Cost-Volume-Profit Analysis for Managerial Planning

Review Problem: Oslo Company prepared the following contribution format income statement based on a
sales volume of 1,000 units (the relevant range of production is 500 units to 1,500 units):

Required: (Answer each question independently and always refer to the original data unless instructed
otherwise. )
1. What is the contribution margin per unit?
2. What is the contribution margin ratio?
3. What is the variable expense ratio?
4. If sales increase to 1,001 units, what would be the increase in net operating income?
5. If sales decline to 900 units, what would be the net operating income?
6. If the selling price increases by $2 per unit and the sales volume decreases by 100 units, what would be the
net operating income?
7. If the variable cost per unit increases by $1, spending on advertising increases by $1,500, and unit sales
increase by 250 units, what would be the net operating income?
8. What is the break-even point in unit sales?
9. What is the break-even point in dollar sales?
10. How many units must be sold to achieve a target profit of $5,000?
11. What is the margin of safety in dollars? What is the margin of safety percentage?
12. What is the degree of operating leverage?
13. Using the degree of operating leverage, what is the estimated percent increase in net operating income of a
5% increase in sales?
14. Assume that the amounts of the company’s total variable expenses and total fixed expenses were reversed.
In other words, assume that the total variable expenses are $6,000 and the total fixed expenses are $12,000.
Under this scenario and assuming that total sales remain the same, what is the degree of operating leverage?
15. Using the degree of operating leverage that you computed in the previous question, what is the estimated
percent increase in net operating income of a 5% increase in sales?
11-19: Tom Flannery has developed a new recipe for fried chicken and plans to open a take-out restaurant in Oklahoma
City. His father-in-law has agreed to invest $500,000 in the operation provided Tom can convince him that profits will
be at least 20 percent of sales revenues. Tom estimated that total fixed expenses would be $24,000 per year and that
variable expenses would be approximately 40 percent of sales revenue.

Required
1. How much sales revenue must be earned to produce profits equal to 20 percent of sales revenue? Prepare a
contribution income statement to verify your answer.
2. If Tom plans on selling 12-piece buckets of chicken for $10 each, how many buckets must he sell to earn a profit
equal to 20 percent of sales? Twenty-five percent of sales ? Prepare a contribution income statement to verify the
second answer.
3. Suppose Tom’s father-in-law meant that the after-tax profit had to be 20 percent of sales revenue. Under this
assumption, how much sales revenue must be generated by Tom’s chicken business? (Assume that the tax rate is 40
percent.)

11-20: Zacarello Company produces a single product. The projected income statement for the coming year is as
follows:

Sales (50,000 units @ $50) $2,500,000

Less: Variable costs 1,440,000
Contribution margin $1,060,000
Less: Fixed costs 816,412
Operating income $ 243,588

Required
1. Compute the unit contribution margin and the units that must be sold to break even. Suppose that 30,000 units are
sold above breakeven. What is the profit?
2. Compute the contribution margin ratio and the break-even point in dollars. Suppose that revenues are $200,000 more
than expected. What would the total profit be?
3. Compute the margin of safety.
4. Compute the operating leverage. Compute the new profit level if sales are 20 percent higher than expected.
5. How many units must be sold to earn a profit equal to 10 percent of sales?
6. Assume that the tax rate is 40 percent. How many units must be sold to earn an after-tax profit of $180,000?

11-21: Graham Company produces a variety of chemicals. One division makes reagents for laboratories. The division’s
projected income statement for the coming year is as follows:

Sales (110,000 units @ $25) $2,750,000

Less: Variable expenses 1,925,000
Contribution margin $ 825,000
Less: Fixed expenses 495,000
Operating income $ 330,000

Required
1. Compute the contribution margin per unit, and calculate the break-even point in units (round to the nearest unit).
Calculate the contribution margin ratio and the break-even sales revenue.
2. The divisional manager has decided to increase the advertising budget by $40,000. This will increase sales revenues
by $400,000. By how much will operating income increase or decrease as a result of this action ?
3. Suppose sales revenues exceed the estimated amount on the income statement by $315,000. Without preparing a new
income statement, by how much are profits underestimated?
4. Refer to the original data. How many units must be sold to earn an after-tax profit of $360,000? Assume a tax rate of
40 percent.
5. Compute the margin of safety based on the original income statement.
6. Compute the operating leverage based on the original income statement. If sales revenues are 20 percent greater than
expected, what is the percentage increase in profits?

11-22: Gosnell Company produces two products: squares and circles. The projected income for the coming year,
segmented by product line, follows:
Squares Circles Total
Sales $300,000 $2,500,000 $2,800,000
Less: Variable expenses 100,000 500,000 600,000
Contribution margin $200,000 $2,000,000 $2,200,000
Less: Direct fixed expenses 28,000 1,500,000 1,528,000
Product margin $172,000 $ 500,000 $ 672,000
Less: Common fixed expenses 100,000
Operating income $ 572,000

The selling prices are $30 for squares and $50 for circles.

Required
1. Compute the number of units of each product that must be sold for Gosnell Company to break even.
2. Compute the revenue that must be earned to produce an operating income of 10 percent of sales revenues.
3. Assume that the marketing manager changes the sales mix of the two products so that the ratio is three squares to five
circles. Repeat Requirements 1 and 2.
4. Refer to the original data. Suppose that Gosnell can increase the sales of squares with increased advertising. The extra
advertising would cost an additional $45,000, and some of the potential purchasers of circles would switch to squares.
In total, sales of squares would increase by 15,000 units, and sales of circles would decrease by 5,000 units. Would
Gosnell be better off with this strategy?

11-23: Gernon Company produces scientific and business calculators. For the coming year, Gernon expects to sell
20,000 scientific calculators and 100,000 business calculators. A segmented income statement for the two products
follows:

Scientific Business Total

Sales $500,000 $2,000,000 $2,500,000
Less: Variable costs 240,000 900,000 1,140,000
Contribution margin $260,000 $1,100,000 $1,360,000
Less: Direct fixed costs 120,000 960,000 1,080,000
Segment margin $140,000 $ 140,000 $ 280,000
Less: Common fixed costs 145,000
Operating income $ 135,000

Required
1. Compute the number of scientific calculators and the number of business calculators that must be sold to break even.
2. Using information from only the “Total” column of the income statement, compute the sales revenue that must be
generated for the company to break even.

11-24: Tressa Company produces combination shampoos and conditioners in individual use bottles for hotels. Each
bottle sells for $0.36. The variable costs for each bottle (materials, labor, and overhead) total $0.27. The total fixed costs
are $54,000. During the most recent year, 830,000 bottles were sold. The president of Tressa, not fully satisfied with the
profit performance of the shampoo, was considering the following options to increase profitability: (1) increase
promotional spending; (2) increase the quality of the ingredients and, simultaneously, increase the selling price; (3)
increase the selling price; and (4) combinations of the three.
Required
1. The sales manager is confident that an advertising campaign could increase sales volume by 50 percent. If the
company president’s goal is to increase this year’s profits by 50 percent over last year’s, what is the maximum amount
that can be spent on advertising?
2. Assume that the company has a plan to imprint the name of the purchasing hotel on each bottle. This will increase
variable costs to $0.30. How much must the selling price be increased to maintain the same break-even point?
3. The company has decided to increase its selling price to $0.40. The sales volume drops from 830,000 to 700,000
bottles. Was the decision to increase the price a good one? Compute the sales volume that would be needed at the new
price for the company to earn the same profit as last year.

11-25: Fitzgibbons Company produces plastic mailboxes. The projected income statement for the coming year follows:

Sales $840,600
Less: Variable costs 353,052
Contribution margin $487,548
Less: Fixed costs 250,000
Operating income $237,548

Required
1. Compute the contribution margin ratio for the mailboxes.
2. How much revenue must Fitzgibbons earn in order to break even?
3. What volume of sales must be earned if Fitzgibbons wants to earn an after-tax income equal to 8 percent of sales?
Assume that the tax rate is 34 percent.
4. What is the effect on the contribution margin ratio if the unit selling price and unit variable cost each increase by 10
percent?
5. Suppose that management has decided to give a 3 percent commission on all sales. The projected income statement
does not reflect this commission. Recompute the contribution margin ratio assuming that the commission will be paid.
What effect does this have on the break-even point?

6. If the commission is paid as described in Requirement 5, management expects sales revenues to increase by $80,000.
Is it a sound decision to implement the commission? Support your answer with appropriate computations.

11-26: Artistic Wood crafting, Inc., began in 2002 as a one-person cabinet-making operation. Employees were added as
the business expanded. By 2005, sales volume totaled $850,000. Volume for the first five months of 2006 totaled
$600,000, and sales were expected to be $1.6 million for the entire year. Unfortunately, the cabinet business in the
region where Artistic Wood crafting is located is highly competitive. More than 200 cabinet shops are all competing for
the same business.
Artistic currently offers two different quality grades of cabinets: Grade I and Grade II, with Grade I being the higher
quality. The average unit selling prices, unit variable costs, and direct fixed costs are as follows:

Unit Price Unit Variable Cost Direct Fixed Cost

Grade I $3,400 $2,686 $95,000
Grade II 1,600 1,328 95,000

Common fixed costs (fixed costs not traceable to either cabinet) are $35,000. Currently, for every three Grade I cabinets
sold, seven Grade II cabinets are sold.

Required
1. Calculate the Grade I and Grade II cabinets that are expected to be sold during 2006.
2. Calculate the number of Grade I and Grade II cabinets that must be sold for the company to break even.
3. Artistic Wood crafting can buy computer-controlled machines that will make doors, drawers, and frames. If the
machines are purchased, the variable costs for each type of cabinet will decrease by 9 percent, but common fixed costs
will increase by $44,000. Compute the effect on operating income in 2006, and also calculate the new break-even point.
Assume the machines are purchased at the beginning of the sixth month. Fixed costs for the company are incurred
uniformly throughout the year.
4. Refer to the original data. Artistic Wood crafting is considering adding a retail outlet. This will increase common
fixed costs by $70,000 per year. As a result of adding the retail outlet, the additional publicity and emphasis on quality
will allow the firm to change the sales mix to 1:1. The retail outlet is also expected to increase sales by 30 percent.
Assume that the outlet is opened at the beginning of the sixth month. Calculate the effect on the company’s expected
profits for 2006, and calculate the new break-even point. Assume that fixed costs are incurred uniformly throughout the
year.

11-27: Carlyle Lighting Products produces two different types of lamps, a floor lamp and a desk lamp. Floor lamps sell
for $30 and desk lamps for $20. The projected income statement for the coming year follows:

Sales $600,000
Less: Variable costs 400,000
 Contribution margin $200,000
Less: Fixed costs 150,000
Operating income $ 50,000

The owner of Carlyle estimates that 60 percent of the sales revenues will be produced by floor lamps with the remaining
40 percent by desk lamps. Floor lamps are also responsible for 60 percent of the variable expenses. Of the fixed
expenses, one-third are common to both products, and one-half are directly traceable to the floor lamp product line.

Required
1. Compute the sales revenue that must be earned for Carlyle to break even.
2. Compute the number of floor lamps and desk lamps that must be sold for Carlyle to break even.
3. Compute the degree of operating leverage for Carlyle Lighting Products. Now, assume that the actual revenues will
be 40 percent higher than the projected revenues. By what percentage will profits increase with this change in sales
volume?

11-28: Victoria Company produces a single product. Last year’s income statement is as follows:

Sales (29,000 units @ $42) $1,218,000

Less: Variable costs 812,000
Contribution margin $ 406,000
Less: Fixed costs 300,000
Operating income $ 106,000

Required:

1. Compute the break-even point in units and sales dollars.

2. What was the margin of safety for Victoria Company last year?
3. Suppose that Victoria Company is considering an investment in new technology that will increase fixed costs by
$250,000 per year but will lower variable costs to 45 percent of sales. Units sold will remain unchanged. Prepare a
budgeted income statement assuming that Victoria makes this investment. What is the new break-even point in units
and sales dollars, assuming that the investment is made?