Chapter 07 - Cost-Volume-Profit Analysis

Suggested Answers to Self-Review Questions Week 4

7-7

The president is correct. A price increase results in a higher unit contribution

margin. An increase in the unit contribution margin causes the break-even point to
decline.
The financial vice president's reasoning is flawed. Even though the break-even
point will be lower, the price increase will not necessarily reduce the likelihood of
a loss. Customers will probably be less likely to buy the product at a higher price.
Thus, the firm may be less likely to meet the lower break-even point (at a high price)
than the higher break-even point (at a low price).

7-15

When sales volume increases, Company X will have a higher percentage increase
in profit than Company Y. Company X's higher proportion of fixed costs gives the
firm a higher operating leverage factor. The company's percentage increase in
profit can be found by multiplying the percentage increase in sales volume by the
firm's operating leverage factor.

7-20

The low-price company must have a larger sales volume than the high-price
company. By spreading its fixed expense across a larger sales volume, the lowprice firm can afford to charge a lower price and still earn the same profit as the
high-price company. Suppose, for example, that companies A and B have the
following expenses, sales prices, sales volumes, and profits.

Company A
Sales revenue:
350 units at $10 ...............................................
100 units at $20 ...............................................
Variable expenses:
350 units at $6 .................................................
100 units at $6 .................................................
Contribution margin .............................................
Fixed expenses .....................................................
Profit.......................................................................

7-22

$3,500
2,100
$1,400
1,000
$ 400

Company B

$2,000
600
$1,400
1,000
$ 400

Activity-based costing (ABC) results in a richer description of an organization's

cost behavior and CVP relationships. Costs that are fixed with respect to sales
volume may not be fixed with respect to other important cost drivers. An ABC
system recognizes these nonvolume cost drivers, whereas a traditional costing
system does not.

7-1
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Chapter 07 - Cost-Volume-Profit Analysis

PROBLEM 7-35 (30 MINUTES)

fixed costs
unit contribution margin
$702,000
135,000 units
$25.00 $19.80

1.

Break - even point (in units)

2.

Break - even point (in sales dollars)

3.

Number of sales units required to

earn target net profit

4.

Margin of safety = budgeted sales revenue break-even sales revenue

fixed cost
contribution - margin ratio
$702,000
$3,375,000
$25.00 $19.80
$25.00
fixed costs target net profit
unit contribution margin
$702,000 $390,000
210,000 units
$25.00 $19.80

= (140,000)($25) $3,375,000 = $125,000

5.

Break-even point if direct-labor costs increase by 10 percent:

New unit contribution margin

= $25.00 $8.20 ($4.00)(1.10) $6.00 $1.60

= $4.80

Break-even point

fixed costs
new unit contribution margin
$702,000
146,250 units
$4.80

7-2
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Chapter 07 - Cost-Volume-Profit Analysis

PROBLEM 7-37 (30 MINUTES)

1.

Unit contribution margin:

Sales price
Less variable costs:
Sales commissions ($32 x 5%) $ 1.60
System variable costs
8.00
Unit contribution margin..

$32.00
9.60
$22.40

Break-even point = fixed costs unit contribution margin

= $1,971,200 $22.40
= 88,000 units
2.

Model B is more profitable when sales and production average 184,000 units.

Sales revenue (184,000 units x $32.00)...

Less variable costs:
Sales commissions ($5,888,000 x 5%)
System variable costs:
184,000 units x $8.00.
184,000 units x $6.40.
Total variable costs..
Contribution margin...
Less: Annual fixed costs..
Net income
3.

Model A

Model B

$5,888,000

$5,888,000

$ 294,400

$ 294,400

1,472,000
$1,766,400
$4,121,600
1,971,200
$2,150,400

1,177,600
$1,472,000
$4,416,000
2,227,200
$2,188,800

Annual fixed costs will increase by $180,000 ($900,000 5 years) because of

straight-line depreciation associated with the new equipment, to $2,407,200
($2,227,200 + $180,000). The unit contribution margin is $24 ($4,416,000 184,000
units). Thus:
Required sales = (fixed costs + target net profit) unit contribution margin
= ($2,407,200 + $1,912,800) $24
= 180,000 units

4.

Let X = volume level at which annual total costs are equal

$8.00X + $1,971,200 = $6.40X + $2,227,200
$1.60X = $256,000
X = 160,000 units

7-3
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Chapter 07 - Cost-Volume-Profit Analysis

PROBLEM 7-39 (40 MINUTES)

1.

Sales mix refers to the relative proportion of each product sold when a company
sells more than one product.

2.

(a)

Yes. Plan A sales are expected to total 65,000 units (19,500 + 45,500), which
compares favorably against current sales of 60,000 units.

(b)

Yes. Sales personnel earn a commission based on gross dollar sales. As

the following figures show, Cold King sales will comprise a greater
proportion of total sales under Plan A. This is not surprising in light of the
fact that Cold King has a higher selling price than Mister Ice Cream ($43 vs.
$37).
Current
Units
Mister Ice Cream .........
Cold King .....................
Total........................

(c)

21,000
39,000
60,000

Sales
Mix
35%
65%
100%

Plan A
Units
19,500
45,500
65,000

Sales
Mix
30%
70%
100%

Yes. Commissions will total $267,800 ($2,678,000 x 10%), which compares

favorably against the current flat salaries of $200,000.
Mister Ice Cream sales: 19,500 units x $37.............
Cold King sales: 45,500 units x $43 ........................
Total sales ............................................................

$ 721,500
1,956,500
$2,678,000

No. The company would be less profitable under the new plan.
Sales revenue:
Mister Ice Cream: 21,000 units x $37; 19,500 units x $37 ..............
Cold King: 39,000 units x $43; 45,500 units x $43 ..........................
Total revenue ...............................................................................
Less variable cost:
Mister Ice Cream: 21,000 units x $20.50; 19,500 units x $20.50 ....
Cold King: 39,000 units x $32.50; 45,500 units x $32.50 ................
Sales commissions (10% of sales revenue) ...................................
Total variable cost .......................................................................
Contribution margin ................................................................................
Less fixed cost (salaries) ........................................................................
Net income ...............................................................................................

Current

Plan A

$ 777,000
1,677,000
$2,454,000

$ 721,500
1,956,500
$2,678,000

$ 430,500
1,267,500

$ 399,750
1,478,750
267,800
$2,146,300
$ 531,700
----___
$ 531,700

$1,698,000
$ 756,000
200,000
$ 556,000

7-4
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Chapter 07 - Cost-Volume-Profit Analysis

3.

(a)

The total units sold under both plans are the same; however, the sales mix
has shifted under Plan B in favor of the more profitable product as judged
by the contribution margin. Cold King has a contribution margin of $10.50
($43.00 - $32.50), and Mister Ice Cream has a contribution margin of $16.50
($37.00 - $20.50).
Plan A
Units
Mister Ice Cream ..............
Cold King ..........................
Total ............................

19,500
45,500
65,000

Sales
Mix
30%
70%
100%

Plan B
Sales
Mix

Units
39,000
26,000
65,000

60%
40%
100%

(b)
Plan B is more attractive both to the sales force and to the company. Salespeople
earn more money under this arrangement ($274,950 vs. $200,000), and the company is
more profitable ($641,550 vs. $556,000).
Sales revenue:
Mister Ice Cream: 21,000 units x $37; 39,000 units x $37 .............
Cold King: 39,000 units x $43; 26,000 units x $43 .........................
Total revenue ...............................................................................
Less variable cost:
Mister Ice Cream: 21,000 units x $20.50; 39,000 units x $20.50 ...
Cold King: 39,000 units x $32.50; 26,000 units x $32.50 ...............
Total variable cost.......................................................................
Contribution margin................................................................................
Less: Sales force compensation:
Flat salaries........................................................................................
Commissions ($916,500 x 30%) .......................................................
Net income ...............................................................................................

Current

Plan B

$ 777,000
1,677,000
$2,454,000

$1,443,000
1,118,000
$2,561,000

$ 430,500
1,267,500
$1,698,000
$ 756,000

$ 799,500
845,000
$1,644,500
$ 916,500

200,000
$ 556,000

7-5
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274,950
$ 641,550

Chapter 07 - Cost-Volume-Profit Analysis

PROBLEM 7-48 (45 MINUTES)

1.

Unit contribution margin

$810,000
$450 per ton
1,800

Break - even volume in tons

fixed costs
unit contribution margin
$495,000
1,100 tons
$450

2.

Projected net income for sales of 2,100 tons:

Projected contribution margin (2,100 $450) ........................................
Projected fixed costs ................................................................................
Projected net income ................................................................................

3.

$945,000
495,000
$450,000

Projected net income including foreign order:

Variable cost per ton = $990,000/1,800 = $550 per ton
Sales price per ton for regular orders = $1,800,000/1,800 = $1,000 per ton

Sales in tons ......................................................................

Contribution margin per ton:
Foreign order ($900 $550) .......................................
Regular sales ($1,000 $550) ....................................
Total contribution margin ................................................

Foreign
Order
1,500

Regular
Sales
1,500

$350
$525,000

$450
$675,000

Contribution margin on foreign order ........................................................ $ 525,000

Contribution margin on Regular sales .......................................................
675,000
Total contribution margin ............................................................................ $1,200,000
Fixed costs ....................................................................................................
495,000
Net income .................................................................................................... $ 705,000

7-6
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Chapter 07 - Cost-Volume-Profit Analysis

4.

New sales territory:

To maintain its current net income, Central Pennsylvania Limestone Company just
needs to break even on sales in the new territory.
Break - even point in tons

fixed costs in new territory

unit contribution margin on sales in new territory
$123,000
307.5 tons
$450 $50

5.

Automated production process:

Break - even point in tons

$495,000 $117,000
$450 $50
$612,000
1,224 tons
$500

Break - even point in sales dollars 1,224 tons $1,000 per ton
$1,224,000

6.

Changes in selling price and unit variable cost:

New unit contribution margin ($1,000)(90%) ($550 $80)
$270
New contribution margin ratio

Dollar sales required to earn target net profit

$270
($1,000)(90%)
.30
fixed costs target net profit
contribution margin ratio
$495,000 $189,000
.30
$2,280,000

7-7
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No reproduction or distribution without the prior written consent of McGraw-Hill Education.