Contribution margin
Less: Fixed costs
Operating income

Old

New

Company

Company

$480,000
216,000
264,000
170,000
$94,000

$480,000
96,000
384,000
270,000
$114,000

(d) New income statements with a 20% decrease in sales:

Old

New

Company

Company

Sales
$320,000
Variable costs
144,000
Contribution margin
176,000
Less: Fixed costs
170,000
Operating income (loss)
$6,000

$320,000
64,000
256,000
270,000
$(14,000)

(e) New Company, with its high ratio of fixed costs to variable costs
is highly leveraged, and stands to add 6.4 times any percentage
sales increases to its operating income, compared to Old
Company, which has less leverage. But the same cost structure
that gives New Company the greater benefits from increased
sales has also given it a higher break-even point. Another risk is
that any decreases in sales will have the same, but opposite
impactcausing a faster decline in profits.
Simply stated, it will take New Company longer to reach breakeven, but after that the return on sales will be much greater. Old
Company will start to earn a profit sooner (lower break-even
point), but the impact on operating income from any increases in
sales will be less. Alternatively, any benefit becomes a risk if the
company is losing sales.