Chapter 5

Exercise 5-1

1. The new income statement would be:

Total Per Unit

Sales (8,050 units) 209,300 26.00
Variable expenses 144,900 18.00
Contribution margin 64,400 8.00
Fixed expenses 56,000
Net operating income 8,400

2. The new income statement would be:

Total Per Unit

Sales (7,950 units) 206,700 26.00
Variable expenses 143,100 18.00
Contribution margin 63,600 8.00
Fixed expenses 56,000
Net operating income 7,600

3. The new income statement would be:

Total Per Unit

Sales (7,000 units) 182,000 26.00
Variable expenses 126,000 18.00
Contribution margin 56,000 8.00
Fixed expenses 56,000
Net operating income 0
Exercise 5-2

1. We need two points for both cost line and the revenue line.
2. The revenue line passes through origin and say at 2000 units, the revenue = 2000*36 = $
72,000.
3. The total cost line has a y-axis intercept = the fixed cost = $12,000. The second point
(cost) for say 2000 units = 12000+2000*24 = $ 60,000

CVP Graph
$80,000

$60,000
Dollars

$40,000

$20,000

$0
0 500 1,000 1,500 2,000
Volume in Units
Total Expense Total Sales Revenue

2. The break-even point = point of intersection of total sales revenue and the total expense lines.
This occurs at sales of 1,000 units.
Exercise 5-3

1. Plot of profit against no of units. Profit = Unit CM * Q – Fixed expenses

Profit Graph
$5,000

$0

-$5,000
Profit

-$10,000

-$15,000

-$20,000
0 500 1,000 1,500 2,000 2,500 3,000 3,500 4,000
Sales Volume in Units

2. Breakeven point = point of intersection with x-axis where profit = 0

Exercise 5-4

1. The company’s contribution margin (CM) ratio is =

Total sales $300,000

Total variable expenses 240,000
= Total contribution margin $ 60,000
÷ Total sales $300,000
= CM ratio 20%

2.
Change in total sales $1,500
× CM ratio 20%
= Estimated change in net operating income $ 300
Exercise 5-5

1. The following table shows the effect of the proposed change in monthly advertising budget:
Current
Sales
Sales $225,000
Variable expenses 135,000
Contribution margin 90,000
Fixed expenses 75,000
Net operating income $ 15,000

Incremental contribution margin: $15,000 × 40% CM ratio $6,000

Less incremental advertising expense 8,000
Change in net operating income $(2,000)

2. The $3 increase in variable expenses will cause the unit contribution margin to decrease from
$30 to $27 with the following impact on net operating income:

Expected total contribution margin with the higher-quality

components: 3,450 units × $27 per unit $93,150
Present total contribution margin: 3,000 units × $30 per unit 90,000
Change in total contribution margin $ 3,150
Exercise 5-6

1. The equation method yields the required unit sales, Q, as follows:

Profit = Unit Contribution Margin × Q − Fixed expenses

$6,000 = ($140 − $60) × Q − $40,000
$6,000 = ($80) × Q − $40,000
$80 × Q = $6,000 + $40,000
Q = $46,000 ÷ $80
= 575 units

2. The formula approach yields the required unit sales as follows:

𝑡𝑎𝑟𝑔𝑒𝑡 𝑝𝑟𝑜𝑓𝑖𝑡+𝑓𝑖𝑥𝑒𝑑 𝑒𝑥𝑝𝑒𝑛𝑠𝑒𝑠
Units sold to attain target profit =
𝑈𝑛𝑖𝑡 𝑐𝑜𝑛𝑡𝑟𝑖𝑏𝑢𝑡𝑖𝑜𝑛 𝑚𝑎𝑟𝑔𝑖𝑛
8000+40000
= 80
= 600 units
Exercise 5-7

1. The equation method yields the break-even point in unit sales, Q, as follows:

Profit = Unit CM × Q − Fixed expenses

$0 = ($8 − $6) × Q − $5,500
$0 = ($2) × Q − $5,500
Q = 2,750 baskets

2. The equation method can be used to compute the break-even point in sales dollars as follows:
𝑢𝑛𝑖𝑡 𝐶𝑀 2
Contribution margin ratio = = 𝑈𝑛𝑖𝑡 𝑠𝑒𝑙𝑙𝑖𝑛𝑔 𝑝𝑟𝑖𝑐𝑒 = 8 = 0.25

Profit = CM ratio × Sales − Fixed expenses

$0 = 0.25 × Sales − $5,500
Sales = $22,000

3. The formula method gives an answer that is identical to the equation method for the break-
even point in unit sales:
𝐹𝑖𝑥𝑒𝑑 𝐶𝑜𝑠𝑡 5500
Unit sales to break even = 𝑈𝑛𝑖𝑡 𝑐𝑜𝑛𝑡𝑟𝑖𝑏𝑢𝑡𝑖𝑜𝑛 𝑚𝑎𝑟𝑔𝑖𝑛 = $2 = 2750 baskets

4. The formula method also gives an answer that is identical to the equation method for the
break-even point in dollar sales:
𝐹𝑖𝑥𝑒𝑑 𝑒𝑥𝑝𝑒𝑛𝑠𝑒𝑠 5500
Dollar sales to break even = 𝐶𝑀 𝑟𝑎𝑡𝑖𝑜 = 0.25 = $ 22,000
Exercise 5-8

1. To compute the margin of safety, we must first compute the break-even unit sales.

Profit = Unit CM × Q − Fixed expenses

$0 = ($25 − $15) × Q − $8,500
$0 = ($10) × Q − $8,500
Q = 850 units

Sales (at the budgeted volume of 1,000 units) $25,000

Break-even sales (at 850 units) 21,250
Margin of safety (in dollars) $ 3,750

2. The margin of safety as a percentage of sales is as follows:

Margin of safety (in dollars) $3,750

÷ Sales $25,000
Margin of safety percentage 15%
Exercise 5-9

1. The company’s degree of operating leverage would be computed as follows:

Contribution margin $36,000

÷ Net operating income $12,000
Degree of operating leverage 3.0

2. The effect of 10% increase in sales net operating income, is computed as follows

Degree of operating leverage 3.0

× Percent increase in sales 10%
Estimated percent increase in net operating income 30%

3. The new income statement reflecting the change in sales is:

Amount Percent of Sales

Sales $132,000 100%
Variable expenses 92,400 70%
Contribution margin 39,600 30%
Fixed expenses 24,000
Net operating income $ 15,600

Net operating income reflecting change in sales $15,600

Original net operating income (a) 12,000
Change in net operating income (b) $ 3,600
Percent change in net operating income (b ÷ a) 30%
Exercise 5-10

1. The overall contribution margin ratio can be computed as follows:

𝐶𝑀 120000
Overall CM ratio = 𝑇𝑜𝑡𝑎𝑙 𝑆𝑎𝑙𝑒𝑠 = 150000 = 80%

2. The overall break-even point in sales dollars can be computed as follows:

𝑇𝑜𝑡𝑎𝑙 𝑓𝑖𝑥𝑒𝑑 𝑒𝑥𝑝𝑒𝑛𝑠𝑒𝑠 90000
Overall break-even sales = = 80% = $112,500
𝐶𝑀 𝑟𝑎𝑡𝑖𝑜

3. To construct the required income statement, we must first determine the relative sales mix for
the two products:

Predator Runway Total

Original dollar sales $100,000 $50,000 $150,000
Percent of total 67% 33% 100%
Sales at break-even $75,000 $37,500 $112,500

Predator Runway Total

Sales $75,000 $37,500 $112,500
Variable expenses* 18,750 3,750 22,500
Contribution margin $56,250 $33,750 90,000
Fixed expenses 90,000
Net operating income $ 0

*Predator variable expenses: ($75,000/$100,000) × $25,000 = $18,750

Runway variable expenses: ($37,500/$50,000) × $5,000 = $3,750
Exercise 5-11

1. Firms break-even point = 𝐹𝑖𝑥𝑒𝑑 𝑒𝑥𝑝𝑒𝑛𝑠𝑒𝑠⁄𝑈𝑛𝑖𝑡 𝑐𝑜𝑛𝑡𝑟𝑖𝑏𝑢𝑡𝑖𝑜𝑛 𝑚𝑎𝑟𝑔𝑖𝑛

= 150000/ 12 = 12,500 units
Firms break-even point in revenue= 𝐹𝑖𝑥𝑒𝑑 𝑒𝑥𝑝𝑒𝑛𝑠𝑒𝑠⁄𝑐𝑜𝑛𝑡𝑟𝑖𝑏𝑢𝑡𝑖𝑜𝑛 𝑚𝑎𝑟𝑔𝑖𝑛 𝑟𝑎𝑡𝑖𝑜
= 150000/ (180000/600000) = $ 500,000

2. The contribution margin at the break-even point is $150,000 because at that point it must
equal the fixed expenses.
𝑡𝑎𝑟𝑔𝑒𝑡 𝑝𝑟𝑜𝑓𝑖𝑡+𝐹𝑖𝑥𝑒𝑑 𝑒𝑥𝑝𝑒𝑛𝑠𝑒𝑠 18000+150000
3. Units sold to attain target profit = = = 14,000 units
𝑈𝑛𝑖𝑡 𝑐𝑜𝑛𝑡𝑟𝑖𝑏𝑢𝑡𝑖𝑜𝑛 𝑚𝑎𝑟𝑔𝑖𝑛 12

Total Unit
Sales (14,000 units × $40 per unit) $560,000 $40
Variable expenses (14,000 units × $28 per unit) 392,000 28
Contribution margin (14,000 units × $12 per unit) 168,000 $12
Fixed expenses 150,000
Net operating income $ 18,000

4. Margin of safety in dollar terms = 600,000 – 500,000 = $ 100,000

Margin of safety in percentage terms: = 100,000/ 600,000 = 16.7%

5. The CM ratio is 30%.

Increased contribution margin = $80,000 incremental sales × 30% CM ratio = $24,000
Exercise 5-12

𝐹𝑖𝑥𝑒𝑑 𝑒𝑥𝑝𝑒𝑛𝑠𝑒𝑠 135,000

1. Unit sales to break-even = = = 5000 units
𝑈𝑛𝑖𝑡 𝑐𝑜𝑛𝑡𝑟𝑖𝑏𝑢𝑡𝑖𝑜𝑛 𝑚𝑎𝑟𝑔𝑖𝑛 27
Or 5000*90 = $ 450,000

2. An increase in variable expenses as a percentage of the selling price would result in a higher
break-even point. If variable expenses increase as a percentage of sales, then the contribution
margin will decrease as a percentage of sales.
3.
Present: Proposed:
8,000 Lanterns 10,000 Lanterns*
Total Per Unit Total Per Unit
Sales $720,000 $90 $810,000 $81
Variable expenses 504,000 63 630,000 63
Contribution margin 216,000 $27 180,000 $18
Fixed expenses 135,000 135,000
Net operating income $ 81,000 $ 45,000

𝑡𝑎𝑟𝑔𝑒𝑡 𝑝𝑟𝑜𝑓𝑖𝑡+𝐹𝑖𝑥𝑒𝑑 𝑒𝑥𝑝𝑒𝑛𝑠𝑒𝑠 72000+135000

4. Units sold to attain target profit = = = 11,500 units
𝑈𝑛𝑖𝑡 𝑐𝑜𝑛𝑡𝑟𝑖𝑏𝑢𝑡𝑖𝑜𝑛 𝑚𝑎𝑟𝑔𝑖𝑛 18
Exercise 5-13

1. The contribution margin per person would be:

Price per ticket $30

Variable expenses:
Dinner $7
Favors and program 3 10
Contribution margin per person $20

The fixed expenses of the Extravaganza total $8,000; therefore, the break-even point is
𝐹𝑖𝑥𝑒𝑑 𝑒𝑥𝑝𝑒𝑛𝑠𝑒𝑠 8000
Units sold to break even= 𝑈𝑛𝑖𝑡 𝑐𝑜𝑛𝑡𝑟𝑖𝑏𝑢𝑡𝑖𝑜𝑛 𝑚𝑎𝑟𝑔𝑖𝑛 = = 400 persons
20

Break even revenues = 400 * 30 = $ 12,000

2. Variable cost per person ($7 + $3) ................................................. $10

Fixed cost per person ($8,000 ÷ 250 persons) ................................ 32
Ticket price per person to break even ............................................. $42
Exercise 5-14

1.
Model A100 Model B900 Total Company
Amount % Amount % Amount %
Sales 700,000 100 300,000 100 1,000,000 100
Variable expenses 280,000 40 90,000 30 370,000 37
Contribution margin
$420,000 60 $210,000 70 630,000 63
Fixed expenses 598,500
Net operating
income 31,500

2. The break-even point for the company as a whole is:

𝐹𝑖𝑥𝑒𝑑 𝑒𝑥𝑝𝑒𝑛𝑠𝑒𝑠 598500
Revenue to break even= 𝐶𝑜𝑛𝑡𝑟𝑖𝑏𝑢𝑡𝑖𝑜𝑛 𝑚𝑎𝑟𝑔𝑖𝑛 𝑟𝑎𝑡𝑖𝑜 = 0.63 = $ 950,000

3. Additional contribution margin from the additional sales = $50,000 × 63% CM ratio =
$31,500
Exercise 5-15

1.
Sales (30,000 doors) $1,800,000 $60
Variable expenses 1,260,000 42
Contribution margin 540,000 $18
Fixed expenses 450,000
Net operating income $ 90,000
𝐶𝑜𝑛𝑡𝑟𝑖𝑏𝑢𝑡𝑖𝑜𝑛 𝑚𝑎𝑟𝑔𝑖𝑛 540,000
Degree of operating leverage = 𝑁𝑒𝑡 𝑜𝑝𝑒𝑟𝑎𝑡𝑖𝑛𝑔 𝑖𝑛𝑐𝑜𝑚𝑒 = =6
90,000

2. a. Sales of 37,500 doors represent an increase of 7,500 doors, or 25%, over present sales of
30,000 doors. Because the degree of operating leverage is 6, net operating income should
increase by 6 times as much, or by 150% (6 × 25%).

b. Expected total dollar net operating income for the next year is:

Present net operating income $ 90,000

Expected increase in net operating income next year (150% × $90,000) 135,000
Total expected net operating income $225,000
Exercise 5-16
1. Variable expenses: $60 × (1 – 40%) = $36.

2.
a.
Contribution margin = selling price – variable expenses = 60 – 36 = $ 24
𝐹𝑖𝑥𝑒𝑑 𝑐𝑜𝑠𝑡 360,000
Breakeven units = 𝑐𝑜𝑛𝑡𝑟𝑖𝑏𝑢𝑡𝑖𝑜𝑛 𝑚𝑎𝑟𝑔𝑖𝑛 𝑝𝑒𝑟 𝑢𝑛𝑖𝑡 = 24 = 15,000 units
In sales dollars: 15,000 units × $60 per unit = $900,000

b.
𝑇𝑎𝑟𝑔𝑒𝑡 𝑝𝑟𝑜𝑓𝑖𝑡+ 𝐹𝑖𝑥𝑒𝑑 𝑐𝑜𝑠𝑡 90,000 + 360,000
Breakeven units = 𝑐𝑜𝑛𝑡𝑟𝑖𝑏𝑢𝑡𝑖𝑜𝑛 𝑚𝑎𝑟𝑔𝑖𝑛 𝑝𝑒𝑟 𝑢𝑛𝑖𝑡 = = 18,750 units
24
In sales dollars: 18,750 units × $60 per unit = $1,125,000

c. The company’s new cost/revenue relationships will be:

Selling price ........................................................... $60 100%

Variable expenses ($36 – $3) ................................. 33 55%
Contribution margin ............................................... $27 45%

Profit = CM ratio × Sales − Fixed expenses

$0 = 0.45 × Sales − $360,000
Sales = $800,000
Exercise 5-17

Total Per Unit

1. Sales (115% of 30,000 = 34,500 units) 172,500 5.00
Variable expenses 103,500 3.00
Contribution margin 69,000 2.00
Fixed expenses 50,000
Net operating income 19,000

2. Sales (120% of 30,000 units = 36,000 units) 162,000 4.50

Variable expenses 108,000 3.00
Contribution margin 54,000 1.50
Fixed expenses 50,000
Net operating income 4,000

3. Sales (95% of 30,000 units = 28,500 units) 156,750 5.50

Variable expenses 85,500 3.00
Contribution margin 71,250 2.50
Fixed expenses ($50,000 + $10,000) 60,000
Net operating income 11,250

4. Sales (90% of 30,000 units = 27,000 units) 151,200 5.60

Variable expenses 86,400 3.20
Contribution margin 64,800 2.40
Fixed expenses 50,000
Net operating income 14,800
Exercise 5-18

a. Case #1 Case #2
Number of units sold 9,000 14,000
Sales $270,000 $30 $350,000 $25
Variable expenses 162,000 18 140,000 10
Contribution margin 108,000 $12 210,000 $15
Fixed expenses 90,000 170,000
Net operating income $ 18,000 $ 40,000
Case #3 Case #4
Number of units sold 20,000 5,000
Sales $400,000 $20 $160,000 $32
Variable expenses 280,000 14 90,000 18
Contribution margin 120,000 $6 70,000 $14
Fixed expenses 85,000 82,000
Net operating income $ 35,000 $(12,000)

b. Case #1 Case #2
Sales $450,000 100 $200,000 100
Variable expenses 270,000 60 130,000 65
Contribution margin 180,000 40 70,000 35
Fixed expenses 115,000 60,000
Net operating income $ 65,000 $ 10,000
Case #3 Case #4
Sales $700,000 100 $300,000 100
Variable expenses 140,000 20 90,000 30
Contribution margin 560,000 80 210,000 70
Fixed expenses 470,000 225,000
Net operating income $ 90,000 $(15,000)