EXERCISES ON CVP ANALYSIS

1. Information for three costs incurred at Loranz, Inc. in the first quarter follows:

Month Cost Activity

Auto expense January $17,600 32,000 miles driven
February $16,225 29,500 miles driven
March $17,105 31,100 miles driven

Internet access January $2,350 12,800 gigs of data

February $2,820 13,400 gigs of data
March $2,390 11,000 gigs of data

Monitoring expense January $2,100 1,600 calls

February $2,100 1,200 calls
March $2,100 2,700 calls

Classify each cost and support your choice with justification of why your choice is considered as
either fixed, variable, or mixed.

Answer
Auto expense: This cost is not fixed because the total cost differs at each level of activity. It is a
variable cost because the unit cost is the same at each of the three levels of activity.
Variable unit cost – January: $17,600 / 32,000 = $0.55
Variable unit cost – February; $16,225 / 29,500 = $0.55
Variable unit cost - March $17,105 / 31,100 = $0.55
Internet access: It is not fixed since the total cost differs at each of the three levels of activity.
The cost is not variable since the cost per unit is not the same at each level of activity:
Unit cost – January: $2,350 / 12,800 = $0.18
Unit cost – February; $2,820 / 13,400 = $0.21
Unit cost - March $2,390 / 11,000 = $0.22
This cost is therefore, mixed, since it does not meet the definition of fixed or variable.

Monitoring expense:
This is a fixed cost because the total cost is the same at each of the three levels of activity.

2. The following monthly data are available for Beach Nail Salon which provides manicures for
nursing home patients who are charged $22 per manicure. Its unit variable costs are $16 and its
total fixed expenses are $5,400. Revenue during April totaled 1,600 units.

a. How much is the break-even point in sales dollars for Beach Nail Salon?
b. How many manicures must the company provide in order to earn a profit of $3,180?
c. A new employee suggests that Beach Nail Salon sponsor a company softball team as a
form of advertising. The cost to sponsor the team is $1,320. How many more manicures
must be provided to cover this cost?

Answer
a. 22x – 16x – 5,400 = 0
x = 900 manicures
Break-even sales = 900 × $22 = $19,800

b. ($5,400 + $3,180) / ($22 − $16) = 1,430 manicures

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c. $1,320 / ($22 − $16) = 220 manicures

3. Mango Enterprises produces mango-flavored tea bags. March’s budget indicated that sales of 500
boxes of tea bags would incur fixed costs of $2,380. The company's contribution margin ratio is
35%, and its contribution margin per box of tea bags is $4. How much sales revenue must Mango
Enterprises generate to break-even?

Answer
0.35x – 2,380 = 0
x = $6,800

4. Resin Products has estimated that fixed costs per month are $79,200 and variable cost per dollar
of sales is $0.52.
a. What is the break-even point per month in sales?
b. What level of sales is needed for a monthly profit of $24,000?
c. For the month of July, the company anticipates sales of $240,000. What is the expected
level of profit?

Answer
a. Contribution margin ratio = 1.00 – 0.52 = 0.48
$79,200 ÷ 0.48 = $165,000

b. ($79,200 + $24,000) ÷ 0.48 = $215,000

c. ($240,000 × 0.48) – $79,200 = $36,000

5. Disc Buddy, Inc. produces flash drives. The selling price is $8 per drive. The variable cost of
production is $2.40 per unit and the fixed cost per month is $3,600.
a. Calculate the contribution margin associated with each flash drive.
b. In August, the company sold 200 more flash drives than planned. What is the expected
effect on profit of selling the additional drives?
c. Calculate the contribution margin ratio associated with one flash drive.
d. In October, the company had sales that were $2,400 higher than planned. What is the
expected effect on profit related to the additional sales?

Answer
a. $8.00 – $2.40 = $5.60

b. Profits will increase by $1,120 ($5.60 × 200)

c. [$8.00 – $2.40] ÷ $8.00 = 70.00%

d. Profits will increase by $1,680 (70.00% × $2,400)

6. Savane Enterprises sells a single product at a price of $57 per unit. Variable costs per unit are $35
and total fixed costs are $719,400. Savane is considering the purchase of new equipment that
would increase fixed costs to $1,023,700, but decrease the variable cost per unit to $28.
a. If Savane expects to sell 40,000 units next year, should the company purchase this new
equipment?
 Chapter 4 Cost-Volume-Profit Analysis 4-3

b. What would Savane’s volume have to be to change your recommendation in part a

above?
Answer
a. Under the current system, Savane’s profit when 40,000 units are sold is
(($57 – $35) × 40,000) – $719,400 = $160,600
If the new equipment is purchased, Savane’s profit when 40,000 units are sold is
(($57 – $28) × 40,000) – $1,023,700 = $136,300
Savane is better off not buying the new equipment.

b. 57x – 35x – 719,400 = 57x – 28x – 1,023,700

x = 43,472 units (rounded)

7. Sports To Go is organized into three departments. The following sales and cost data are available
for the prior year:
Water Foot Field Total
Sales $160,000 $96,000 $150,000 $406,000
Less variable costs 64,000 42,000 84,000 190,000
Contribution margin 96,000 54,000 66,000 216,000
Less fixed costs 40,000 16,000 32,000 88,000
Profit $ 56,000 $ 38,000 $ 34,000 $128,000

a. What is Sports To Go’s weighted average contribution margin ratio? Round your
percentage value to two decimal places.
b. What level of sales is needed for Sports to Go to earn a profit of $156,720 assuming the
same ratio of units sold and same selling price per unit?
c. Sports To Go places an advertisement in the local paper each week. All else equal, which
department would you emphasize in the advertisement?

Answer
a. $216,000 ÷ $406,000 = 53.20%

b. ($88,000 + $156,720) ÷ 0.5320 = $460,000

c. Contribution margin ratios of the three departments:

Water Department ($96,000 ÷ $160,000) = 60.00%
Foot Department ($54,000 ÷ $96,000) = 56.25%
Field Department ($66,000 ÷ $150,000) = 44.00%
Water Department; because its weekly advertisement earns $0.60 on each incremental
dollar of sales.

8. Iggy’s Ice Pops produces two flavors of ice pops. Information regarding the products is
summarized for the month of April below:
Kiwi Melon Total
Number of units 2,000 3,000 5,000
Sales revenue $3,000 $3,600 $6,600
Variable costs 1,500 900 2,400
Fixed costs 900 2,400 3,300
Profit $ 600 $ 300 $ 900

a. If Iggy’s sells 50 more kiwi pops, by how much will profit increase?
b. How much is Iggy’s weighted average contribution margin ratio?
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c. What level of sales does Iggy’s need in order to earn a profit of $1,200 assuming the
current sales mix? (Round to the nearest dollar.)

Answer
a. CM per kiwi ice pop: ($3,000 – $1,500) / 2,000 = $0.75 per ice pop
For 50 units: $0.75 × 50 = $37.50. No change in fixed costs.

b. ($6,600 – $2,400) / $6,600 = 0.6364 = 63.64%

c. 0.6364x – $3,300 = $1,200

x = $7,071

9. Kerwin Chocolates prepared the following concerning its two favors of chocolate covered
popcorn sold in 2-pound bags:
Very Good Even Better Totals
Units 4,000 12,000 16,000
Revenue $100,000 $180,000 $280,000
Variable costs 56,000 105,000 161,000
Fixed costs 20,000 40,000 60,000
Profit $ 24,000 $ 35,000 $ 59,000

Selling price per unit $25.00 $15.00

Contribution margin per unit $11.00 $6.25
Profit margin per unit $6.00 $2.92
a. What is Kerwin’s weighted average contribution margin per unit?
b. Calculate Kerwin’s break-even point in units assuming the current mix.
c. What would be the number of Very Good and Even Better bags at the break-even level of
sales?
d. What is Kerwin’s weighted average contribution margin ratio?
e. What level of sales (in dollars) would be needed to earn a profit of $64,950 assuming the
current sales mix?
f. What would be the sales (in dollars) of Very Good and Even Better bags for Kerwin’s
total sales calculated in Part e?

Answer
a. ($280,000 – $161,000) ÷ 16,000 = $7.44

b. $60,000 ÷ $7.44 = 8,065 bags

c. Very Good: 8,065 × (4,000 ÷ 16,000) = 2,016 bags

Even Better: 8,065 × (12,000 ÷ 16,000) = 6,049 bags

d. ($280,000 – $161,000) ÷ 280,000 = 42.50%

e. ($64,950 + $60,000) ÷ 0.4250 = $294,000

f. Very Good: $294,000 × ($100,000 ÷ $280,000) = $105,000

Even better: $294,000 × ($180,000 ÷ $280,000) = $189,000
 Chapter 4 Cost-Volume-Profit Analysis 4-5

10. MusicRx produces two MP3 players, standard and mini. Information regarding the products is
summarized for the month of April in the following table:

Standard Mini Total

Sales revenue $126,000 $84,000 $210,000
Variable costs 30,800 29,700 60,500
Fixed costs 36,400 28,000 64,400
Operating income $ 58,800 $26,300 $ 85,100
Contribution margin ratio 75.56% 64.64%
Contribution margin per unit $31.73 $10.86
MusicRx sells 3 standard MP3 players for every 5 mini players sold. It generates $3 of sales for
standard players for every $2 of mini players. The sales mix is expected to stay stable.

a. How much will total revenue be for MusicRx at break-even? (Round intermediate
calculations to four decimal places.)
b. What would be the sales (in dollars) of mini players for total sales calculated in Part a?
c. Suppose that 60 additional standard MP3 players and 100 additional mini MP3 players
are sold. By how much will profit increase?

Answer

a. WACM ratio = ($210,000 – $60,500) / $210,000 = 71.19%

0.7119x − 64,400 = 0
x = $90,462.14 = $90,462

b. 2/5 × $90,462 = $36,185

c. (60 × $31.73) + (100 × $10.86) = $2,989.80

SHORT-ANSWER ESSAYS

1. What is a mixed cost? How are mixed costs handled in a CVP analysis?

Answer
A mixed cost is a cost that contains both a variable cost element and a fixed cost element. Mixed
costs must be separated into their variable and fixed components before any CVP analysis can be
performed.

2. Fixed and variable costs can be estimated using account analysis or regression analysis. Briefly
explain each of these techniques and any advantages or disadvantages associated with each of
them.

Answer
Account analysis requires the manager to use professional judgment to classify costs as either
fixed or variable. An advantage of this technique is that it can be used without any historical data.
Disadvantages are that the method is subjective and that the manager must have a good
understanding of the costs in order to make reliable classifications.

Regression analysis is a statistical technique that uses all the available historical data points to
estimate the slope and intercept of a cost equation. It is difficult to do without a computer and
4-6 Chapter 4 Cost-Volume-Profit Analysis

requires historical data. However, when used appropriately, it provides accurate predictions of
future cost behavior.

3. What is the relevant range? Why is it important in CVP analysis?

Answer
The relevant range is the range of activity for which estimates and predictions are likely to be
accurate. CVP estimates and predictions for operating levels which are outside the relevant range
are not likely to be valid.

4. How would each of the following events affect a company’s break-even point? Each item is
independent of the others. Use I for increase, D for decrease, and N for no effect.

______ a. decrease in fixed manufacturing cost

______ b. increase in variable cost per unit

______ c. increase in the number of units sold

______ d. increase in the selling price

______ e. decrease in fixed selling and administrative costs

Answer
a. D d. D
b. I e. D
c. N

5. When is the contribution margin ratio approach to CVP analysis most useful? Why?

Answer
The contribution margin ratio approach to CVP analysis is most useful in a company that sells a
variety of substantially different products. In these cases, it makes more sense to calculate the
number of sales dollars that must be generated in order for the company to break-even rather than
the number of units needed to break-even.

6. What is operating leverage? What effect does operating leverage have on a company’s profit?

Answer
Operating leverage relates to the level of fixed costs versus variable costs in a firm’s cost
structure. Firms with high operating leverage will experience greater increases in net income
when sales increase. However, when these firms have a decrease in sales, net income will
decrease more dramatically than it would for firms with less leverage.