Chapter 4

Cost-Volume-Profit Relationships

Exercise 4-3 (10 minutes)

1. The company’s contribution margin (CM) ratio is:
Total sales (25,000 units)....... $2,500,000
Total variable expenses.......... 1,500,000
= Total contribution margin.... $ 1,000,000
÷ Total sales......................... $2,500,000
= CM ratio............................ 40%

2. The break-even level of sales dollars is:

Fixed expenses $ 800,000

= =$ 2,000,000
CM ratio .40
3. The break-even level of unit sales is:

Sales price per unit = $2,500,000 ÷ 25,000 units = $100

Breakeven unit sales = $2,000,000 (break-even sales dollars) ÷ $100 =
20,000 units

Alternatively:
Contribution margin per unit = $1,000,000 ÷ 25,000 units = $40
Break-even units:

Fixed expenses $ 800,000

= =20,000 units
CM per unit $ 40

4. The change in operating income from an increase in total sales of

$600,000 can be estimated by using the CM ratio as follows:
Change in total sales...................... $600,000
× CM ratio..................................... 40%
= Estimated change in operating
income....................................... $ 240,000
Exercise 4-5 (10 minutes)
1. Using the formula method:
Break-even point in units sold = Fixed expenses ÷ Unit CM
= $4,200 ÷ $3 per scarf
= 1,400 scarfs

2. Using the formula method:

Break-even point in sales dollars = Fixed expenses ÷ CM ratio
= $4,200 ÷ 0.20
=$21,000
3.
Break-even point in units sold = Fixed expenses ÷ Unit CM
= $4,200 ÷ $2 per scarf
= 2,100 scarfs
Exercise 4-6 (10 minutes)
1. Unit sales required to earn before-tax target profit of $20,000:

Fixed expenses + Target profit $ 200,000+$ 20,000

=
CM per unit $ 50∗¿=4,400units ¿
*$200 - $150

2. The formula approach yields the dollar sales required to attain a target
profit of $60,000 (before tax) as follows:

Fixed expenses + Target profit $ 200,000+ $ 60,000

=
CM ratio .25∗¿=$ 1,040,000 ¿

*$50  $200

3. Unit sales required to earn target after-tax income of $120,000 given a

tax rate of 25%.
Target after −tax profit
¿ expenses+
1−Tax Rate
¿
Unit Contribution Margin
$ 120,000
$ 200,000+
1−.25
¿
$ 50
$ 200,000+ $ 160,000
¿
$ 50

¿ 7,200 units
 Exercise 4-7 (15 minutes)

1. Break-even hours for residential clients:

Fixed expenses $ 500

= =50 hours
CM per unit $ 10

Break-even hours for commercial clients:

Fixed expenses $ 825

= =55 hours
CM per unit $ 15

2. Revenue at 120 hours per month*................... $4,200

Break-even revenue (at 55 hours)**................ 1,925
Margin of safety (in dollars)............................. $ 2,275

*$35 x 120; **$35 x 55

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

Margin of safety (in dollars)....................... $2,275
÷ Sales.................................................... $4,200
Margin of safety as a percentage of sales... 54.2%
Exercise 4-8 (20 minutes)
1. The company’s degree of operating leverage would be computed as
follows:
Contribution margin............... $48,000
÷ Operating income............... $10,000
Degree of operating leverage. 4.8

2. A 5% increase in sales should result in a 24% increase in operating

income, computed as follows:
Degree of operating leverage................................... 4.8
× Percent increase in sales...................................... 5%
Estimated percent increase in operating income........ 24%

3. The new income statement reflecting the change in sales would be:
Percent
Amount of Sales
Sales............................ $84,000 100%
Variable expenses......... 33,600 40%
Contribution margin...... 50,400 60%
Fixed expenses............. 38,000
Operating income.......... $ 12,400
Operating income reflecting change in sales............ $12,400
Original operating income...................................... 10,000
Change – income.................................................. $2,400
Percent change in operating income (2,400/12,400)
24%
Exercise 4-9 (30 minutes)
1. The overall contribution margin ratio can be computed as follows:

Total contribution margin $ 72,000

= =60 %
Total sales $ 120,000
2. The overall break-even point in sales dollars can be computed as
follows:
¿ $ 54,000
Total ¿ expenses = =$ 90,000
Overall CM ratio 60 %
3. The weighted average contribution margin per hour can be computed as
follows:
(1) (2) (3)

(1) X (2)
Weighted
Services CM Sales Average
Per Hour Mix * CM Per Hour
Lawn care $ 8.00 75% $6.00
Garden maintenance $12.00 25% 3.00
Total $9.00
*Lawn care: 6,000 hours ÷ (6,000 + 2,000); Garden maintenance: 2,000
hours ÷ (6,000 + 2,000)

Alternatively, the calculation could be done as follows:

Total contribution margin $ 72,000
= =$ 9 per hour
Total hours 6,000+2,000

4. The total break-even point in hours can be computed as follows:

¿ $ 54,000
Total ¿ expenses = =6,000 hours
Weighted averageCM per hour $ 9 per hour
Exercise 4-9 (continued)

5. The hours of each service that must be provided to break-even is

calculated as follows:
Lawn care: 6,000 hours x 75% = 4,500 hours
Garden maintenance: 6,000 hours x 25% = 1,500 hours

6. Overall sales required to generate an after-tax target profit:

Target after −tax profit

¿ expenses+
1−Tax Rate
¿
Overall Contribution Margin Ratio

$ 42,000
$ 54,000+
1−.3
¿
.60
$ 54,000+ $ 60,000
=$ 190,000
.6
Exercise 4-14 (30 minutes)
1. Variable expenses: $30 × (100% – 50%) = $15.

2. Break-even point in units and sales dollars:

In units: $450,000  ($30 - $15) = 30,000 units

In sales dollars: $450,000  .50 = $900,000

3. Sales in units and dollars to achieve a target operating income of

$150,000

In units: ($450,000 + $150,000)  ($30 - $15) = 40,000 units

In dollars: ($450,000 + $150,000)  .5 = $1,200,000

4. New break-even point in units:

($450,000 + $54,000)  ($30 - $12) = 28,000 units

5. Sales in dollars to achieve a target after-tax profit of $100,000 with a tax

rate of 20%.

($450,000 + ($100,000  1-.2)  .5 = $1,150,000

 Exercise 4-15 (15 minutes)
1.
Per
Total Unit
Sales (15,000 games)......... $300,000 $20
Variable expenses............... 90,000 6
Contribution margin............ 210,000 $14
Fixed expenses................... 182,000
Net operating income.......... $ 28,000

The degree of operating leverage is:

2. a. Sales of 18,000 games represent a 20% increase over last year’s

sales. Because the degree of operating leverage is 7.5, net operating
income should increase by 7.5 times as much, or by 150% (7.5 ×
20%).

b. The expected total dollar amount of net operating income for next
year would be:
Last year’s net operating income...................... $28,000
Expected increase in net operating income next
year (150% × $28,000)................................ 42,000
Total expected net operating income................ $70,000
Exercise 4-16 (30 minutes)
1. Break-even point in units and sales dollars:

In units: $108,000  ($50 - $32) = 6,000 units

In sales dollars: $108,000  .36* = $300,000
*($50 - $32)  $50

2. An increase in the variable expenses as a percentage of the selling price

would result in a higher break-even point. The reason is that if variable
expenses increase as a percentage of sales, then the contribution
margin will decrease as a percentage of sales. A lower CM ratio would
mean that more tackle boxes would have to be sold to generate enough
contribution margin to cover the fixed costs.

3.
Increase in unit sales………………….. . (a) 2,000
New selling price................ $45*
Variable cost per unit.......... 32
New contribution margin (b) $13
Incremental operating income: (a) x (b) $ 26,000
(a) 8,000 x .25
*
$50 – ($50 x .1)

Loss of operating income due to sales price reduction of $5 on

the base unit sales of 8,000 X $5 = $40,000

Therefore:

Incremental operating income above $26,000

Loss due to sale price reduction ($40,000)
Net decrease in operating income ($14,000)
4. Number of stoves to achieve a target profit of $35,000 per month:
($108,000 + $35,000)  ($13) = 11,000 stoves
Exercise 4-17 (30 minutes)

1. Basic Deluxe Total Company

Amount % Amount % Amount %
Sales............... $600,000 100 $400,000 100 $1,000,000 100
Variable
expenses....... 240,000 40 260,000 65 500,000 50
Contribution
margin.......... $360,000 60 $140,000 35 500,000 50 *
Fixed expenses 400,000
Operating
income.......... $ 100,000
*$500,000 ÷ $1,000,000 = 50%.

2. The break-even point in sales dollars for the company as a whole would
be:

¿ expenses $ 400,000
= =$ 800,000
CM ratio 50 %
3. The break-even point in units for the company as a whole would be:

(1) (2) (3)

(1) X (2)
Current Weighted
Monthly Sales CM per Average CM
Products Sales in Units* Mix** unit Per Unit
Basic 40,000 .767 $9.00 $6.90
Deluxe 12,173 .233 $11.50 2.68
Total 52,173 $9.58
*Basic: $600,000  ($9  .60); Deluxe: $400,000  ($11.50  .35)
**Basic: 40,000  52,173; Deluxe: 12,173  52,173
Exercise 4-17 (continued)

Breakeven units =

¿ $ 400,000
Total ¿ expenses = =41,754 units
Weighted averageCM per unit $ 9.58 per unit

Individual product unit sales at break-even: Basic: 32,025 (41,754

x .767); Deluxe: 9,729 (41,754 x .233)

4. The additional contribution margin from additional sales of $50,000 can

be computed as follows:
$50,000 × 50% CM ratio = $25,000
This answer assumes no change in selling prices, variable costs per unit,
fixed expenses, or sales mix.

5. The additional contribution margin from additional sales of 5,000 units

can be computed as follows:
5,000 units × $9.58 per unit* = $47,900

*weighted average contribution margin from part 3 above.

This answer assumes no change in selling prices, variable costs per unit,
fixed expenses, or sales mix.
Problem 4-19 (45 minutes)

1. Sales (15,000 units × $70 per unit)...................... $1,050,000

Variable expenses (15,000 units × $40 per unit).... 600,000
Contribution margin............................................ 450,000
Fixed expenses................................................... 540,000
Operating loss..................................................... $ (90,000)

2
.

18,000 units × $70 per unit = $1,260,000 to break even

3. See the next page.

4. At a selling price of $58 per unit, the contribution margin is $18 per unit.
Therefore:

This break-even point is different from the break-even point in part (2)
because of the change in selling price. With the change in selling price,
the unit contribution margin drops from $30 to $18, resulting in an
increase in the break-even point.
Problem 4-19 (continued)
3.
Unit Unit Unit Total
Selling Variable Contribution Volume Contribution Fixed Operating
Price Expense Margin (Units) Margin Expenses income (loss)
$70 $40 $30 15,000 $450,000 $540,000 $ (90,000)
$68 $40 $28 20,000 $560,000 $540,000 $ 20,000
$66 $40 $26 25,000 $650,000 $540,000 $110,000
$64 $40 $24 30,000 $720,000 $540,000 $180,000
$62 $40 $22 35,000 $770,000 $540,000 $230,000
$60 $40 $20 40,000 $800,000 $540,000 $260,000
$58 $40 $18 45,000 $810,000 $540,000 $270,000
$56 $40 $16 50,000 $800,000 $540,000 $260,000

The maximum profit is $270,000. This level of profit can be earned by selling 45,000 units at a price
of $58 each.
Problem 4-20 (30 minutes)

1. Product
Sinks Mirrors Vanities Total
Percentage of total
sales.......................... 25% 42% 33% 100%
Sales............................ $126,000 100% $210,000 100% $168,000 100% $504,000 100%
Variable expenses......... 37,800 30 % 168,000 80% 92,400 55 % 298,200 59%
Contribution margin...... $88,200 70% $ 42,000 20% $ 75,600 45% 205,800 41%*
Fixed expenses............. 223,600
Operating income
(loss)......................... $( 17,800)
*$205,800 ÷ $504,000 = 41% (rounded).
Problem 4-20 (continued)
2. Break-even sales:

¿ $ 223,600
Total ¿ expenses = =$ 545,366 ( rounded )
Contribution marginratio .41

3. The break-even point in units for the company as a whole would be:

(1) (2) (3)

(1) X (2)
Weighted
CM Sales Average CM
Products Per Unit Mix* Per Unit
Sinks $168 25% $42
Mirrors $ 40 50% 20
Vanities $144 25% 36
Total $98
*Sinks: 525 units ÷ 2,100 (525 + 1,050 + 525)
Mirrors: 1,050 units ÷ 2,100 (525 + 1,050 + 525)
Vanities: 525 units ÷ 2,100 (525 + 1,050 + 525)

Breakeven units =
¿ $ 223,600
Total ¿ expenses = =2,282units ( rounded )
Weighted averageCM per unit $ 98

4. Memo to the president:

Although the company exceeded its sales budget of $500,000 for the
month, the mix of products sold changed substantially from that
budgeted. This is the reason the budgeted operating income was not
met, and the reason the break-even sales dollars and units were greater
than budgeted. The company’s sales mix (in dollars) was planned at
48% Sinks, 20% Mirrors, and 32% Vanities. The actual sales mix was
25% Sinks, 42% Mirrors, and 33% Vanities.
As shown by these data, sales shifted away from Sinks, which provides
Problem 4-20 (continued)
 our greatest contribution per dollar of sales, and shifted strongly toward
Mirrors, which provides our least contribution per dollar of sales.
Consequently, although the company exceeded its budgeted level of
sales, these sales provided considerably less contribution margin than
we had planned, with a resulting decrease in operating income. Notice
from the attached statements that the company’s overall CM ratio was
only 41%, as compared to a planned CM ratio of 52% and the weighted
average contribution margin per unit was only $98 compared to the
budgeted amount of $130 per unit. This also explains why the break-
even point was higher than planned. With less average contribution
margin per dollar of sales, a greater level of sales had to be achieved to
provide sufficient contribution margin to cover fixed costs.

Problem 4-24 (30 minutes)

1. The contribution margin per sweatshirt would be:
Selling price............................................. $13.50
Variable expenses:
Purchase cost of the sweatshirts............. $8.00
Commission to the student salespersons.. 1.50 9.50
Contribution margin.................................. $ 4.00
Since there are no fixed costs, the number of unit sales needed to yield
the desired $1,200 in profits can be obtained by dividing the target
$1,200 profit by the unit contribution margin:

2. Since an order has been placed, there is now a “fixed” cost associated
with the purchase price of the sweatshirts (i.e., the sweatshirts can’t be
returned). For example, an order of 75 sweatshirts requires a “fixed”
cost (investment) of $600 (=75 sweatshirts × $8.00 per sweatshirt).
The variable cost drops to only $1.50 per sweatshirt, and the new
contribution margin per sweatshirt becomes:
Selling price......................................... $13.50
Variable expenses (commissions only).... 1.50
Contribution margin.............................. $12.00
Since the “fixed” cost of $600 must be recovered before Mr. Hooper
shows any profit, the break-even computation would be:

If a quantity other than 75 sweatshirts were ordered, the answer would

change accordingly.
Problem 4-25 (45 minutes)

1. a. Warm Cozy Total

$ % $ % $ %
Sales.......................... $4,800 100 $2,400 100 $7,200 100.0
Variable expenses.... 1,200 25 1,200 50 2,400 33.3
Contribution margin.... $3,600 75 $1,200 50 4,800 66.7
Fixed expenses........... 2,250
Operating income........ $2,550

b.

Fixed expenses $2,250

Break−even sales dollars= = =$3,375 (rounded)
CM ratio 66.67%
Margin of safety = Actual sales – break-even sales
Dollars: $7,200 - $3,375 = $3,825
Percentage: $3,825 ÷ $7,200 = 53.1%

c.

Fixed expenses $2,250

Break-even units = = =375 units
Weighted average CM per unit $6*

*[(600 ÷ 800) x ($8 - $2)] + [(200 ÷ 800) x ($12 - $6)]

Or
$4,800  800

Margin of safety = Actual sales – break-even sales

Units: 800 – 375 = 425
Percentage: 425 ÷ 800 = 53.1%
Problem 4-25 (continued)

d. Sales in units required to achieve an after-tax target profit:

Target after−tax profit

¿ expenses+
1−Tax Rate
¿
Weighted average contribution margin per unit

$ 4,725
$ 2,250+
1−.3
¿
$6

$ 2,250+ $ 6,750
=1,500units
$6
Problem 4-25 (continued)

2. a. Warm Cozy Toasty Total

$ % $ % $ % $ %
Sales.............................. $4,800 100 $2,400 100 $4,000 100 $11,200 100
Variable expenses........... 1,200 25 1,200 50 3,200 80 5,600 50
Contribution margin......... $3,600 75 $1,200 50 $ 800 20 $ 5,600 50
Fixed expenses............... 2,250
Operating income............ $ 3,350
Problem 4-25 (continued)
b. Break-even sales = Fixed expenses ÷ CM ratio
= $2,250 ÷ 0.50
= $4,500

Margin of safety:
Dollars: $11,200 - $4,500 = $6,700
Percentage: $6,700 ÷ $11,200 = 59.8%

3. The reason for the increase in the break-even point can be traced to the
decrease in the company’s average contribution margin ratio when the
third product is added. Note from the income statements above that this
ratio drops from 67% to 50% with the addition of the third product.
Toasty has a CM ratio of only 20% ($800 ÷ $4,000), which causes the
overall average contribution margin ratio to fall, since both of the other
products have a higher ratio.
This problem shows the somewhat tenuous nature of break-even
analysis when more than one product is involved. The manager must be
very careful of his or her assumptions regarding sales mix when making
decisions such as adding or deleting products.
It should be pointed out to the president that even though the break-
even point is higher with the addition of the third product, the
company’s margin of safety is also greater. Notice that the margin of
safety increases from $3,825 to $6,700 or from 53.1% to 59.8%. Thus,
sales from the new product will shift the company much further above
its break-even point, even though the break-even point itself is higher.

Problem 4-29 (30 minutes)

1. The contribution margin per unit on the first 16,000 units is:
Per Unit
Sales price.......................... $3.00
Variable expenses................ 1.25
Contribution margin............. $1.75
The contribution margin per unit on anything over 16,000 units is:
Per Unit
Sales price.......................... $3.00
Variable expenses................ 1.40
Contribution margin............. $1.60
Thus, for the first 16,000 units sold, the total amount of contribution
margin generated would be:
16,000 units × $1.75 per unit = $28,000
Since the fixed costs on the first 16,000 units total $35,000, the $28,000
contribution margin above is not enough to permit the company to
break even. Therefore, in order to break even, more than 16,000 units
would have to be sold. The fixed costs that will have to be covered by
the additional sales are:
Fixed costs on the first 16,000 units........................ $35,000
Less contribution margin from the first 16,000 units. 28,000
Remaining unrecovered fixed costs......................... 7,000
Add monthly rental cost of the additional space
needed to produce more than 16,000 units........... 1,000
Total fixed costs to be covered by remaining sales.... $ 8,000
Problem 4-29 (continued)
The additional sales of units required to cover these fixed costs would
be:

Therefore, a total of 21,000 units (16,000 + 5,000) must be sold in

order for the company to break even. This number of units would equal
total sales of:
21,000 units × $3.00 per unit = $63,000 in total sales

2.

Thus, the company must sell 7,500 units above the break-even point to
earn a profit of $12,000 each month. These units, added to the 21,000
units required to break even, equal total sales of 28,500 units each
month to reach the target profit.

3. If a bonus of $0.10 per unit is paid for each unit sold in excess of the
break-even point, then the contribution margin on these units would
drop from $1.60 to $1.50 per unit.
The desired monthly profit would be:
25% × ($35,000 + $1,000) = $9,000
Thus,

Therefore, the company must sell 6,000 units above the break-even
point to earn a profit of $9,000 each month. These units, added to the
21,000 units required to break even, would equal total sales of 27,000
units each month.