CHAPTER 3

COST-VOLUME-PROFIT ANALYSIS
NOTATION USED IN CHAPTER 3 SOLUTIONS
SP:
VCU:
CMU:
FC:
TOI:

Selling price
Variable cost per unit
Contribution margin per unit
Fixed costs
Target operating income

3-1
Cost-volume-profit (CVP) analysis examines the behavior of total revenues, total costs,
and operating income as changes occur in the units sold, selling price, variable cost per unit, or
fixed costs of a product.
3-2
1.
2.
3.

4.

The assumptions underlying the CVP analysis outlined in Chapter 3 are

Changes in the level of revenues and costs arise only because of changes in the number
of product (or service) units sold.
Total costs can be separated into a fixed component that does not vary with the units sold
and a component that is variable with respect to the units sold.
When represented graphically, the behavior of total revenues and total costs are linear
(represented as a straight line) in relation to units sold within a relevant range and time
period.
The selling price, variable cost per unit, and fixed costs are known and constant.

3-3
Operating income is total revenues from operations for the accounting period minus cost
of goods sold and operating costs (excluding income taxes):
Costs of goods sold and operating
Operating income = Total revenues from operations costs (excluding income taxes)
Net income is operating income plus nonoperating revenues (such as interest revenue)
minus nonoperating costs (such as interest cost) minus income taxes. Chapter 3 assumes
nonoperating revenues and nonoperating costs are zero. Thus, Chapter 3 computes net income
as:
Net income = Operating income Income taxes
3-4
Contribution margin is the difference between total revenues and total variable costs.
Contribution margin per unit is the difference between selling price and variable cost per unit.
Contribution-margin percentage is the contribution margin per unit divided by selling price.
3-5
Three methods to express CVP relationships are the equation method, the contribution
margin method, and the graph method. The first two methods are most useful for analyzing
operating income at a few specific levels of sales. The graph method is useful for visualizing the
effect of sales on operating income over a wide range of quantities sold.

3-1

3-6
Breakeven analysis denotes the study of the breakeven point, which is often only an
incidental part of the relationship between cost, volume, and profit. Cost-volume-profit
relationship is a more comprehensive term than breakeven analysis.
3-7
CVP certainly is simple, with its assumption of output as the only revenue and cost
driver, and linear revenue and cost relationships. Whether these assumptions make it simplistic
depends on the decision context. In some cases, these assumptions may be sufficiently accurate
for CVP to provide useful insights. The examples in Chapter 3 (the software package context in
the text and the travel agency example in the Problem for Self-Study) illustrate how CVP can
provide such insights. In more complex cases, the basic ideas of simple CVP analysis can be
expanded.
3-8
An increase in the income tax rate does not affect the breakeven point. Operating income
at the breakeven point is zero, and no income taxes are paid at this point.
3-9
Sensitivity analysis is a what-if technique that managers use to examine how a result
will change if the original predicted data are not achieved or if an underlying assumption
changes. The advent of the electronic spreadsheet has greatly increased the ability to explore the
effect of alternative assumptions at minimal cost. CVP is one of the most widely used software
applications in the management accounting area.
3-10

Examples include:
Manufacturingsubstituting a robotic machine for hourly wage workers.
Marketingchanging a sales force compensation plan from a percent of sales dollars to
a fixed salary.
Customer servicehiring a subcontractor to do customer repair visits on an annual
retainer basis rather than a per-visit basis.

3-11

Examples include:
Manufacturingsubcontracting a component to a supplier on a per-unit basis to avoid
purchasing a machine with a high fixed depreciation cost.
Marketingchanging a sales compensation plan from a fixed salary to percent of sales
dollars basis.
Customer servicehiring a subcontractor to do customer service on a per-visit basis
rather than an annual retainer basis.

3-12 Operating leverage describes the effects that fixed costs have on changes in operating
income as changes occur in units sold, and hence, in contribution margin. Knowing the degree of
operating leverage at a given level of sales helps managers calculate the effect of fluctuations in
sales on operating incomes.
3-13 CVP analysis is always conducted for a specified time horizon. One extreme is a very
short-time horizon. For example, some vacation cruises offer deep price discounts for people
who offer to take any cruise on a days notice. One day prior to a cruise, most costs are fixed.
The other extreme is several years. Here, a much higher percentage of total costs typically is
variable.

3-2

CVP itself is not made any less relevant when the time horizon lengthens. What happens
is that many items classified as fixed in the short run may become variable costs with a longer
time horizon.
3-14 A company with multiple products can compute a breakeven point by assuming there is a
constant sales mix of products at different levels of total revenue.
3-15 Yes, gross margin calculations emphasize the distinction between manufacturing and
nonmanufacturing costs (gross margins are calculated after subtracting fixed manufacturing
costs). Contribution margin calculations emphasize the distinction between fixed and variable
costs. Hence, contribution margin is a more useful concept than gross margin in CVP analysis.
On financial considerations alone, SG should take the subsidy because it can purchase
500 more acres (6,500 acres 6,000 acres).
3.

Let the decrease in contributions be $x .

Cash available to purchase land = $19,000,000 $x $1,000,000
Cost to purchase land = $3,000 $1,000 = $2,000
To purchase 6,000 acres, we solve the following equation for x .
19,000,000 x 1,000,000
6,000
2,000
18,000,000 x 6,000 2,000
18,000,000 x 12,000,000
x $6,000,000
SG will be indifferent between taking the government subsidy or not if contributions
decrease by $6,000,000.

3-3

EXERCISES
3-30
Solution
i. Operating income = Net income after taxes /(1 Tax rate)
= Rs 80,000/(1 .40) = Rs 1,33,334
ii. Contribution margin Fixed costs = Operating income
Contribution margin Rs 3,00,000 = Rs 1,33,334
Contribution margin = Rs 4,33,334
iii. Revenue Variable cost = Contribution margin
Revenue 0.75 Revenue = Contribution margin
0.25 Revenues = Rs 4,33,334
Revenue = Rs 4,33,334/0.25 = Rs 17,33,336
iv. Break-even revenues = Fixed costs/contribution margin %
= Rs 3,00,000/0.20 = Rs 15,00,000
3-31
Solution
1. (a) [Units sold (Selling price Variable costs) Fixed costs] = Operating income
[6,00,000 (Rs 10- Rs 6) Rs 15,00,000] = Operating income
Rs 9,00,000 = Operating income
1. (b) Fixed cost/Contribution margin per unit = Breakeven units
Rs 15,00,000/4 = 3,75,000 units
Break-even units Selling price = Break-even revenues
3,75,000 Rs 10 per unit = Rs 37,50,000
Or,
Fixed cost/Contribution margin per unit = Break-even revenues
= Rs 15,00,000/0.40 = Rs 37,50,000
Contribution margin ratio = (Selling price Variable costs)/Selling price
= ( Rs 10 6)/ Rs 10 x 100 = 40 per cent
2. Variable cost per unit = Rs 6.50
6,00,000 [Rs 10 Rs 6.50] Rs 15,00,000 = Rs 6,00,000
3. Fixed cost = Rs 15,00,000 1.10 = Rs 16,50,000
Units sold = 6,00,000 1.10 = 6,60,000
6,60,000 (Rs 10- Rs 6) Rs 16,50,000 = Rs 9,90,000
4. Units sold = 6,00,000 1.40 = 8,40,000 units
Selling price = Rs 10 0.8 = Rs 8
Variable cost per unit = Rs 6 0.9 = Rs 5.4
Fixed cost = Rs 15,00,000 0.8 = Rs 12,00,000
Operating income = Rs 8,40,000 ( Rs 8 Rs 5.4) Rs 12,00,000 = Rs 9,84,000
5. Computation of new break-even Point
Fixed cost = Rs 15,00,000 1.15 = Rs 17,25,000
Fixed cost/Contribution margin per unit = Rs 17,25,000/4 = 4,31,250 units
6. Selling price =Rs 10 1.10 = Rs 11
Fixed cost = Rs 16,00,000
Fixed cost/Contribution margin per unit = Rs 16,00,000/Rs 11-Rs 6)
= Rs 16,00,000/Rs 5 = 3,20,000 units
3-32
Solution
Salaries of Rs 3,00,000 could be variable costs and fixed costs. We assume it to be fixed cost.
1. Computation of Contribution Margin
Revenues
Less: Variable costs
Cost of goods sold
Rs 4,00,000
Sales commissions
1,00,000
Other operating costs
80,000
Contribution

Rs 10,00,000

5,80,000
Rs 4,20,000

2. Contribution margin percentage = Rs 4,20,000/10,00,000 = 42 per cent

3. Impact on operating income
Revenues (120% 10,00,000)
Cost of goods sold (40% of sales)
Gross margin
Operating costs
Salaries
Sales commissions (10% Rs 12 lakh)
Depreciation of equipment and fixtures
Store rent
Advertising
Other Operating Costs
Variable [(Rs 80,000/10,00,000) 12,00,000]
Fixed
Operating Income
Short cut Method
Incremental revenue (20 per cent 10,00,000)
Incremental contribution margin (42 per cent 2,00,000)
Incremental fixed cost (advertising)
Incremental operating income

Rs 12,00,000
4,80,000
7,20,000
Rs 3,00,000
1,20,000
24,000
96,000
20,000
96,000
20,000

6,76,000
44,000
Rs 2,00,000
84,000
20,000
Rs 64,000

If Mr. Nitin spends Rs 20,000 more on advertising operating income will increase by Rs 64,000, converting an operating loss of Rs 20,000
to an operating income of Rs 44,000.
3-33
Solution
1.
Revenue per package
Variable cost per package
Contribution margin per package

Rs 20,000
14,000
6,000

Break-even (units) = Fixed costs/Contribution margin per package

= Rs 18,00,000/6,000 = 300 Tour packages
2. Contribution margin ratio = Contribution margin per package/Selling price
= Rs 6,000/Rs 20,000 = 30 per cent
Revenue to achieve target income = (Fixed cost + Target operating income)/Contribution margin ratio
= (Rs 18,00,000 + 6,00,000/0.30)
= Rs 80,00,000
3. New fixed costs = Rs 18,00,000 + 3,00,000 = Rs 21,00,000
Break-even (units) = Fixed costs/Contribution margin per unit
Contribution margin per unit = Fixed costs/Break-even (units)
= Rs 21,00,000/300 tour packages = Rs 7,000 per tour package
Desired variable cost per tour package = Rs 20,000 7,000 = Rs 13,000.
The current variable cost per unit is Rs 14,000, the unit variable cost will need to be reduced by Rs 1,000 to achieve the break-even point
calculated in requirement 1.
3-34
Solution
1. Variable cost percentage is Rs 8 /Rs 20 = 40 per cent
Let R = Revenues needed to obtain target net income
R 0.40R Rs 10,00,000 = Rs 3,50,000/(1 0.30)
0.60R 10,00,000 = Rs 5,00,000
0.60R = Rs 15,00,000
R = Rs 15,00,000/0.60 = Rs 25,00,000
2. (a) Customers needed to break-even:
Contribution margin per customer = Rs 20 Rs 8 = Rs 12
Breakeven number of customers = Fixed costs/Contribution margin per customer
= Rs 10,00,000/Rs 12 = 83,333.33 customers or 83,334 (rounded)

Customers needed to earn net income of Rs 3,50,000

Total revenues/Sales revenue per customer
Rs 25,00,000/Rs 20 =1,25,000 customers
3.
Revenues (2,00,000 Rs 20)
Variable cost at 40 per cent
Contribution margin
Fixed costs
Operating income
Income tax @ 30 per cent
Net income

Rs 40,00,000
16,00,000
24,00,000
10,00,000
14,00,000
4,20,000
9,80,000

3-35A
Solution
1. CVP Analysis, International Cost Structure Differences
Country

Singapore
Thailand
U.S.

Annual fixed
costs
(1)
$ 6,500,000
4,500,000
12,000,000

Selling
price
(2)
$ 32
$ 32
$ 32

Variable
manufacturing
costs per
sweater
(3)
$ 8.00
$ 5.50
$ 13.00

(a) Breakeven point in units sold

500,000
300,000
1,200,000

Singapore
Thailand
U.S.

Variable marketing
& distribution
costs per
sweater
(4)
$ 11.00
$ 11.50
$ 9.00

Unit Contribution
Margin

Breakeven
point in units

(5) = (2) (3) (4)

$ 13
15
10

(6) = (1) (5)

500,000
300,000
1,200,000

(b) Breakeven point in revenues Col. (a) x $ 32

$ 16,000,000
9,600,000
38,400,000

2. Calculation of Budged Operating Income

Operating income = Revenues Variable cost Fixed costs
Variable costs
Singapore
($8 + $11) 800,000 = $ 15,200,000
Thailand
($5.50 + R 11.50) 800,000 = $ 13,600,000
U.S.
($13.00 + $9.00) 800,000 = $17,600,000
Revenues
Singapore
Thailand
U. S.

$ 32 800,000
$ 25,600,000
25,600,000
25,600,000

Variable costs
$ 15,200,000
13,600,000
17,600,000

Fixed costs
$ 6,500,000
4,500,000
12,000,000

Operating income
$ 3,900,000
7,500,000
(4,000,000)

Thailand has the lowest breakeven point; it has both the lowest fixed costs ($4,500,000) and the lowest variable cost per unit ($17.00)
Hence, for a given selling price, Thailand will always have a higher operating income (or a lower operating loss) than Singapore or the U.S.
The US breakeven point is 12,00,000 units. Hence with sales of 8,00,000 units, it has an operating loss of $4,000,000.
3-36
Solution
1. a.
Cost of goods sold
Fixed manufacturing costs
Variable manufacturing costs
Variable manufacturing costs per unit = Rs 11,00,000/2,00,000 = Rs 5.5 per unit
b.
Total marketing and distribution costs
Variable marketing and distribution (2,00,000 x Rs 4)

Rs 16,00,000
() 5,00,000
Rs 11,00,000

Rs 11,50,000
8,00,000

Fixed marketing and distribution costs

Rs 3,50,000
2. Selling price = Rs 26,00,000/2,00,000 units = Rs 13 per unit
Contribution margin per unit = Selling price Variable manufacturing costs per unit Variable marketing & distribution costs per unit.
= Rs 13 Rs 5.50 Rs 4 = Rs 3.50
Operating income = (Contribution margin per unit x Sales quantity) Fixed Manufacturing costs Fixed marketing and distribution costs
= (Rs 3.50 2,30,000) Rs 5,00,000 Rs 3,50,000
= Rs ( 45,000)

Ramesh has confused gross margin with contribution margin. He has interpreted gross margin as if it was all variable, and interpreted
marketing and distribution costs as all fixed. In fact, the manufacturing costs, subtracted from sales to calculate gross margin, and marketing and
distribution costs contain both fixed and variable components.
3. Breakeven point in units = Fixed manufacturing, marketing and distribution costs/Contribution margin per unit
= Rs 8,50,000/Rs 3.50 = 2,42,858 units (rounded up)
Breakeven point in revenues = 2,42,858 Rs 13 = Rs 31,57,154
3-37
Solution
1. Variable Costs per Scholarship Offer
Scholarship amount
Operating costs
Total variable costs

Rs 40,000
4,000
44,000

Let the number of scholarships be denoted by B

Rs 44,000 B = Rs 1,00,00,000 Rs 12,00,000
Rs 44,000 B = Rs 88,00,000
B = 88,00,000/44,000 = 200 scholarships
2. Total budget for next year = Rs 1,00,00,000 (1.00 0.22) = Rs 78,00,000
Then Rs 44,000B = Rs 78,00,000 Rs 12,00,000 = Rs 66,00,000
B = Rs 66,00,000/Rs 44,000 = 150 scholarships
3. Total Budget for Next Year
Total budget for next year
Fixed costs
Variable costs for scholarships
If the total number of scholarships is to remain at 200
Variable cost per scholarship 66,00,000/200
Variable operating cost per scholarship
Amount per scholarship

Rs 78,00,000
12,00,000
Rs 66,00,000
Rs 33,000
4,000
Rs 29,000

3-38
Solution
1. (a) In order to break-even, Birla company must sell 500 units (as shown below). This amount represents the point where revenues equal
total costs.
Let Q denote the quantity of canopies sold.
Revenue = Variable costs + Fixed costs
Rs 20,000 Q = Rs 10,000 Q + Rs 50,00,000
Rs 10,000 Q = Rs 50,00,000
Q = Rs 50,00,000/Rs 10,000 = 500 units
Break-even can also be calculated using contribution margin per unit,
Contribution margin per unit = Selling price Variable cost per unit
Rs 20,000 Rs 10,000 = Rs 10,000
Breakeven = Fixed Costs/ Contribution Margin per unit
= Rs 50,00,000/Rs 10,000 = 500 units
1. (b) In order to achieve its net income objective, Birla Company must sell 2,500 units (as shown below). This amount represents the point
where revenues equal total costs plus the corresponding operating income objective to achieve net income of Rs 1,20,00,000.
Revenue = Variable Costs + Fixed Costs + Net Income/(1-Tax rate)
Rs 20,000Q = Rs 10,000Q + Rs 50,00,000 + Rs 1,20,00,000/(1-0.4)
10,000Q = Rs 50,00,000 + Rs 2,00,00,000
Q = 2,500 units
2. To achieve its net income objective, Birla Company should select the first alternative where the sales price is reduced by Rs 2,000 and
2,700 units are sold during the remainder of the year. This option results in the highest net income and is the only option that equals or
exceeds the companys net income objective. Calculation for the three options are shown below:
Option 1
Revenues = (Rs 20,000 350) + (Rs 18,000 2,700) = Rs 5,56,00,000
Variable costs = [Rs 10,000 (350 + 2,700)] = Rs 3,05,00,000

Operating income = Rs 5,56,00,000 3,05,00,000 50,00,000 = 2,01,00,000

Net income = 2,01,00,000 (1 0.4) = Rs 1,20,60,000
Option 2
Revenues = (Rs 20,000 350) + (Rs 18,500 2,200) = Rs 4,77,00,000
Variable costs = (Rs 10,000 350) + (Rs 9,500 2,200) = Rs 2,44,00,000
Operating income = Rs 4,77,00,000 2,44,00,000 50,00,000 = Rs 1,83,00,000
Net income = Rs 1,83,00,000 (1 0.4) = Rs 1,09,80,000
Option 3
Revenues = (350 Rs 20,000) + (2,000 Rs 19,000) = Rs 4,50,00,000
Variable costs = (Rs 10,000 2,350) = 2,35,00,000
Operating income =Rs 4,50,00,000 2,35,00,000 45,00,000 = Rs 1,70,00,000
Net income = Rs 1,70,00,000 (1 0.4) = Rs 1,02,00,000
3-39
Solution
1. Let Q = Number of units of Deluxe carrier to break-even
3Q = Number of units of Standard Carrier to break-even
Revenues Variable costs Fixed costs = Zero operating income
Rs 1,000 [3Q] + 1,500 (Q) 700 (3Q) 900 (Q) Rs 6,00,00,000 = 0
3,000Q + 1,500Q 2,100Q 900Q Rs 6,00,00,000 = 0
1,500Q = Rs 6,00,00,000
Q = 6,00,00,000/1,500 = 40,000
Q = 40,000 units of Deluxe
3Q = 1,20,000 units of standard
The break-even point is 1,20,000 standard units plus 40,000 Deluxe units, a total of 1,60,000 units.
2. (a) Break-even point = Fixed cost/Contribution margin per unit
Contribution margin per unit are: Standard: Rs 1,000 Rs 700 = Rs 300
Deluxe: Rs 1,500 900 = Rs 600
If only Standard carriers are sold, break-even point would be: Rs 6,00,00,000/300 = 2,00,000 units
(b) If only Deluxe Carriers are sold, the break-even point would be: Rs 6,00,00,000/600 = 1,00,000 units
3. Operating income = Contribution margin of Standard + Contribution margin of Deluxe Fixed costs
= Rs 1,80,000 (300) + 20,000 (Rs 600) Rs 6,00,00,000
Rs 5,40,00,000 + 1,20,00,000 Rs 6,00,00,000
= Rs 60,00,000
Calculation of Breakeven Point:
Let Q = Number of units of Deluxe product to breakeven
9Q = Number of units of Standard product to breakeven
Rs 1,000(9Q) + 1,500(Q) Rs 700(9Q) 900(Q) 6,00,00,000 = 0
3,300Q = Rs 6,00,00,000
Q = 6,00,00,000/3,300 = 18,182 (rounded)
Q = 18,182 units of Deluxe
9Q = 1,63,638 units of Standard
The breakeven point is 1,63,638 Standard + 18,182 Deluxe, a total of 1,81,820 units.
The major lesson of this problem is that changes in the sales mix change breakeven points and operating incomes. In this example, the
budgeted and actual total sales in number of units were identical, but the proportion of the product having the higher contribution margin
declined. Operating income suffered, decreasing from Rs 1,50,00,000 to Rs 60,00,000. Moreover, the breakeven point rose from 1,60,000 to
1,81,820 units.
3-40
Solution
1. Both the products have the same unit contribution margin:
Unit contribution margin = Selling price per unit Variable costs per unit
= Rs 100 Rs 80 = Rs 20
Breakeven point = Fixed costs/Unit contribution margin
= Rs 40,00,000/Rs 20 = 2,00,000 units for each product.

2. The expected demand for the two umbrellas is:

Event
Emerald
(1) Demand
(2) Probability
50,000
0.0
1,00,000
0.1
2,00,000
0.2
3,00,000
0.4
4,00,000
0.2
5,00,000
0.1
Expected demand
1.0

(1) (2) Units

10,000
40,000
1,20,000
80,000
50,000
3,00,000

Shocking Pink
(3) Probability
(1) (3) Units
0.1
5,000
0.1
10,000
0.1
20,000
0.2
60,000
0.4
1,60,000
0.1
50,000
1.0
3,05,000

Expected operating income of emerald green umbrellas:

Rs 20 (3,00,000) Rs 40,00,000 = Rs 20,00,000
Expected operating income of shocking pink umbrellas:
Rs 20 (3,05,000) Rs 40,00,000 = Rs 21,00,000
The Shocking Pink umbrellas should be chosen because they have the higher expected operating income.
3. The expected operating income from the two products would be identical. If the choice criterion is to maximize expected operating income,
the company will be indifferent between Emerald Green and Shocking Pink umbrellas. However, assume that management considers risk
factors. Emerald Green umbrellas, for example have a 10 per cent chance of selling only 1,00,000 units which would result in a net
operating loss of Rs 20,00,000. Also there is a 30 per cent chance that sales of Emerald Green will exceed 3,00,000 units. If this event
happens, the operating income of Emerald Green umbrellas will be higher than the operating income of Shocking Pink umbrellas. If
management is reluctant to take risks, it would prefer selling the 3,00,000 units of Shocking pink. The expected values are important, but
the dispersion of the probability distribution is also important, Normally, the wider the dispersion, the greater the risk. Knowledge of the
entire probability distribution helps management assess the risk before reaching a decision.
3-41
Solution
1. Contribution margin per pair = Selling price per pair Variable costs per pair
= Rs 300 210 = Rs 90 per pair
Breakeven point in number of pairs:
Fixed costs/Contribution margin per pair = Rs 7,20,000/Rs 90 = 8,000 pairs
Breakeven points in revenues:
Fixed costs/Contribution margin % per rupee of sales = Rs 7,20,000/(100%-70%) = Rs 24,00,000
2.
Revenues, Rs 300 35,000
Variable costs, 210 35,000
Contribution margin
Fixed costs
Operating income (loss)

Rs 1,05,00,000
73,50,000
31,50,000
7,20,000
24,30,000

3. Fixed costs: Rs 7,20,000 + 1,62,000 = Rs 8,82,000

Contribution margin per pair = Rs 300 195 = Rs 105
a. Breakeven point in units = Rs 8,82,000/105 = 8,400 pairs
b. Breakeven point in revenues = Rs 300 8,400 = Rs 25,20,000
4. Fixed costs = Rs 7,20,000
Contribution margin per pair = Rs 300 Rs 210 Re 0.30 = Rs 89.7
a. Breakeven point in units = Rs 7,20,000/89.70 = 8,027 pairs (rounded)
b. Breakeven point in revenues = Rs 300 8,027 = Rs 24,08,100
5. Break-even point = 8000 pairs
Store manager receives commission on 42,000 pairs.
Revenues, Rs 300 50,000
Variable costs
Cost of shoes
Sales person commission
Store manager commission
Contribution margin
Fixed costs
Operating income

Rs 1,50,00,000
Rs 97,50,000
7,50,000
12,600

1,05,12,600
44,87,400
7,20,000
37,67,400

3-42
Solution
1. The unit sales level as well as at the point of indifference would be the same for each plan. Therefore, the unit sales level sought would be
that which produces the same total costs for each plan.
Let Q = Unit sales level
Rs 195Q + Rs 7,20,000 + Rs 1,62,000 = Rs 210 + Rs 7,20,000
Rs 1,62,000 = Rs 15Q
Q = 10,800 pairs
2.
Particulars
Sales in units
Revenues at Rs 300
Variable costs at Rs 210 and at Rs 195
Contribution margin
Fixed costs
Operating income

Commission Plan
50,000
60,000
1,50,00,000
1,80,00,000
1,05,00,000
1,26,00,000
45,00,000
54,00,000
7,20,000
7,20,000
Rs 37,80,000
46,80,000

Salary Plan
50,000
1,50,00,000
97,50,000
52,50,000
8,82,000
43,68,000

60,000
1,80,00,000
1,17,00,000
63,00,000
8,82,000
54,18,000

The decision regarding the plans will depend heavily on the units ales level that is generated by the fixed salary plan. For example as part
(1) shows, at identical unit sales levels in excess of 10,800 units, the fixed salary plan will always provide a more profitable final result than
the commission plan.
3. Let TQ = Target number of units
Rs 300 TQ 195TQ 8,82,000 = Rs 16,80,000
105TQ = Rs 25,62,000
TQ = Rs 25,62,000/Rs 105
TQ = 24,400 units
Rs 300 TQ Rs 210 TQ Rs 7,20,000 =Rs 16,80,000
90TQ = Rs 24,00,000
TQ = 24,00,000/90 = 26,667 units (rounded)
The decision regarding the salary plan depend heavily on prediction of demand. For instance, the salary plan offers the same operating
income at 24,400 units as the commission plan offers at 26,667 units.
3-43
Solution
1.
Revenues, Rs 300 48,000 + Rs 180 2,000
Variable costs
Goods sold Rs 195 50,000
Commission, 5% 1,47,60,000
Contribution margin
Fixed costs
Operating income

Rs 1,47,60,000
Rs 97,50,000
7,38,000

1,04,88,000
42,72,000
7,20,000
35,52,000

2. Optimal operating income, given perfect knowledge, would be the Rs 43,20,000 [(Rs 300 195 15) 48,000] contribution minus Rs
7,20,000 fixed costs = Rs 36,00,000.
3. The point of indifference is where the operating incomes are equal. Let X = unit cost per pair that would produce the identical operating
income of Rs 35,52,000. Then:
48,000 [Rs 300 ( X + Rs 15)] Rs 7,20,000 = Rs 35,52,000
48,000 (285 X) Rs 7,20,000 = Rs 35,52,000
Rs 1,36,80,000 48,000 7,20,000 = Rs 35,52,000
Rs 94,08,000 = 48,000x
X = Rs 196
Therefore, any rise in purchase cost in excess of Rs 196 per pair increases the operating income benefit of signing the long-term contract.
In a short cut solution, Liberty Shoe Company could take the Rs 48,000 difference between the ideal operating income of Rs 36,00,000
at the current cost per pair and the operating income under the contract (Rs 35,52,000) and divide it by 48,000 units to get Re 1 per pair
difference.