Chapter 5: Cost-Volume-Profit Relationships

Practice problems

P.1 The Effect of Changes in Activity on Net Operating Income

Whirly Corporation’s contribution format income statement for the most recent month is shown below:

Required: (Consider each case independently):

1. What would be the revised net operating income per month if the sales volume increases by
100 units?
2. What would be the revised net operating income per month if the sales volume decreases by
100 units?
3. What would be the revised net operating income per month if the sales volume is 9,000 units?
Solution:
1. The revised net operating income would be:

Total Per Unit

Sales (10,100 units) $353,500 $35.00
Variable expenses 202,000 20.00
Contribution margin 151,500 $15.00
Fixed expenses 135,000
Net operating income $ 16,500

You can get the same net operating income using the following approach:

Original net operating income $15,000

Change in contribution margin
(100 units × $15.00 per unit) 1,500
New net operating income $16,500

2. The revised net operating income would be:

Total Per Unit

Sales (9,900 units) $346,500 $35.00
Variable expenses 198,000 20.00
Contribution margin 148,500 $15.00
Fixed expenses 135,000
Net operating income $ 13,500

You can get the same net operating income using the following approach:

1
 Original net operating income $15,000
Change in contribution margin
(-100 units × $15.00 per unit) (1,500)
New net operating income $13,500

3. The revised net operating income would be:

Total Per Unit

Sales (9,000 units) $315,000 $35.00
Variable expenses 180,000 20.00
Contribution margin 135,000 $15.00
Fixed expenses 135,000
Net operating income $ 0

Note: This is the company’s break-even point.

P.2 Changes in Variable Costs, Fixed Costs, Selling Price, and Volume

Data for Hermann Corporation are shown below:

Per Unit Percent of Sales
Selling price $90 100%
Variable expenses 63 70
Contribution margin $27 30%

Fixed expenses are $30,000 per month and the company is selling 2,000 units per month.
Required:
1. How much will net operating income increase (decrease) per month if the monthly advertising
budget increases by $5,000 and monthly sales increase by $9,000?
2. Refer to the original data. How much will net operating income increase (decrease) per month
if the company uses higher-quality components that increase the variable expense by $2 per
unit and increase unit sales by 10%.
Solution:
1. The following table shows the effect of the proposed change in monthly advertising budget:
Sales With
Additional
Current Advertising
Sales Budget Difference
Sales ................................................. $180,000 $189,000 $ 9,000
Variable expenses ............................ 126,000 132,300 6,300
Contribution margin......................... 54,000 56,700 2,700
Fixed expenses ................................. 30,000 35,000 5,000
Net operating income ....................... $ 24,000 $ 21,700 $ (2,300)

Assuming no other important factors need to be considered, the increase in the advertising budget
should not be approved because it would lead to a decrease in net operating income of $2,300.
Alternative Solution 1
Expected total contribution margin:
$189,000 × 30% CM ratio ............................................ $56,700

2
 Present total contribution margin:
$180,000 × 30% CM ratio ............................................ 54,000
Incremental contribution margin ...................................... 2,700
Change in fixed expenses:
Less incremental advertising expense ........................... 5,000
Change in net operating income ....................................... $ (2,300)
Alternative Solution 2
Incremental contribution margin:
$9,000 × 30% CM ratio ................................................ $2,700
Less incremental advertising expense............................... 5,000
Change in net operating income ....................................... $ (2,300)

2. The $2 increase in variable expense will cause the unit contribution margin to decrease from $27 to
$25 with the following impact on net operating income:

Expected total contribution margin with the higher-quality

components:
2,000 units × 1.1 × $25 per unit .......................................... $55,000
Present total contribution margin:
2,000 units × $27 per unit ................................................... 54,000
Change in total contribution margin ....................................... $ 1,000
Assuming no change in fixed expenses, the net operating income will also increase by $1,000. The
higher-quality components should be used.

P.3 Break-Even Analysis

Mauro Products distributes a single product, a woven basket whose selling price is $15 per unit and
whose variable expense is $12 per unit. The company’s monthly fixed expense is $4,200.
Required:
1. Calculate the company’s break-even point in unit sales.
2. Calculate the company’s break-even point in dollar sales.
3. If the company’s fixed expenses increase by $600, what would become the new break-even
point in unit sales? In dollar sales?.
Solution:
1. The break-even point in unit sales, Q, is computed as follows:
Profit = Unit CM × Q − Fixed expenses
$0 = ($15 − $12) × Q − $4,200
$0 = ($3) × Q − $4,200
$3Q = $4,200
Q = $4,200 ÷ $3
Q = 1,400 baskets

2. The break-even point in dollar sales is computed as follows:

Unit sales to break even (a) ............................................................. 1,400
Selling price per unit (b) .................................................................. $15
Dollar sales to break even (a) × (b) ................................................. $21,000

3. The new break-even point in unit sales, Q, is computed as follows:

Profit = Unit CM × Q − Fixed expenses
$0 = ($15 − $12) × Q − $4,800

3
 $0 = ($3) × Q − $4,800
$3Q = $4,800
Q = $4,800 ÷ $3
Q = 1,600 baskets

The break-even point in dollar sales is computed as follows:

Unit sales to break even (a) ............................................................. 1,600
Selling price per unit (b) .................................................................. $15
Dollar sales to break even (a) × (b) ................................................. $24,000

P.4 Target Profit Analysis

Lin Corporation has a single product whose selling price is $120 per unit and whose variable
expense is $80 per unit. The company’s monthly fixed expense is $50,000.
Required:
1. Calculate the unit sales needed to attain a target profit of $10,000.
2. Calculate the dollar sales needed to attain a target profit of $15,000.

Solution:
1. The required unit sales, Q, to attain the target profit is computed as follows:

Profit = Unit CM × Q − Fixed expenses

$10,000 = ($120 − $80) × Q − $50,000
$10,000 = ($40) × Q − $50,000
$40 × Q = $10,000 + $50,000
Q = $60,000 ÷ $40
Q = 1,500 units

2. One approach to solving this requirement is to compute the unit sales required to attain the target
profit and then multiply this quantity by the selling price per unit:

Profit = Unit CM × Q − Fixed expenses

$15,000 = ($120 − $80) × Q − $50,000
$15,000 = ($40) × Q − $50,000
$40 × Q = $15,000 + $50,000
Q = $65,000 ÷ $40
Q = 1,625 units

Unit sales to attain the target profit (a) ............................................ 1,625

Selling price per unit (b) .................................................................. $120
Dollar sales to attain target profit (a) × (b) ...................................... $195,000

P.5 Compute the Margin of Safety

Molander Corporation is a distributor of a sun umbrella used at resort hotels. Data concerning the
next month’s budget appear below:
Selling price per unit …………… $30
Variable expense per unit ……… $20
Fixed expense per month ……… $7,500
Unit sales per month …………... 1,000

4
Required:
1. What is the company’s margin of safety?
2. What is the company’s margin of safety as a percentage of its sales?

Solution:
1. To compute the margin of safety, we must first compute the break-even unit sales.

Profit = Unit CM × Q − Fixed expenses

$0 = ($30 − $20) × Q − $7,500
$0 = ($10) × Q − $7,500
$10Q = $7,500
Q = $7,500 ÷ $10
Q = 750 units; or, at $30 per unit, $22,500

Sales (at the budgeted volume of 1,000 units) .................................. $30,000

Less break-even sales (at 750 units) ................................................. 22,500
Margin of safety (in dollars) ............................................................. $ 7,500

2. The margin of safety as a percentage of sales is as follows:

Margin of safety (in dollars) (a) ............................................ $7,500

Sales (b) ................................................................................ $30,000
Margin of safety percentage (a) ÷ (b) ................................... 25%

P.6 Compute and Use the Degree of Operating Leverage

Engberg Company installs lawn sod in home yards. The company’s most recent monthly contribution
format income statement follows:

Required:
1. What is the company’s degree of operating leverage?
2. Using the degree of operating leverage, estimate the impact on net operating income of a 5%
increase in sales.
3. Verify your estimate from part (2) above by constructing a new contribution format income
statement for the company assuming a 5% increase in sales.

Solution:
1. The company’s degree of operating leverage would be computed as follows:

Contribution margin (a) ....................................................... $48,000

Net operating income (b) ..................................................... $10,000

5
 Degree of operating leverage (a) ÷ (b) ................................. 4.8

2. A 5% increase in sales should result in a 24% increase in net operating income, computed as follows:

Degree of operating leverage (a) ....................................................................................... 4.8

Percent increase in sales (b) ............................................................................................... 5%
Estimated percent increase in net operating income (a) × (b) ........................................... 24%

3. The new income statement reflecting the change in sales is:

Percent of
Amount Sales
Sales .............................................. $84,000 100%
Variable expenses ......................... 33,600 40%
Contribution margin...................... 50,400 60%
Fixed expenses .............................. 38,000
Net operating income .................... $12,400

Net operating income reflecting change in sales ........................................ $12,400

Original net operating income (a) ............................................................... 10,000
Change in net operating income (b) ............................................................ $ 2,400
Percent change in net operating income (b) ÷ (a) ....................................... 24%

P.7 Multiproduct Break-Even Analysis

Lucido Products markets two computer games: Claimjumper and Makeover. A contribution format
income statement for a recent month for the two games appears below:

Required:
1. What is the overall contribution margin (CM) ratio for the company?
2. What is the company’s overall break-even point in dollar sales?
3. Verify the overall break-even point for the company by constructing a contribution format income
statement showing the appropriate levels of sales for the two products.

Solution:
1. The overall contribution margin ratio can be computed as follows:
Total contribution margin
Overall CM ratio =
Total sales
$30,000
= =30%
$100,000

6
2. The overall break-even point in dollar sales can be computed as follows:

Total fixed expenses

Overall break-even =
Overall CM ratio
$24,000
= = $80,000
30%
3. To construct the required income statement, we must first determine the relative sales mix for the two
products:
Claimjumper Makeover Total
Original dollar sales ...................... $30,000 $70,000 $100,000
Percent of total .............................. 30% 70% 100%
Sales at break-even ....................... $24,000 $56,000 $80,000

Claimjumper Makeover Total

Sales .............................................. $24,000 $56,000 $80,000
Variable expenses* ....................... 16,000 40,000 56,000
Contribution margin...................... $ 8,000 $16,000 24,000
Fixed expenses .............................. 24,000
Net operating income .................... $ 0
*Claimjumper variable expenses: ($24,000/$30,000) × $20,000 = $16,000
Makeover variable expenses: ($56,000/$70,000) × $50,000 = $40,000

P.8 Multiproduct Break-Even Analysis

Olongapo Sports Corporation distributes two premium golf balls—Flight Dynamic and Sure Shot.
Monthly sales and the contribution margin ratios for the two products follow:

Required:
1. Prepare a contribution format income statement for the company as a whole. Carry computations
to one decimal place.
2. What is the company’s break-even point in dollar sales based on the current sales mix?
3. If sales increase by $100,000 a month, by how much would you expect the monthly net operating
income to increase? What are your assumptions?
Solution:
1.
Flight Dynamic Sure Shot Total Company
Amount % Amount % Amount %
Sales .......................... $150,000 100 $250,000 100 $400,000 100.0
Variable expenses ..... 30,000 20 160,000 64 190,000 47.5
Contribution margin . $120,000 80 $ 90,000 36 210,000 52.5*
Fixed expenses.......... 183,750
Net operating income $ 26,250

*$210,000 ÷ $400,000 = 52.5%

7
2. The break-even point for the company as a whole is:

Dollar sales to = Fixed expenses

break even Overall CM ratio
$183,750
= = $350,000
0.525

3. The additional contribution margin from the additional sales is computed as follows:

$100,000 × 52.5% CM ratio = $52,500

Assuming no change in fixed expenses, all of this additional contribution margin of $52,500 should
drop to the bottom line as increased net operating income.

This answer assumes no change in selling prices, variable costs per unit, fixed expense, or sales mix.

P.9 Break-Even Analysis and CVP Graphing

The Hartford Symphony Guild is planning its annual dinner-dance. The dinner-dance committee
has assembled the following expected costs for the event:

The committee members would like to charge $35 per person for the evening’s activities.
Required:
1. What is the break-even point for the dinner-dance (in terms of the number of persons who
must attend)?
2. Assume that last year only 300 persons attended the dinner-dance. If the same number attend
this year, what price per ticket must be charged in order to break even?
3. Refer to the original data ($35 ticket price per person). Prepare a CVP graph for the dinner-dance
from zero tickets up to 600 tickets sold.

Solution:
1. The contribution margin per person would be:

Price per ticket .................................................................. $35

Variable expenses:
Dinner ........................................................................... $18
Favors and program ...................................................... 2 20
Contribution margin per person ........................................ $15

The fixed expenses of the dinner-dance total $6,000 (= $2,800 + $900 + $1,000 + $1,300). The break-
even point would be:

8
 Profit = Unit CM × Q − Fixed expenses
$0 = ($35 − $20) × Q − $6,000
$0 = ($15) × Q − $6,000
$15Q = $6,000
Q = $6,000 ÷ $15
Q = 400 persons; or, at $35 per person, $14,000

Alternative solution:

Unit sales to = Fixed expenses

break even Unit contribution margin

$6,000
= = 400 persons
$15
or, at $35 per person, $14,000.

2. Variable cost per person ($18 + $2).................................................. $20

Fixed cost per person ($6,000 ÷ 300 persons) .................................. 20
Ticket price per person to break even ............................................... $40
3. Cost-volume-profit graph:

$20,000
Total Sales
$18,000
Break-even point: Total
$16,000 400 persons or Expenses
$14,000 total sales
$14,000

$12,000
Total Sales

$10,000

$8,000

$6,000 Total
Fixed
$4,000 Expenses

$2,000

$0
0 100 200 300 400 500 600 700
9
Number of Persons