Basic Cost-Volume Profit (CVP) Analysis by knockjob54

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```									Problem #1:

Basic Cost-Volume Profit (CVP) Analysis

Stratford Company distributes a lighweight lawn chair that sells for \$15 per unit. Variable costs are \$6 per unit, and fixed costs total \$180,000
annually.

Required:

1. What is the product’s CM ratio?
2. Use the CM ratio to determine the break-even point in sales dollars.
3. The company estimates that sales will increase by \$45,000 during the coming year due to increased demand. By how much should net
operating income increase?
4. Assume that the operating results for last year were as follows:
Sales                         \$360,000
Variable Expenses               144,000

Contribution Margin          \$216,000
Fixed expenses                180,000

Net Operating Income         \$ 36,000

a. Compute the degree of operating leverage at the current level of sales.
b. The president expects sales to increase by 15% next year. By how much should net operating income increase?

5. Refer to the original data. Assume that the company sold 28,000 units last year. The sales manager is convinced that a 10% reduction in the
selling price, combined with a \$70,000 increase in advertising expenditures, would cause annual sales in units to increase by 50%. Prepare two
contributing format income statements, one showing the results of last year’s operations and one showing what the results of operations would be if
these changes were made. Would you recommend that the company do as the sales manager suggests?

Problem #2
Basics of CVP Analysis: Cost Structure

Memofax, Inc. produces memory enhancement kits for fax machines. Sales have been very erratic with some months showing a profit and some
months showing a loss. The company’s contribution format income statement for the most recent month is given below:
Sales(13,500 units at \$20 per unit)          \$270,000
Variable expenses                              189,000
Contribution Margin                           81,000
Fixed expenses                                90,000
Net operating loss                         \$ (9,000)

Required:
1. Compute the company’s CM ratio and its break-even point in both units and dollars
2. The sales manager feels that an \$8,000 increase in the monthly advertising budget, combined with an intensified effort by the sales staff, will
result in a \$70,000 increase in monthly sales. If the sales manager is right, what will be the effect on the company’s monthly net operating
3. Refer to the original data. The president is convinced that a 10% reduction in the selling price, combined with an increase of \$35,000 in the
monthly advertising budget will cause unit sales to double. What will the new contribution format income statement look like if these
4. Refer to the original data. The company’s advertising agency thinks that a new package would help sales. The new package being proposed
would increase packaging costs by \$0.60 per unit. Assuming no other changes, how many units would have to be sold each month to earn a
profit of \$4,500?
5. Refer to the original data. By automating certain operations, the company could slash its variable expenses in ahlf. However, fixed costs
would increase by \$118,000 per month.
a. Compute the new CM ratio and the new break-even point in both units and dollars.
b. Assume that the company expects to sell 20,000 units next month. Prepare two contribution format income statements, one assuming
that operations are not automated and one assuming that they are.
c. Would you recommend that the company automate its operations? Explain.
SOLUTION TO PROBLEM NO.:1:
REQUIREMENT NO.:1:

PRODUCT'S CM RATIO:
\$
Selling price per unit                     15
\$
less:Variable cost per unit                6
\$
CONTRIBUTION PER UNIT                      9
Contribution margin ratio =
Contribution margin per unit/Selling
price per unit                                       60%

REQUIREMENT NO.:2:
Break-even point in total sales dollars=
Fixed expenses/CM ratio

\$
Fixed expenses                             180,000
CM ratio                                             60%
\$
Break-even point in total sales dollars    300,000

REQUIREMENT NO.:3:

\$
Increase in sales                          45,000
\$
less:Variable cost(\$45,000/\$15)*\$6         18,000
\$
Increase in net operating income           27,000

REQUIREMENT NO.:4:

\$
a   Sales                                      360,000
\$
less:Variable expenses                     144,000
\$
Contribution Margin                        216,000
\$
Fixed expenses                         180,000
\$
Net Operating Income                   36,000
Degree of Operating Leverage=
Contribution Margin/Net Income                       6

\$
b   Increase in sales @15%                 54,000
\$
Increase in variable expenses @15%     21,600
\$
INCREASE IN NET OPERATING INCOME       32,400

REQUIREMENT NO.:5:
INCOME STATEMENT
BASED ON RESULTS OF LAST YEAR OPERATIONS
a   Sales in units                                   28,000
\$
Selling price per unit                 15
\$
Sales                                  420,000
\$
less:Variable expenses @ \$6 per unit   168,000
\$
CONTRIBUTION MARGIN                    252,000
\$
less:Fixed Expenses                    180,000
\$
NET OPERATING INCOME                   72,000

b                   INCOME STATEMENT
BASED ON CHANGES PROPOSED BY THE SALES MANAGER

Sales in units(increase by 50%)                  42000
\$
Selling price (reduced by 10%)         13.50
\$
Decrease in Unit contribution margin   7.50
Expected total contribution margin        \$
with lower selling price:                 315,000
Present total contribution margin         \$
(28,000 units *9)                         252,000
INCREMENTAL CONTRIBUTION                  \$
MARGIN                                    63,000
Change in fixed costs:
\$
\$
Reduction in net income                   (7,000)

COMPARATIVE INCOME STATEMENTS
PRESENT 28,000 UNITS                EXPECTED 42,000 UNITS
TOTAL             PER UNIT          TOTAL               PER UNIT      DIFFERENCE
\$                   \$              \$                    \$                 \$
Sales                                     420,000             15             567,000              13.50            147,000
\$                   \$              \$                    \$                 \$
less:Variable expenses                    168,000             6              252,000              6                84,000
\$                   \$              \$                    \$                 \$
Contribution margin                       252,000             9              315,000              7.50             63,000
\$                                  \$                                      \$
less:Fixed expenses                       180,000                            250,000                               70,000
\$                                  \$                                      \$
Net Income                                72,000                             65,000                                (7,000)

Based on the comparative income statements it is evident that the suggestion of the sales manager will result in
reduction of net income by \$7,000. S0, the changes should not be made.

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