3-22 CVP computations

SOLUTION

(10–15 min.) CVP computations.

1a. Contribution margin $ 17,280,000

($80 per unit× 40% × 540,000 units)

1b. Sales ($80 per unit × 540,000 units) $43,200,000

Contribution margin (from above) 17,280,000
Variable costs $25,920,000

1c. Contribution margin (from above) $17,280,000

Fixed costs 2,100,000
Operating income $15,180,000

2a. Sales (from above) $43,200,000

Variable costs ($25,920,000 × 80%) 20,736,000
Contribution margin $22,464,000

2b. Contribution margin (from above) $22,464,000

Fixed costs ($2,100,000 + 3,800,000) 5,900,000
Operating income $16,564,000

3. If the production manager’s proposal is accepted, the operating income is expected to increase by $1,384,000 ($16,564,000 −
$15,180,000).
The management would consider other factors before making the final decision. It is likely that product quality will improve
as a result of the modernized production process. However, due to increased automation, many workers will probably have to
be laid off. Simplex’s management will have to consider the impact of such an action on employee morale. In addition, the
proposal increases the company’s fixed costs dramatically. This will increase the company’s operating leverage and risk.

3-23 CVP analysis, changing revenues and costs

SOLUTION

(35–40 min.) CVP analysis, changing revenues and costs.

1a. SP = 10% × $1,300 = $130 per ticket

VCU = $34 per ticket
CMU = $130 – $34 = $96 per ticket
FC = $36,000 a month

FC $36,000
Q = CMU = $96 per ticket

= 375 tickets

FC + TOI $36,000 + $12,000

1b. Q = CMU =
$96 per ticket

$48,000
=
$96 per ticket
= 500 tickets

2a. SP = $130 per ticket

VCU = $30 per ticket
CMU = $130 – $30 = $100 per ticket
 FC = $36,000 a month

FC $36,000
Q = CMU = $100 per ticket

= 360 tickets

FC + TOI $36,000 + $12,000

2b. Q = CMU = $100 per ticket

$48,000
= $100 per ticket
= 480 tickets

3a. SP = $46 per ticket

VCU = $30 per ticket
CMU = $46 – $30 = $16 per ticket
FC = $36,000 a month

FC $36,000
Q = CMU = $16 per ticket
= 2,250 tickets

FC + TOI $36,000 + $12,000

3b. Q = CMU = $16 per ticket

$48,000
= $16 per ticket

= 3,000 tickets

The reduced commission sizably increases the breakeven point and the number of tickets required to yield a target operating income
of $12,000:

10%
Commission Fixed
(Requirement 2) Commission of $60
Breakeven point 360 2,250
Attain OI of $12,000 480 3,000

4a. The $8 delivery fee can be treated as either an extra source of revenue (as done below) or as a cost offset. Either approach
increases CMU $8:

SP = $54 ($46 + $8) per ticket

VCU = $30 per ticket
CMU = $54 – $30 = $24 per ticket
FC = $36,000 a month

FC $36,000
Q = CMU =
$24 per ticket

= 1,500 tickets

FC + TOI $36,000 + $12,000

4b. Q = CMU =
$24 per ticket
 $48,000
= $24 per ticket

= 2,000 tickets
The $8 delivery fee results in a higher contribution margin, which reduces both the breakeven point and the tickets sold to attain
operating income of $12,000.

3-24 CVP exercises.

SOLUTION

(20 min.) CVP exercises.

Revenues Variable Costs Contribution Fixed Costs Budgeted

Margin Operating
Income

Orig. $12,500,000 G $9,750,000 G $2,750,000 $2,240,000 G $ 510,000

1. 12,500,000 9,750,000 3,162,500 a 2,240,000 922,500
2. 12,500,000 9,750,000 2,337,500 b 2,240,000 97,500

3. 12,500,000 9,750,000 2,750,000 2,464,000 c 286,000

4. 12,500,000 9,750,000 2,750,000 2,016,000 d 734,000

5. 14,000,000 e 10,920,000 f 3,080,000 2,240,000 840,000
6. 11,000,000 g 8,580,000 h 2,420,000 2,240,000 180,000
7. 13,500,000 i 10,530,000 j 2,970,000 2,419,200 k 550,800
8. 12,500,000 9,165,000 l 3,335,000 2,374,400 m 960,600

Gstands for given.

a$2,750,000 × 1.15; b$2,750,000 × 0.85; c$2,240,000 × 1.10; d$2,240,000 × 0.90; e$12,500,000 × 1.12; f$9,750,000 × 1.12;
g$12,500,000 × 0.88; h$9,750,000 × 0.88; i$12,500,000 × 1.08; j$9,750,000 × 1.08; k$2,240,000 × 1.08; l$9,750,000 × 0.94;
m$2,240,000 × 1.06

9. Alternative 8, an 8% decrease in variable costs holding revenues constant with a 6% increase in fixed costs, yields the highest
budgeted operating income because it has decreased variables costs and consequently made a highest increase in the contribution
margin which has contributed in the highest increase in operating income after nullifying the effect of increase in fixed costs.

3-25

SOLUTION

1a. [Units sold (Selling price – Variable costs)] – Fixed costs = Operating income
[300,000 ($12.50 – $7.00)] – $880,000 = $770,000

1b. Fixed costs ÷ Contribution margin per unit = Breakeven units

$880,000 ÷ [($12.50 – $7.00)] = 160,000 units
Breakeven units × Selling price = Breakeven revenues
160,000 units × $12.50 per unit = $2,000,000
or,
Selling price -Variable costs
Contribution margin ratio =
Selling price
$12.50 - $7.00
= = 0.44 = 44%
$12.50
Fixed costs ÷ Contribution margin ratio = Breakeven revenues
$880,000 ÷ 0.44 = $2,000,000
 2. 300,000 ($12.50 – $7.00 × 110%)) – $880,000 = $560,000
3. [300,000 (1.02) ($12.50 – $7.00)] – ($880,000 + 250,000)] = $2,813,000
4. [300,000 (1.25) ($11.25 – $7. 70)] – [$880,000 (0.9)] = $539,250
5. $880,000 (1.2) ÷ ($12.50 – $7.00) = 192,000 units
6. ($880,000 + $30,000) ÷ ($14.00 – $7.00) = 130,000 units

3-27 CVP analysis, income taxes.

SOLUTION

(20–25 min.) CVP analysis, income taxes.

1. Variable cost percentage is $3.80  $9.50 = 40%

Let R = Revenues needed to obtain target net income
$159,600
R – 0.40R – $456,000 =
1 − 0.30
0.60R = $456,000 + $228,000
R = $684,000  0.60
R = $1,140,000

Fixed costs + Target operating income

or, Target revenues =
Contribution margin percentage
Target net income $159,600
Fixed costs + $456,000 +
Target revenues = 1 − Tax rate = 1 − 0.30 = $1,140,000
Contribution margin percentage 0.60

Proof: Revenues $1,140,000

Variable costs (at 40%) 456,000
Contribution margin 684,000
Fixed costs 456,000
Operating income 228,000
Income taxes (at 30%) 68,400
Net income $ 159,600

2.a. Customers needed to break even:

Contribution margin per customer = $9.50 – $3.80 = $5.70
Breakeven number of customers = Fixed costs  Contribution margin per customer
= $456,000  $5.70 per customer
= 80,000 customers

2.b. Customers needed to earn net income of $159,600:

Total revenues  Sales check per customer
$1,140,000  $9.50 = 120,000 customers

3. Using the shortcut approach:

 Change in   Unit 
Change in net income =  number of    contribution   (1 − Tax rate )
 customers   margin 
   
= (145,000 – 120,000)  $5.70  (1 – 0.30)
= $142,500  0.7 = $99,750
New net income = $99,750 + $159,600 = $259,350

Alternatively, with 145,000 customers,

 Operating income = Number of customers  Selling price per customer
– Number of customers  Variable cost per customer – Fixed costs
= 145,000  $9.50 – 145,000  $3.80 – $456,000 = $370,500
Net income = Operating income × (1 – Tax rate) = $370,500 × 0.70 = $259,350

The alternative approach is:

Revenues, 145,000  $9.50 $1,377,500
Variable costs at 40% 551,000
Contribution margin 826,500
Fixed costs 456,000
Operating income 370,500
Income tax at 30% 111,150
Net income $ 259,350

3-28 CVP analysis, sensitivity analysis.

SOLUTION

CVP analysis, sensitivity analysis.

1. CMU = $40−$26−(0.1 × $40) = $10.00

FC $2,250,000
Q = = = 225,000 shirts
CMU $10 per shirt
Note: No income taxes are paid at the breakeven point because operating income is $0.

FC + TOI $2,250,000 + $600,000

2a. Q = =
CMU $10 per shirt
$2,850,000
=
$10 per shirt
= 285,000 shirts

Target net income $600,000 $600,000

2b. Target operating income = = =
1 − tax rate (1 − 0.3) 0.7
= $857,143 (rounded)
Quantity of output units = Fixed costs + Target operating income $2, 250,000 + $857,143
required to be sold =
Contribution margin per unit $10

= 310,714 shirts (rounded)

3a. Contribution margin per unit increases by 15%

Contribution margin per unit = $10 × 1.15 = $11.5

Quantity of output units required to be sold =

Fixed costs + Target operating income $2, 250,000 + $857,143
=
Contribution margin per unit $11.5

= 270,186 shirts (rounded)

The net income target in units decreases from 310,714 shirts in requirement 2b to 270,186 shirts.

3b. Increasing the selling price to $45.00

Contribution margin per unit = $45 − $26 − (0.1 × $45) = $14.5
Quantity of output units = Fixed costs + Target operating income $2, 250,000 + $857,143
required to be sold =
Contribution margin per unit $14.5

= 214,286 shirts (rounded)

The net income target in units decreases from 310,714 pieces in requirement 2b to 214,286 shirts.

3c. Increase variable costs by $3.00 per unit and decrease fixed manufacturing costs by 50%.
Contribution margin per unit = $40 – $29 ($26 + $3) – (0.1 × $40) = $7.00
Fixed manufacturing costs = (1 – 0.5) × $1,600,000 = $800,000
Fixed marketing costs = $650,000
Total fixed costs = $800,000 + $650,000 = $1,450,000

Quantity of output units = Fixed costs + Target operating income $1, 450,000 + $857,143
required to be sold =
Contribution margin per unit $7

= 329,592 shirts (rounded)

The net income target in units increases from 310,714 shirts in requirement 2b to 329,592 shirts.

3-29 CVP analysis, margin of safety.

SOLUTION

(10 min.) CVP analysis, margin of safety.

Fixed costs
1. Breakeven point revenues =
Contribution margin percentage
Contribution margin percentage =
(Fixed manufacturing costs + Fixed administrative costs + Fixed marketing costs)
=
Breakeven point revenues
($400,000 + $250,000 + $150,000) $800,000
= = = 0.25 or 25%
$3,200,000 $3,200,000
Selling price − Variable cost per unit
2. Contribution margin percentage = Selling price
SP − $30
0.25 = SP
0.25 SP = SP – $30
0.75 SP = $30
SP = $40
3. Breakeven sales in units = Breakeven revenues ÷ Selling price = $3,200,000 ÷ $40 = 80,000 units
Margin of safety in units = Sales in units – Breakeven sales in units
= 105,000 – 80,000 = 25,000 units

Revenues, 105,000 units  $40 $4,200,000

Breakeven revenues 3,200,000
Margin of safety $1,000,000

The risk of making a loss is high. If due to adverse situations, sales decrease by 25,000 units ÷ 105,000 units i.e. by 23.81% or
more, Ariba will make a loss. The most likely reasons for this risk are increased competition, entry of substitute products, sudden
drop in demand due to economic condition, or bad management.
3-30 Operating leverage.

SOLUTION
(25 min.) Operating leverage.

1a. Let Q denote the quantity of carpets sold

Breakeven point under Option 1
$1,500Q − $900Q − (0.25  $1,500Q) = 0
225Q = 0
Q = 0

1b. Breakeven point under Option 2

$1,500Q − $900Q = $30,000
$600Q = $30,000
Q = $30,000  $600 = 50 carpets

2. Operating income under Option 1 = $225Q

Operating income under Option 2 = $600Q − $30,000

Find Q such that $225Q = $600Q − $30,000

Or $375Q = $30,000
Q = $30,000 $375 = 80 carpets
Revenues = $1,500 × 80 carpets = $120,000
For Q = 80 carpets, operating income under both Option 1 ($225 × 80) and Option 2 ($600 × 80 − $30,000) =
$18,000

For Q > 80, say, 81 carpets,

Option 1 gives operating income = $225  81 = $18,225
Option 2 gives operating income = ($600  81) − $30,000 = $18,600

So Broadpull Rugs will prefer Option 2.

For Q < 80, say, 79 carpets,
Option 1 gives operating income = $225  79 = $17,775
Option 2 gives operating income = ($600  79) − $30,000 = $17,400

So Broadpull Rugs will prefer Option 1.

Contribution margin
3. Degree of operating leverage = Operating income
Contribution margin per unit  Quantity of carpets sold
=
Operating income
Under Option 1, contribution margin per unit = $1,500 – $900 – 0.25  $1,500 = $225, so
$225  80
Degree of operating leverage = $18,000 = 1.0
Under Option 2, contribution margin per unit = $1,500 – $900 = $600, so
$600  80
Degree of operating leverage = $18,000 = 2.67 (rounded)
4. The calculations in requirement 3 indicate that when sales are 80 units, a percentage change in sales and contribution margin
will result in 2.67 times that percentage change in operating income for Option 2, but the same percentage change in operating
income for Option 1 (because there are no fixed costs in Option 1). The degree of operating leverage at a given level of sales helps
managers calculate the effect of fluctuations in sales on operating incomes.
3-32 Sales mix, new and upgrade customers.

SOLUTION
1. CM (130 x 60%) + (80 x 40%) = $110
Breakeven point in units = $16,500,000/ $110= 150,000 units
Breakeven point in units is:
Sales to new customers: 60% 90,000 units
Sales to upgrade customers: 40% 60,000 units
Total number of units to breakeven (rounded) 150,000 units

Check
Revenues ($195  90,000) + ($115  60,000) $24,450,000
Variable costs ($65  90,000) + ($35  60,000) 7,950,000
Contribution margin 16,500,000
Fixed costs 16,500,000
Operating income $ 0
2. When 170,000 units are sold, mix is:

Units sold to new customers (60%  170,000) 102,000

Units sold to upgrade customers (40%  170,000) 68,000
Revenues ($195  102,000) + ($115  68,000) $27,710,000
Variable costs ($65  102,000) + ($35  68,000) 9,010,000
Contribution margin 18,700,000
Fixed costs 16,500,000
Operating income $ 2,200,000

3a. CM = ($130 x 40%) + ($80 x 60%) = $100

Breakeven point in units = ($16,500,000/$110)= 165,000
Breakeven point in units is:
Sales to new customers: 66,000 units
Sales to upgrade customers: 99,000 units
Total number of units to breakeven 165,000 units

Check
Revenues ($195  66,000) + ($115  99,000) $24,255,000
Variable costs ($65  66,000) + ($35  99,000) 7,755,000
Contribution margin 16,500,000
Fixed costs 16,500,000
Operating income $ 0

3b.
CM = ($130 x 80%) + ($80 x 20%) = $120
Breakeven point in units = ($16,500,000/$120) = 137,500 units
Breakeven point in units is:
Sales to new customers: 80% 110,000 units
Sales to upgrade customers: 20% 27,500 units
Total number of units to breakeven 137,500 units

Check
Revenues ($195  110,000) + ($115  27,500) $24,612,500
Variable costs ($65  110,000) + ($35  27,500) 8,112,000
Contribution margin 16,500,000
Fixed costs 16,500,000
Operating income $ 0

3c. As Chartz increases its percentage of new customers, which have a higher contribution margin per unit than upgrade
customers, the number of units required to break even decreases:

New Upgrade Breakeven

Customers Customers Point
Requirement 3(a) 40% 60% 165,000
Requirement 1 60 40 150,000
Requirement 3(b) 80 20 137,500
3-33 Sales mix, three products.

SOLUTION

(15–25 min.) Sales mix, three products.

A 40,000 16.67%
B 120,000 50%
C 80,000 33.33%
TOTAL 240,000 100%

Contribution margin per unit = (16.67% $7) + (50%  $5) + (33.33%  $4) = $5
$552,000
Breakeven point (in bundles) = = 110,400 units
$5
Breakeven point in units is:
Product A: 16.67% 18,400 units
Product B: 50% 55,200 units
Product C: 33.33% 36,800 units
Total number of units to breakeven 110,400 units

2. Calculate sales mix at 220,000 total units:

A: 1/6 (or 40,000/240,000)  220,000 = 0.167; 0.167  220,000 = 36,740 units

B: 3/6 (or 120,000/240,000)  220,000 = 0.5; 0.5  220,000 = 110,000 units
C: 2/6 (or 80,000/240,000)  220,000 = 0.333; 0.333  220,000 = 73,260 units
Contribution margin:
A: 36,740  $7 $257,180
B: 110,000  $5 550,000
C: 73,260  $4 293,040
Contribution margin $1,100,220
Fixed costs 552,000
Operating income $548,220

3. Contribution margin
A: 40,000  $7 $280,000
B: 100,000  $5 500,000
C: 100,000  $4 400,000
Contribution margin $1,180,000
Fixed costs 552,000
Operating income $628,000

Sales of A, B, and C are in ratio 40,000 : 100,000 : 100,000.

A 40,000 16.67%
B 100,000 41.67%
C 100,000 41.67%

Contribution margin per unit ($7 X 16.67%)+ ($5 x 41.67%) + ($4 x 41.67%) = $4.92

Breakeven point in units = $552,000 / $4.92 = 112, 272 units (rounded)

Breakeven point in units is:

Product A: 16.67% 18,712 units
Product B: 41.67% 46,780 units
Product C: 41.67% 46,780 units
Total number of units to breakeven 112,272 units

Breakeven point increases because the new mix contains less of the higher contribution margin per unit, product B, and
more of the lower contribution margin per unit, product C.
4. No, it is not always better to choose the sales mix with the lowest breakeven point because this calculation ignores the demand
for the various products. The company should look to and sell as much of each of the three products as it can to maximize
operating income even if this means that this sales mix results in a higher breakeven point.

3-41 CVP analysis, income taxes.

SOLUTION

(30–40 min.) CVP analysis, income taxes.

Target net income
1. Revenues – Variable costs – Fixed costs =
1 − Tax rate
Let X = Net income for 2017
X
22,000($35.00) – 22,000($18.50) – $214,500 =
1 − 0.40
X
$770,000 – $407,000 – $214,500 =
0.60
$462,000 – $244,200 – $128,700 = X
X = $89,100

Alternatively,
Operating income = Revenues – Variable costs – Fixed costs
= $770,000 – $407,000 – $214,500 = $148,500
Income taxes = 0.40 × $148,500 = $59,400
Net income = Operating income – Income taxes
= $148,500 – $59,400 = $89,100

2. Let Q = Number of units to break even

$35.00Q – $18.50Q – $214,500 = 0
Q = $214,500  $16.50 = 13,000 units

Or $214,500/ $16.5 = 13,000 (FC/CM PER UNIT)

3. Let X = Net income for 2018

X
25,000($35.00) – 25,000($18.50) – ($214,500 + $16,500) =
1 − 0.40
X
$875,000 – $462,500 – $231,000 =
0.60
X
$181,500 =
0.60
X = $108,900

4. Let Q = Number of units to break even with new fixed costs of $146,250
$35.00Q – $18.50Q – $231,000 = 0
Q = $231,000  $16.50 = 14,000 units
Breakeven revenues = 14,000  $35.00 = $490,000

5. Let S = Required sales units to equal 2017 net income

$89,100
$35.00S – $18.50S – $231,000 =
0.60
$16.50S = $379,500
S = 23,000 units
Revenues = 23,000 units  $35 = $805,000

6. Let A = Amount spent for advertising in 2018

 $108,450
$875,000 – $462,500 – ($214,500 + A) =
0.60
$875,000 – $462,500 – $214,500 – A = $180,750
$875,000 – $857,750 = A
A = $17,250