UNIT III

BY SWARANJEET ARORA
LEARNING OUTCOMES

• Explain the features of cost–volume– profit (CVP) analysis

• Determine the breakeven point and output level needed to achieve a target operating
income

• Understand how income taxes affect CVP analysis

• Explain how managers use CVP analysis to make decisions

• Explain how sensitivity analysis helps managers cope with uncertainty

• Use CVP analysis to plan variable and fixed costs

• Apply CVP analysis to a company producing multiple products

• Apply CVP analysis in service and not-for-profit organizations

• Distinguish contribution margin from gross margin

ESSENTIALS OF CVP ANALYSIS

• Managers want to know how profits will change as

the units sold of a product or service changes.
• Managers like to use “what-if” analysis to examine
the possible outcomes of different decisions so they
can make the best one.
INCOME STATEMENT

Sales/Revenue
Less Variable Cost
Contribution
Less Fixed Cost
EBIT (Operating Profit)
Less TAX
NET PROFIT
EXPRESSING CVP RELATIONSHIPS

• There are three related ways (we will call them “methods”) to model CVP
relationships:
• 1. The equation method
• 2. The contribution margin method
• 3. The graph method Different methods are useful for different decisions.
• The equation method and the contribution margin method are most useful when
managers want to determine operating income at a few specific sales levels (for
example, 5, 15, 25, and 40 units sold). The graph method helps managers visualize
the relationship between units sold and operating income over a wide range of
quantities.
CVP (EQUATION METHOD)

• Revenues - Variable costs - Fixed costs = Operating income

• Revenues = Selling price * Quantity of units sold
• Variable costs = Variable cost per unit * Quantity of units sold
(Selling price * Quantity of units sold) - ( Variable cost per unit
* Quantity of units sold) - Fixed costs = Operating income
CONTRIBUTION MARGIN METHOD

• (Selling price per unit - Variable cost per unit ) * Quantity of units sold
- Fixed costs = Operating income
• (Contribution margin per unit * Quantity of units sold) - Fixed costs =
Operating income
COST–VOLUME–PROFIT ASSUMPTIONS

• 1. Changes in revenues and costs result solely from changes in the

number of product (or service) units sold. That is, the number of units
sold is the only revenue driver and the only cost driver. Just as a cost
driver is any factor that affects costs, a revenue driver is a variable,
such as number of units sold, that causally affects revenues.
• 2. Total costs can be separated into two components: a fixed
component that does not vary with units sold (such as Emma’s $2,000
booth fee) and a variable component that changes based on units sold.
• 3. When represented graphically, the behaviors of total revenues and
total costs are linear (meaning they can be represented as a straight
line) in relation to units sold within a relevant range (and time period).
• 4. Selling price, variable cost per unit, and total fixed costs (within a
relevant range and time period) are known and constant.
THE BREAKEVEN POINT (BEP)

• The breakeven point (BEP) is that quantity of output sold at which total revenues
equal total costs—that is, the quantity of output sold that results in $0 of operating
income.
We Know that,
Operating Profit=[ (Contribution Margin/Unit)* Quantity of Units] –Fixed Cost
If operating profit is zero then,
Contribution Margin per unit * Quantity of Units =Fixed Cost
Or Quantity of Units= Fixed Cost/ Contribution Margin per unit
Breakeven revenues = Breakeven quantity of units * Selling price
TARGET INCOME
SOLUTION

(i) (a)BEP (Units)= FC/ Contribution per unit

• Contribution per unit = SP- VC= 90-20=70
• FC= 14000
• BEP= 14000/70= 200 tickets
• (i) (b)

= (14000 + 7000)/ 70= 300 units

SOLUTION

(ii) (a)BEP (Units)= FC/ Contribution per unit

• Contribution per unit = SP- VC= 50-20=30
• FC= 14000
• BEP= 14000/30= 467 approx tickets
• (i) (b)

= (14000 + 7000)/ 30= 700 tickets

NUMERICAL

• (ii) (a)-
 1 11 111 1V
FC 36000 36000 36000 36000
Target EBIT 12000 12000 12000 12000
Revenue/ unit 130 130 46 46+8= 54
VC/ Unit 34 30 30 30
Cont/unit 96 100 16 24
BEP (Units)= 375 360 2250 1500
FC/Cont per
unit
Target Income 500 480 3000 2000
Units
PART 1

Sales (3,00,000*12.50) 37,50,000

(-) VC (3,00,000*7) 21,00,000
CONT 16,50,000
(-) FC 8,80,000
EBIT 7,70,000

BEP (Units)= 8,80,000/5.5=

1,60,000
BEP (Sales)= 1,60,000* 12.50=
20,00,0000
PART 1I

Sales (3,00,000*12.50)= (3,06,000*12.50)=

37,50,000 38,25,000
(-) VC (3,00,000*7.7)= (3,00,000*7)=
23,10,000 21,00,000
CONT 14,40,000 17,25,000
(-) FC 8,80,000 8.80,000+2,50,00
0= 11,30,000
EBIT 5,60,000 5,95,000
PART 1I

Sales 37,50,000
(3,00,000*12.50)
(-) VC 21,00,000
(3,00,000*7.7)
CONT 16,50,000
(-) FC 8,80,000
EBIT 7,70,000

BEP (Units)= 8,80,000/5.5=

1,60,000
BEP (Sales)= 1,60,000* 12.50=
20,00,0000
S
 Sales 475000
Less VC COGS (40%) 190000
Sales comm (15%) 71250
op cost (8.42%) 40000 301250
Cont 173750
Less FC Salaries 175000
Dep 22000
Insurance 5000
Store rent 60000
fi xed op cost 10000 272000
EBIT/ LBIT -98250

Cont margin % Cont/Sales 36.57895

Contribution margin ratio Cont/Sales 0.365789
BEP (Revenues) FC/ Cont margin ratio 743597.1
 Sales 617500
Less VC COGS (40%) 247000
Sales comm (15%) 92625
op cost (8.42%) 51993.5 391618.5
Cont 225881.5
Less FC Salaries 175000
Dep 22000
Insurance 5000
Store rent 60000
fi xed op cost 10000
Sales promotion 15000 287000

EBIT/ LBIT -61118.5

Cont margin % Cont/Sales 36.58

Contribution margin ratio Cont/Sales 0.3658
BEP (Revenues) FC/ Cont margin ratio 784581.7
1

• SP/ unit =$ 6300=£ 3500

• VC/Unit=£ 3000
• FC=£ 100,00,000
• 1 (a) Cont/Unit= 500
• (b) BEP= 100,00,000/500=20,000 units
• BEP (Sales)= 20,000*3500= £ 7,00,00,000
 Sales 25,000*3500 87500000
Less VC 25,000*3000 75000000
Cont 12500000
Less FC 10000000
EBIT 2500000
3

• 25000= (70,00,000+25,00,000)/ (x-3000)

• X= £3380
4

• =(100,00,000+50,00,000)/500
• 30,000 units
1.

• BEP (Sales)= 32,00,000

• FC= 8,00,000
• BEP (sales)= FC/ Contribution ratio
• 32,00,000= 8,00,000/cont ratio
• Cont Ratio= 0.25
• Cont margin % = 25%
2.

• Cont= sales- VC
• 0.25X= X- 0.75 X
• VC= 30 (given)
• 0.75 X= 30
• X= 40 $
3.

• Margin of safety= Sales- BEP (sales)

• Sales= 105000*40= 42,00,000 $
• BEP (sales)= 32,00,000 $ (given)
• Margin of safety= 10,00,000 $
• BEP (units)= 32,00,000 $/40 $= 80,000 units
• MOS (units)= 25,000 units
1.

• SP /unit=50
• VC/ unit=30 Sales (3500*60)+(2000*40) 290000
• Cont/ unit= 20
Less VC 5500*30 165000
• EBIT= 20,000
• No. of units sold= 6,000
Cont 125000
• FC= ? Less FC 100000
• 6000= (FC+20000)/20 EBIT 25000
• FC=1,00,000 $
2

Units 2500 5000 8000

Sales 2500*300 750000 5000*200 1000000 8000*175 1400000
Less VC 2500*75 187500 5000*50 250000 8000*30 240000
Cont 562500 750000 1160000
Less FC 250000 350000 750000+50000 800000
EBIT 312500 400000 360000
• Sales-VC-FC= EBIT
• [(195*0.6X)+(115*0.4X)]- [(65*0.6X)+(35*0.4X)]-16500000=0
• So X= 1,50,000 units (BEP in units)
• 0.6 X= 90,000 units
• 0.4 X= 60,000 units
1 VERIFICATION

• Cont-FC= EBIT
• (7X+5*3*X+4*2*X)- 552000=0
Cont (7*18400)+(55200*5)+(36800*4) 552000
• 30X= 552000 Less FC 552000
• X= 18400 units EBIT 0
• 3X= 55200
• 2X= 36800
BEP (units)= 18400+36800+55200= 110400 units
2

X=2,20,000/6 36666.67
X 36666.67
3x 110000
2x 73333.33

Cont (7*36667)+(110000*5)+(73333*4) 1100001

Less FC 552000
EBIT 548001
 Cont (7*40000)+(5*100000)+(4*100000) 1180000
3. Less FC 552000
EBIT 628000

• Cont-FC= EBIT
• (7*2X+5*5*X+4*5*X)- 552000=0
• 59X= 552000
• X= 9355.93 units
• 2X= 18712 units
• 5X= 46780 units
BEP (units)=18712+46780+46780=112272 units
• Total Mfg cost= Fixed Mfg cost+ Variable Mfg Cost
• 60,00,000= 24,00,000+36,00,000
• Variable mfg cost/ unit= 36,00,000/20,00,000= 1.8 per unit
• Sales commission = 0.03*1,00,00,000= 3,00,000
• Total selling and admin cost= Fixed admin cost+ sales commission+ variable admin
cost
• 31,00,000=23,00,000+ 3,00,000+5,00,000
• Variable selling and admin cost / unit= 5,00,000/20,00,000=0.25 per unit
• Variable sales commission/ unit= 3,00,000/20,000,000=0.15 per unit
SPECIAL ORDER CALCULATIONS

• Total sales= 6,60,000

• Units= 1,50,000
• Selling price per unit= 6,60,000/1,50,000= 4.4 per unit
• VC per unit = 1.8+0.25+0.2=2.25 per unit
• Cont/ unit=4.4-2.25= 2.15 per unit
 3 1,50,000*2.15=322500

Previous With special order

Sales 10000000 10000000+660000 10660000
(-) VC 3600000+500000+300000 4400000 4400000+ (2.25*150000) 4737500
Cont 5600000 5922500
(-) FC 2400000+2300000 4700000 4700000
EBIT 900000 1222500

EBIT change 322500

1,2 AND 3

Sales 120000
Less VC 60,000+6,000 66000
Cont 54000
Less FC 22,000+14,000 36000
EBIT 18000
Cont margin % (54000/120000)*100 45
BEP (units) 36000/3.6 10000
BEP (Sales) 36000/0.45 80000
MOS 120000-80000 40000
 No of beds available per day 80
No. of beds available per year (80*365) 29200
Actual patients 26000
Revenues 1300000
Total Varible cost 1066000
Total Fixed Cost 252000
Total Contribution 234000 (1300000-1066000)
SP per unit 50 (1300000/26000)
VC per unit 41 (1066000/26000)

1 Contribution Margin Ratio 0.18 18%

2 BEP (Units) 28000
3 BEP (Revenues) 1400000
4 BEP (Units) 31500 vc/unit 42 1092000/26000
5 BEP (Units) 30000 FC= 270,000
SENSITIVITY ANALYSIS

• Sensitivity Analysis is a tool used in financial modeling to analyze how

the different values of a set of independent variables affect a specific
dependent variable under certain specific conditions.
 Per Unit Total Per Unit Option 1 Total
Units 30000 30000
Sales 25 750000 25 750000
Less Variable Cost
Raw Material 5 150000 5 150000
Mfg 4 120000 3 90000
Other 6 180000 450000 6 180000 420000
Contribution 300000 330000
Less Fixed Cost 174000 1.2*174000 208800
EBIT 126000 121200
% change in EBIT -3.80952
 Per Unit Total Per Unit Option 2 Total
Units 30000 36000
Sales 25 750000 25 900000
Less Variable Cost
Raw Material 5 150000 5 180000
Mfg 4 120000 4 144000
Other 6 180000 450000 6 216000 540000
Contribution 300000 360000
Less Fixed Cost 174000 174000
Less Advertising campaign 0 30000
EBIT 126000 156000
% change in EBIT 23.80952
 Per Unit Total Per Unit Option 3 Total
Units 30000 24000
Sales 25 750000 30 720000
Less Variable Cost
Raw Material 5 150000 8 192000
Mfg 4 120000 4 96000
Other 6 180000 450000 6 144000 432000
Contribution 300000 288000
Less Fixed Cost 174000 174000
EBIT 126000 114000
% change in EBIT -9.52381
 Per Unit Total Per Unit Option 4 Total
Units 30000 48000
Sales 25 750000 25 1200000
Less Variable Cost
Raw Material 5 150000 5 240000
Mfg 4 120000 4 192000
Other 6 180000 450000 6 288000 720000
Contribution 300000 480000
Less Fixed Cost 174000 348000
EBIT 126000 132000
% change in EBIT 4.761905
S
1

SP per unit 40
VC per unit 31
TFC 171000
BEP (units) 171000/9 19000
BEP (Sales) 19000*40 760000
2

Sales 15000*40 600000

Less VC 15000*31 465000
Cont 135000
Less FC 171000
EBIT -36000
3

SP per unit 40
VC per unit 29
TFC 171000+19190 190190
BEP (units) 190190/31 6135.16
BEP (Sales) 6135*40 245400
4.

SP per unit 40
VC per unit 32.5
Cont per unit 7.5
TFC 171000
BEP (units) 171000/7.5 22800
BEP (Sales) 22800*40 912000
4.

Sales 25000*40 1000000

Less VC 25000*31 775000
Less VC supervisor 6000*0.5 3000
Less VC manager 6000*1 6000
Cont 216000
Less FC 171000
EBIT 45000
 Per unit projected Per unit plan 1 Per unit plan 2 Per unit plan 3
Units 2100 2100 1750 2200
Sales 4000 8400000 3400 7140000 3600 6300000 2800 6160000
Less VC 1000 2100000 1000 2100000 700 1225000 1000 2200000
Cont 3000 6300000 5040000 5075000 3960000
Less FC 4800000 4800000 4800000 4320000
EBIT 1500000 240000 275000 -360000

Add profit of last quarter 3000*400 1200000 1200000 1200000

Total 1440000 1475000 840000

BEP (Units)4800000/3000 1600
BEP (REV) 1600*4000 6400000
1 AND 2

SP 10
VC 4+1.9 5.9
FC 55000+6500 61500
Contribution margin 10-5.9 4.1
Contribution ratio 4.1/10 0.41
BEP (Units) 61500/4.1 15000
BEP (Revenues) 61500/0.41 150000
3

Sales 10*20000 200000

Less VC 5.9*20000 118000
Cont 82000
Less FC 61500
EBIT 20500
4

Units 24000
Sales 9.5 228000
Less VC 5.9 141600
Cont 86400
Less FC 61500
Less Adv Exp 10000
EBIT 14900
5

• [15*X+ 10*3X]-[8X+5.9*3X]-61500=0
• 45X-25.7X=61500
• MOS= Sales –BEP sales
• MOS= Sales- (FC/PV ratio)
• MOS= [(Sales*PV ratio)- FC]/ PV ratio
• MOS= Cont- FC/PV raio
• MOS= Profit/PV ratio
MCQ

• Contribution margin is 30 per cent, profit is INR 45000. Calculate margin of safety
• A) 700 units
• B) 1200 units
• C) 800 units
• D) 1500 units
• ANSWER: D
• Sol : MOS= 45000/30= 1500
• Determine Margin of safety if Profit is Rs 15,000 and P/V ratio is 40%.

a) Rs 37,500
b) Rs 33,000
c) Rs 38,000
d) None of the above

Answer:A
Cont/sales=P/V ratio
15000/sales= 0.40
• Profit is 10 per cent of sales. Margin of safety is 40 per cent. Calculate profit volume
ratio
• A) 20 per cent
• B) 25 per cent
• C) 30 per cent
• D) 10 per cent
• ANSWER: B
• Cont/sales=P/V ratio
• 10/40=25
•Orion Company sells several products. Information of average revenue and costs is as follows:
•
• Selling price per unit $23
• Variable costs per unit:
• Direct material $4
• Direct manufacturing labor $1.70
• Manufacturing overhead $0.40
• Selling costs $2
• Annual fixed costs$100,000
•The company sells 12,000 units at the end of the year.
•
•If direct labor and direct material costs increase by $1 each, contribution margin ________.
•A) increases by $24,000
•B) increases by $12,000
•C) decreases by $24,000
•D) decreases by $12,000
•Answer: C
•Explanation: Contribution margin = ($23 − $5 − $2.70 − $0.40 − $2) × 12,000
= $154,800.
•The previous contribution margin was $178,800 which means it decreased by
$24,000
•Lobster Liquidators will make $550,000 if the fishing season weather is good,
$240,000 if the weather is fair, and would actually lose $40,000 if the weather is
poor during the season. If the weather service gives a 45% probability of good
weather, a 25% probability of fair weather, and a 30% probability of poor
weather, what is the expected monetary value for Lobster Liquidators?
•A) $247,500
•B) $295,500
•C) $750,000
•D) $250,000
•Answer: B
•Explanation: 0.45 ($550,000) + 0.25 ($240,000) + 0.3 (-$40,000) = $295,500
•Patrick Ross has three booth rental options at the county fair where he plans to sell his new product. The booth
rental options are:
•
• Option 1: $1,000 fixed fee, or
• Option 2: $750 fixed fee + 5% of all revenues generated at the fair, or
• Option 3: 20% of all revenues generated at the fair.
•
•The product sells for $37.50 per unit. He is able to purchase the units for $12.50 each.
•
•3) How many actions and events will a decision table contain?
•A) 1 action and 3 events
•B) 1 action and 6 events
•C) 2 actions and 3 events
•D) 3 actions and 6 events
•Answer: D