Blocher 9e SM Ch09-Final Student

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Questions 9-1 through 9-10
9-2 What is the contribution margin ratio and how is it used?
The contribution margin ratio (CMR) is: (Selling price per unit − Variable cost per unit) ÷ (Selling price per unit)
= p ÷ (p – v).
The contribution margin ratio (CMR) is a measure of profitability. The CMR tells us the change in operating
profit associated with a given change in sales dollars. It is a useful measure of the relative contribution to profit
of different products, divisions, or sales units. The use of this ratio can give an organization a good
approximation of the sales dollars necessary for the store to break even. A relatively high CMR is associated
with higher risk (due to the higher fixed costs) but also higher upside potential.
9-4 Why do management accountants use sensitivity analysis?
9-4 Management accountants use sensitivity analysis in two ways to deal with uncertainties in profit planning:
1. To determine which factors have the greatest influence on profit, and to assess the magnitude of that
influence.
2. To examine the sensitivity of profit to a given forecast or estimate for any one of the factors affecting the
level of profit.
9-6 Why does the issue of taxes not affect the calculation of the breakeven point?
9-6 The issue of taxes does not affect the calculation of the breakeven point because the breakeven point is
determined at the level of zero profit and income taxes are paid on the basis of profit earned.
9-8 What is operating leverage, and for what is it used?
9-8 The concept of operating leverage refers to the extent to which fixed (rather than variable) costs
characterize an organization’s cost structure. The higher the proportion of fixed costs, the higher the operating
leverage and the greater the sensitivity of profit to changes in sales volume. A measure of this sensitivity, at
any volume level (X), is the degree of operating leverage (DOL).
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9-10 How is CVP analysis used to calculate the breakeven point for multiple products?
9-10 To find the breakeven point for multiple products, one must assume that the sales mix of the products is
known and will remain constant. (Each product will continue to comprise the same proportion of total sales.)
The constant sales mix permits two or more products to be treated as one, by computing a weighted-average
values for price, unit variable cost, and contribution margin, where the individual product weights are based on
the assumed sales mix percentages.
Brief Exercises 9-11 through 9-20
9-12 Felton Paper produces paper for textbooks. Felton plans to produce 500,000 cases of paper next
quarter to sell at a price of $100 per case. The variable cost per case, including both manufacturing
and selling costs, is $80. What is the total contribution margin for next quarter?
selling price per unit, p = $100

variable cost per unit, v = $80
sales volume (units), Q = 500,000
Total Contribution Margin:

contribution margin per unit $20
× sales volume (units) 500,000
Total Contribution Margin = $10,000,000
9-14 The Cobb Clinic treats walk in patients for various illnesses. The accounting manager has
estimated they have $5,000 in monthly fixed costs in addition to a $20 cost per patient. If the
charge is $30 per visit, how many visits per month does the clinic need to breakeven?
charge per patient per visit, p = $30.00

Fixed Cost (F) per month = $5,000
variable cost per patient per visit, v = $20.00
p × Q = F + (v × Q)
$30 × Q = $5,000 per month + ($20 × Q)
($30 − $20) per patient × Q = $5,000 per month
breakeven point = 500 patient-visits per month
9-16 Williams & Williams Co. produces plastic spray bottles and wants to earn a profit of
$200,000 next quarter. Variable cost is $0.50 per bottle, fixed costs of $400,000, and sell the
bottles for $1.00 each. How many bottles must they sell to meet the profit goal?
fixed costs per quarter, F = $400,000

selling price per unit, p = $1.00
variable cost per unit, v = $0.50
targeted pre-tax profit, πB = $200,000
required unit sales:

fixed costs + desired profit = $600,000 per quarter
contribution margin per unit = $0.50
required unit sales, Q = 1,200,000 bottles/quarter
9-18 ABC Audio sells headphones and would like to earn an after-tax profit of $400 every week.
Each set of headphones incurs variable cost of $5 and sells for $10. Rent and other fixed costs
are $200 per week; the income tax rate is 20%. How many headphones must they sell per week
to meet this goal?
Q = F + πA/(1− t)
(p – v)
income tax rate, t = 20%
targeted after-tax profit per week = $400
selling price per unit, p = $10.00
variable cost per unit, v = $5.00
fixed costs per week, F = $200
pre-tax profit target = $500 = $400/(1 - 20%)

pre-tax profit target + F = $700
contribution margin per unit (p − v) = $5.00
required sales volume, per week = 140
9-20 May Clothing is a retail men’s clothing store. May's cost is $20 per shirt. The sales price
is $40 per shirt. They plan to sell 400,000 shirts each year, which at this level would result in a
before tax profit of $2,500,000. What is their degree of operating leverage (DOL) at this
volume level?
Degree of Operating Leverage (DOL) = Contribution Margin ÷ operating income

Selling price per unit, p = $40.00
Variable cost per unit, v = $20.00
Sales volume per year, Q = 400,000
Operating income, per year = $2,500,000
Contribution Margin = $8,000,000
DOL = CM ÷ Operating Income = 3.2
Exercise 9-22: Cost Planning; Machine Replacement
Vista Company manufactures electronic equipment. It currently purchases the special switches used in each of its
products from an outside supplier. The supplier charges Vista $2 per switch. Vista’s CEO is considering
purchasing either machine A or machine B so the company can manufacture its own switches. The project data
are:
Data
Make
Machine A Machine B Buy
Annual Fixed Costs $ 135,000 $ 204,000
Variable costs $ 0.65 $ 0.30
Cost per switch $ 2.00
Required
1. For each machine, what is the minimum number of switches that Vista must make annually for total
costs to equal outside purchase cost?
2. What volume level would produce the same total costs regardless of the machine purchased?
3. What is the most profitable alternative for producing 200,000 switches per year?
4. Which of the decision alternatives would you recommend, and why?
Solution
1. Breakeven Volumes, by Machine:
Machine A Machine B
$2Q = $0.65Q + $135,000 $2Q = $0.3Q + $204,000
100,000 120,000
Excel Formulas
2. costs of using Machine A = costs of using Machine B

$0.65Q + $135,000 = $0.30Q + $204,000
$0.35Q = $69,000
Q = 197,143 units 197,143
When 197,143 switches are needed, the Vista Company is indifferent as to

which machine to use; the total cost under each of the two decision
alternatives is the same at this volume.
An alternative way to determine the indifference point is:
Fixed costs of Machine B − Fixed costs of Machine A

Unit variable costs of A − Unit variable costs of B
$204,000 − $135,000
($0.65 − $0.30)/unit
= $69,000 ÷ $0.35/unit = 197,143 units
Summary of (1) and (2): If output is less than 100,000, buy the switches; if
output is less than 197,143 units but greater than 100,000, buy and use
machine A; if output is greater than 197,143 units, then buy and use machine
B.
3. Total costs if volume = 200,000 units/year: 200,000

costs when purchasing from outside supplier:
$2 × 200,000 = $400,000 $400,000
$265,000
costs when using machine A:
$135,000Copyright
+ $0.65 (200,000)
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by McGraw $265,000
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costs when using machine B:

$204,000 + $0.30 (200,000) = $264,000
3. Total costs if volume = 200,000 units/year:
costs when purchasing from outside supplier:
$2 × 200,000 = $400,000
costs when using machine A:

$135,000 + $0.65 (200,000) = $265,000 $265,000
costs when using machine B:
$264,000 (least costly option)
$204,000 + $0.30 (200,000) = $264,000
When 200,000 switches are needed, it is most profitable to produce them with
machine B, though the difference is only $1,000.
4. Recommendation to management--which of the alternatives would you recommend, and why?
Considerations regarding outsourcing (rather than making internally): What is the reliability of the existing supplier?
What are likely price increases in the future from this supplier? What is the reliability of the external supplier
(delivery time, etc.)? As we've seen with supply disruptions in Japan subsequent to the 2011 tsunami/earthquake,
it may make sense to diversify and spread production/supply over multiple geographic areas to minimize production
shut-downs attributable to such disruptions.
Considerations regarding insourcing (rather than purchasing from an external supplier): Is sufficient capital available
(to purchase and install the machinery)? Are there any training-related costs to be borne? The decision to insource
increases the operating leverage of the company, which in turn increases the business (or operating) risk of the
company. Therefore, what is the long-term upside potential for increases in sales--if large, then perhaps a move to
a greater level of fixed costs makes sense. What are anticipated year-to-year fluctuations in sales/demand for the
component in question? If these are significant, then perhaps lower operating leverage is more advantageous.
Finally, by locking the company into a certain technology, does this decrease flexibility (for future investments in
alternative technologies, for example)?
The basic point to be made here is that choice of cost structure both reflects and influences a company's strategy.
This elevates the discussion beyond the more procedural aspect of CVP analysis (calculating degree of operating
leverage [DOL], margin of safety ratios, breakeven points, etc.).
Exercise 9-24: Cost Planning; The Cost of an MBA; Time Value of Money
The motivation for getting the MBA degree has many aspects -- the prestige, greater opportunity for promotion,
change of occupation, and an increase in pay. To focus just on this last motivation, suppose that you are
interested in getting an MBA and are studying the various programs in the U.S. and you want to balance the
costs of getting the degree against the future benefits in increase of pay. You have information on the costs of
two MBA programs, which includes the cost of tuition, living expenses, and forgone pre-MBA salary for the two
years you are in the MBA program. School A has an average cost of $100,000 and school B, a far more
prestigious school which you think your grades would qualify you to be a successful applicant, has a cost of
$250,000.
Required
Assume that you have a ten-year planning horizon and the relevant cost of borrowing is 6%. How great would the
increase in pay for a job after leaving school B have to be relative to school A, for you to be indifferent between
the two schools, based on increase in pay only. Hint: the present value factor for an annuity of ten years at 6% is
in an Appendix at the end of Chapter 12, and equals 7.360.
Solution
Using the present value factor (7.360) for an annuity for ten years at 6% shows that the present value of a
stream of $13,587 per year ($100,000 ÷ 7.360) is equivalent to a present sum of $100,000; this means that for
the student a current payment (at one point in time in this simplified example) of $100,000 is equivalent to
receiving a benefit of $13,587 in each of the ten years after graduation, assuming a discount rate of 6%. For
school B, a stream of ten payments of $33,967 is, at 6%, the present-value equivalent to $250,000.
Therefore, School B would have to provide its graduates with an increase in annual pay of $20,380 = $33,967
− $13,587 for the more prestigious school to provide the desired financial benefit.
Note that the cost of the program includes the foregone pre-MBA salary, and for students at prestigious
programs like school B, the pre-MBA salaries are relatively high. So the increase in salary post-MBA does not
show the degree of “bump” that is seen in other schools. The Economist 2015 ranking of the ability to boost
income showed a surprising result, the highest of all U.S. cools surveyed was Michigan State University’s Eli
Broad College of Business. The $101,430 average post-MBA salary was a staggering 238% increase over
pre-MBA income.
Also, the calculation above does not reflect the opportunity that might attract a new MBA to a company, apart
from the pay offer. For example, Fortune provides a listing of its Top-100 Employers, based on surveys of
employees and considers such benefits as flex-time, unlimited sick days, subsidized child care, etc.
Source: "Show me the money," https://www.economist.com/whichmba/mba-rankings/salary
also https://fortune.com/best-companies/2019/search/
Exercise 9-26: The Role of Income Taxes
For the most recent year, Triad Company had fixed costs of $240,000 and variable costs of 75% of total sales
revenue, earned $70,000 of net income after taxes, and had an income tax rate of 35%.
Data
Fixed Costs $ 240,000
Net Income after tax $ 70,000
Variable cost ratio 75%
Tax rate 35%
Required
Calculate the following
1. Before-tax income
2. Total contribution margin
3. Total sales
4. Breakeven point in dollar sales
Solution
Excel Formulas
1. Pre-tax profit = After-tax income ÷ (1 - t) = $70,000 ÷ (1 − 0.35) = $107,692.31 $107,692.31
2. Contribution margin − Fixed costs = Pre-tax tax profit
Contribution margin − $240,000 = $107,692
therefore, CM = $347,692.31 $347,692.31
3. Total sales − Total variable cost = Total contribution margin

Total sales − Variable cost ratio × Sales = $347,692
Total sales − (0.75 × Sales) = $347,692
(0.25 × Sales) = $347,692
therefore, Sales = $1,390,769.23 $ 1,390,769.23
Or
Since variable costs = .75 of sales, CM ratio must be .25 of sales 0.25
4. Contribution margin ratio (CMR) = $347,692 ÷ $1,390,769 = 0.25
Breakeven point = Fixed costs = $240,000 = $960,000.00

CMR 0.25 $960,000.00
Exercise 9-28: Cost Planning; High-End Copiers
Companies that have a high demand for making copies, both color and black and white, often choose to lease a high-end
copier that provides fast and reliable service at a reasonable cost. The lease is usually for three to five years and the cost
to the user is $0.01 per page for black and white copies and typically $0.10 per page for color copies. These are the
terms of your current three-year lease contract with Ricoh Company, which is up for renewal this month; the lease terms
are expected to be the same for the next three years, if renewed.
Hewlett-Packard Company (HP) developed an innovative copier that can reduce the costs of color copies. The copier
measures exactly how much color is used in a color copy, so that the price of the copy can be determined by the amount
of color used rather than a fixed price per page. The cost could be as low as $.075 per page for a color copy. HP calls this
a “flexible pricing” approach. Assume for this example that the cost of the leased copier (three year lease) is only the per
page charge – the initial lease cost is negligible, and the service costs would not differ between the HP copier and the
copier you are using now.
Your company is an advertising agency, Tanner and Jones, LLC, and the quality of the color copies is critical to your
business success. The ability to rely on the copier at any time is also very important, as some customer requests require
urgent attention. You believe that the Ricoh and HP printers are of the same reliability, but you have not had experience
with the HP copier to be sure of the copy quality. The demonstration of the HP copier has shown as good or better copy
quality, but you have not had three years experience with it to know what it would be like day to day.
Data
Ricoh variable cost per page = $0.100
HP variable cost per page = $0.075
Three-Year HP fixed cost = $12,400
Anticipated volume (copies) per year = 200,000
Required
1. Assume that your company is considering the lease of one of these H-P copiers, and you expect that the
average price for a color copy for your company would be $0.075 cents because you would carefully prioritize
color copy jobs and reduce the number of copies requiring a large amount of color. You expect that training your
copy center staff to properly use the new copier would cost about $12,400 for materials and lost work time. What
is the breakeven number of color copies per year that would make you indifferent between the new H-P copier
and your current copier.
2. As in part 1 above, assume you expect that your per copy cost for color copies with the H-P copier will be
$0.075, the training costs are $12,400 and you expect to make 200,000 copies per year for the next three years.
In your negotiations with Ricoh concerning the new lease and the cost of color copies, what price would you
bargain for?
3. Consider your choice between the copiers within the context of the competitive
and business environment of Tanner and Jones. What are the issues you should consider in addition to the
cost of copies?
Solution Excel Formulas

1.
The breakeven number of copies (C) can be determined as follows:
Ricoh Cost = HP Cost

($0.10 × C) = $12,400 + ($0.075 × C) 496,000 over three years
C = 496,000 copies over the next three years, or 165,333 per year 165,333 copies per year
If Tanner and Jones is making more than 165,333 color copies per year, the HP copier should lead
to lower total costs.
2. The breakeven price (P) can be determined as follows:

200,000 copies per year = 600,000 copies for three years
Ricoh Cost = HP cost
(P × 600,000) = $12,400 + ($0.075 × 600,000)
P = $0.0957 per copy $0.0957 per copy
Tanner and Jones should be able to negotiate with Ricoh to reduce its color copy price from $0.10
to perhaps $0.96.
3. Since Tanner and Jones competes on quality and service, it is critical that the company has a
reliable and very high quality color copier. If there is any question that the H-P copier might not
provide the quality of copy that Tanner and Jones has experienced with the Ricoh, then this
concern would supersede any expected savings. If the company is operating at 200,000 copies
per year, the expected three-year
Copyright savings
© 2022 by is only
McGraw Hill. $2,600,
All rights orNo$867
reserved. per year:
reproduction or distribution without the prior written consent of McGraw Hill.
[($0.10 × 600,000) - $12,400] - ($0.075 × 600,000) = $2,600
This small amount of savings should not justify the risk of unknown color quality. On the other
(P × 600,000) = $12,400 + ($0.075 × 600,000)
P = $0.0957 per copy
Tanner and Jones should be able to negotiate with Ricoh to reduce its color copy price from $0.10
to perhaps $0.96.
3. Since Tanner and Jones competes on quality and service, it is critical that the company has a
reliable and very high quality color copier. If there is any question that the H-P copier might not
provide the quality of copy that Tanner and Jones has experienced with the Ricoh, then this
concern would supersede any expected savings. If the company is operating at 200,000 copies
per year, the expected three-year savings is only $2,600, or $867 per year:
[($0.10 × 600,000) - $12,400] - ($0.075 × 600,000) = $2,600 $2,600 three-year savings
This small amount of savings should not justify the risk of unknown color quality. On the other
hand, it is possible that the H-P copier would deliver higher quality and lower cost. Since the
strategic concern is quality, then the H-P copier is now preferred. From a strategic point of view,
Tanner and Jones needs to carefully research the quality of the H-P copies before making a
decision. Also, if Tanner and Jones is expected to grow, then the attractiveness of the H-P copier
also increases, because the lower price per copy now applies to a larger number of copies.
Source: Christopher Lawton, “H-P Begins Push Into High-End Copiers,” The Wall Street Journal,
April 24, 2007, p. B3.
Solution
1. Calculate the degree of operating leverage(DOL) for each company. If sales increase, which company
benefits more? How do you know?
Company A 1.429
Company B 2.333
If sales increase, company B will benefit more. Company B has a higher proportion of fixed costs in
relation to variable costs; therefore it has a higher operating leverage than does company A. The
degree of operating leverage (DOL) is a measure, at a specific level of sales, of how a percentage
change in sales volume will affect profits. The higher the operating leverage, the more sensitive profits
are to changes in sales volume.
2. Assume that sales rise 10 percent in the next year. Calculate the percentage increase in profit for each company. Are the results
what you expected?
Sales Increase 10%
Company A Company B
Amount % of Sales Amount % of Sales
Sales $110,000 100% $110,000 100%
Variable costs $55,000 50% $33,000 30%
Contribution margin $55,000 50% $77,000 70%
Fixed costs $15,000 $40,000
Operating income $40,000 $37,000
A's calculated % change in profit 14.29%

B's calculated % change in profit 23.33%
The above results are what we expected. The DOL tells us the estimated percentage change in operating income
for each percentage change in sales. A DOL of 1.429 implies that the change in operating income will be 1.429
times as large as the percentage change in sales volume. Therefore, as shown below , if sales increase by 10
percent, operating income for company A should increase by 14.29 percent, while the same 10 percent increase in
sales resulted in a 23.33 percent change in operating income for company B.
Company A's % change in operating profit = DOL × % change in sales
Exercise 9-32: Degree of Operating Leverage (DOL)
TastyKreme and Krispy Kake are both producers of baked goods, but each has followed a different production strategy. The differences in
their strategies resulted in differences in their cost structure, as shown in the following table:
Data
TastyKreme Krispy Kake
Estimated sales in units 20,000 15,000
Unit price $ 6.00 $ 8.00
Variable cost per unit $ 3.00 $ 3.00
Total fixed costs $ 30,000 $ 45,000
Sales volume change -10%
Required
1. Compute the operating income and degree of operating leverage (DOL) for each company.
2. Assuming sales volume for each company will decline by 10%, and their cost structures will not
change, compute the percentage and dollar amount of the change in operating income for each
company.
Solution
1
TastyKreme Krispy Kake
Estimated sales in units 20,000 15,000
Unit price $ 6.00 $ 8.00
Variable cost per unit 3.00 3.00
Unit contribution margin 3.00 5.00
Total contribution margin $ 60,000 $ 75,000
Total fixed costs 30,000 45,000
Operating income $ 30,000 $ 30,000
DOL 2.00 2.50
2. Change in income
Percentage change in sales volume -10% -10%

DOL 2.00 2.50
Percentage change in operating income -20% -25%
Old income $ 30,000 $ 30,000

Dollar change in operating income $ (6,000) $ (7,500)
Exercise 9-34: Contribution Income Statements Using Excel; Sensitivity Analysis; Goal Seek
Data
Input Data: ###Per-Unit 2022
Fixed manufacturing costs ### $40,000
Fixed selling costs ### $20,000
Selling price $75.00
Variable manufacturing cost $30.00
Variable selling costs $5.00
Planned production ### 2,400
Planned sales volume ### 2,400
Assumed decrease in demand 10%
Required
1. Using the data for 2022 in Exhibit 9.1, create an Excel spreadsheet to provide a sensitivity analysis of the
effect on operating profit of potential changes in demand for HFI, Inc., ranging from a 20 percent decrease to
20 percent increase. Use Exhibits 9.2 and 9.6 as a guide. Assume that 2/3 of the fixed costs are
manufacturing-related; the remaining one-third are selling-related. The variable manufacturing cost per unit is
$30, while the variable selling cost per unit is $5.
2. Using the spreadsheet you created, compute the new operating profit assuming a 10% decrease in demand.
3. Use the Goal Seek tool within Excel to determine which sales price would allow HFI to earn $100,000
operating profit, assuming that all the other cost information is the same as in Exhibit 9.1.
Solution
Contribution Income Statements
1. A variety of possible spreadsheets could satisfy this requirement. One example is given below using increments of
5%. The sensitivity analysis shows sales levels from -20% to + 20% of 2022 expected sales of 2,400 units, and the
related effect on operating profit.
At a sales volume of 2,400 units HFI’s degree of operating leverage (DOL) is 2 2/3. From this volume level, each
percentage change in sales results in a 2.667% change in operating profit.
Per unit
Units amounts Total
Sales 2,400 $75.00 $ 180,000
Variable manufacturing cost 2,400 $30.00 $ 72,000
Variable selling 2,400 $ 5.00 12,000 84,000
Contribution margin $ 40.00 $ 96,000
Fixed manufacturing cost $40,000
Fixed selling cost $20,000 60,000
Operating profit $ 36,000
DOL @ current sales volume = 2.67

Variable Total Per unit
cost per fixed selling Operating
% change Units sold unit cost price profit
-20% 1,920 $35.00 $60,000 $75.00 $ 16,800
-15% 2,040 $35.00 $60,000 $75.00 21,600
-10% 2,160 $35.00 $60,000 $75.00 26,400
-5% 2,280 $35.00 $60,000 $75.00 31,200
current volume (2022) 2,400 $35.00 $60,000 $75.00 36,000
5% 2,520 $35.00 $60,000 $75.00 40,800
10% 2,640 $35.00 $60,000 $75.00 45,600
15% 2,760 $35.00 $60,000 $75.00 50,400
20% 2,880 $35.00 $60,000 $75.00 55,200
2. The operating profit assuming a 10% decrease in demand. Since the spreadsheet for item 1 can vary, the solution is
provided in a generic format.
### ### Per unit ### ###

### Units ### amounts### ### Total
Sales ### 2160
### 75
### ### $ 162,000
Variable manufacturing cost ### 2160
### 30
### 64800
###
Variable selling ### 2160
### ###
5 10800
### 75,600
Contribution margin ### ### 40
### ### 86,400
Fixed manufacturing cost ### ### ### 40000
###
Fixed selling cost 20000 60,000
Operating profit ### $ 26,400
Note that the DOL × % decrease in demand = 2.67 × 10% = 26.7% projected decrease in operating income
$ 36,000 - $ 9,600 = $ 26,400
3. Using Goal Seek in Excel to solve for the required selling price per unit in order to generate a pre-tax
profit of $100,000.
See tab labeled "Ex. 9-34 Goal Seek"
Exercise 9-34: Contribution Income Statements; Sensitivity Analysis; Goal Seek
Data
Input Data: Per-Unit 2022
Fixed mfg costs $40,000
Fixed selling costs $20,000
Revenue $75.00
Variable mfg cost $30.00
Variable selling costs $5.00
Planned production 2,400
Planned sales 2,400
Required
3. Use the Goal Seek option within Excel to determine the selling price per unit that would allow HFI to earn
$100,000 operating profit, assuming that all the other cost information is the same as in Exhibit 9.1.
Solution
Units Price/Cost Total

Sales 2,400 $75.00 $ 180,000
Variable manufacturing cost 2,400 $30.00 $ 72,000
Variable selling 2,400 $ 5.00 12,000 84,000
Contribution Margin $ 40.00 $ 96,000
Fixed manufacturing cost $40,000
Fixed selling cost $20,000 60,000
Operating profit $ 36,000
2. The Goal Seek tool is available under the Tools menu in Excel. The above result is produced after running
Goal Seek. The selling price would have to increase to $101.67 in order for HFI to achieve its operating profit goal
of $100,000.
Step #1: Access Goal Seek
Go to "Data," then "What-If Analysis," then "Goal Seek." The following window should appear:
Step #2: Inputs
Set the "Set cell:" box to M27. Set the "To Value:" box to "100000." Finally, set the "By changing cell:"
box to the cell that contains the variable you want to change in order to achieve the stated goal, in this
case a pre-tax (operating) profit of $100,000. The cell containing the variable whose value Excel will
be changing is the selling price per unit, i.e., cell I21.
Step #3: Run Goal Seek
After hitting "OK," Goal Seek returns the following result (which replaces the entries in cells B33:M40
above):
Here is a link to the Microsoft website the contains information about using Goal Seek
https://support.office.com/en-us/article/use-goal-seek-to-find-the-result-you-want-by-adjusting-an-input-value-320cb99e-f4a4-417f-b1c3-4f369d6e66c7
Exercise 9-36: Multiple-Product CVP Analysis
Smith Company can produce two types of carpet cleaners, Brighter and Cleaner.
The number of machine-hours to produce one unit of Brighter is 1, while the number of machine hours to produce one unit of
Cleaner is 2. Total fixed costs for the manufacture of both products are $265,200.
Data
Brighter Cleaner Total
Sales (units) 400 600 1000
Price $750 $1,000
Sales revenue $300,000 $600,000 $ 900,000
Variable cost 300 450
Common fixed costs $265,200
Required
1. Determine the breakeven point in total units for Smith Company, based on the assumption that the sales mix (on the
basis of relative sales volume in units) stays constant. Use the weighted-average contribution margin approach.
Round the number of units up to the next whole number.
2. At this breakeven level, how many units of each product must be sold? Be sure to round up to the next whole number.
3. What is the overall breakeven point in sales dollars? (Use both an indirect approach, based on your answer to
requirement 2, and a direct approach, based on the weighted-average contribution margin ratio and the assumption
that sales mix based on relative sales dollars stays constant.)
4. Of what potential value to management is the information regarding the machine-hour consumption of each of
the two products?
Solution
Brighter Cleaner Total

Sales units 400 600 1,000
Selling price per unit $750 $1,000
Sales $300,000 $600,000 $900,000
Variable costs per unit $300 $450
CM per unit $450 $550
cm ratio 0.60 0.55

Fixed cost $265,200
1. Breakeven point in terms of number of units:
Brighter Cleaner Sum

Contribution margin per unit $450 $550
Sales mix (based on units) 0.40 0.60 1.00
Weighted-average CM per unit $510.00
Total fixed costs to be recovered $265,200

÷ Weighted-average CM per unit $510.00
Total units to breakeven 520.00
2. Breakdown of units into individual products:

Brighter Cleaner Sum
Sales mix % 0.40 0.60 1.00
Breakdown 208.00 312.00 520.00
3. Total sales revenue needed to breakeven:
Approach #1 (Indirect):
Quantity sold to breakeven 208.00 312.00
Price $ 750 $ 1,000
Sales $ 156,000 $ 312,000 $ 468,000
Or
Total units needed to breakeven (req. #1 above) 520.00
× Weighted-average selling price per unit $900.00 (0.40 × $750) + (0.60 × $1,000)
Total sales dollars to breakeven = $468,000
Approach #2 (Direct):
Sales mix based on relative sales $ = 0.3333 0.6667
Contribution margin ratios = 0.60 0.55
Weighted-avg. contribution margin ratio = 0.5667
Overall breakeven point in sales dollars:

Fixed costs to be recovered $265,200
÷ Weighted-average CM ratio 0.5667
Total sales dollars to breakeven = $468,000
4. If machine hours are limited (i.e., if they represent a "scarce resource") then information regarding the machine-hour
consumption of the two products would be important for product-planning purposes. That is, such information could be
used to calculate the contribution margin per machine hour for each of the two products. This information, in turn, would
help guide the product-mix decision: the greater the contribution margin per machine hour, the greater the profitability
(and therefore desirability) of the product.
Problem 9-38: Profit Planning; Multiple Products
Most businesses sell several products at varying prices. The products often have different unit variable costs. Thus, the
total profit and the breakeven point depend on the proportions in which the products are sold. Sales mix is the relative
contribution of sales among various products sold by a firm. Assume that the sales of Jordan, Inc., for a typical year are
as follows:
Data
Product Units Sold Sales Mix
A 18,000 80%
B 4,500 20%
Total = 22,500 100%
Assume the following unit selling prices and unit variable costs:
Selling Variable Contribution
Product Price/Unit Cost/Unit Margin/Unit
A $80.00 $65.00 $15.00
B $140.00 $100.00 $40.00
Fixed costs per year: $400,000
Standard "sales basket:"

Units of product A 4
Units of product B 1
Increase in fixed costs = $40,000
Required
1. Determine the breakeven point in total units and. for this breakeven point, calculate the number of units of A
and B that must be sold. Use the weighted-average contribution margin approach and round solution to the
next whole number.
2. Use the Goal Seek function in Excel to determine the overall breakeven point (in units) for the company.
3. Determine the overall breakeven point in terms of sales dollars based on the weighted-average contribution
margin ratio. (Hint: the weights are based on relative sales dollars, not units, in the standard sales mix.)
Break down this total sales dollars breakeven point into sales dollars of Product A and sales dollars of
Product B.
4. Explain the following statement: "For the multiproduct firm, there is no breakeven point independent of the
sales-mix assumption."
5. Assume the original facts except that now fixed costs are expected to be $40,000 higher than originally
planned. How does this expected increase in costs affect the breakeven point in units? How does the
percentage change in the breakeven point compare to the percentage increase in fixed costs? What general
conclusion might you draw on the basis of these calculations?
Solution
Excel Formulas
1. Weighted-average contribution per unit
= ($15 × 80%) + ($40 × 20%) = $20 per unit $20.00 per unit
Overall break-even point = $400,000 ÷ $20/unit = 20,000 units 20,000 units
Breakdown of overall breakeven sales in units:

Product A: 20,000 × 80% = 16,000 16,000 Product A
Product B: 20,000 × 20% = 4,000
4,000 Product B
2. Goal Seek: see below.
3. Breakeven point in terms of sales dollars:

a. Breakeven dollars = F ÷ Weighted-average cm ratio
Relative sales dollars, based on standard sales mix:

Overall break-even point = $400,000 ÷ $20/unit = 20,000 units
Breakdown of overall breakeven sales in units:

Product A: 20,000 × 80% = 16,000
Product B: 20,000 × 20% = 4,000
2. Goal Seek: see below.
3. Breakeven point in terms of sales dollars:
a. Breakeven dollars = F ÷ Weighted-average cm ratio
Relative sales dollars, based on standard sales mix: $1,440,000

Product A: 18,000 units × $80 per unit = $1,440,000 $630,000
Product B: 4,500 units × $140 per unit = $630,000 $2,070,000
Weights:
Product A: $1,440,000 ÷ $2,070,000 = 0.6956522 0.6956522
Product B: $630,000 ÷ $2,070,000 = 0.3043478 0.3043478
Weighted-average contribution margin ratio: 0.1304347826

A: 0.6956522*($15 ÷ $80) = 0.6956522 × 0.1875 = 0.13043478 0.0869565217
B: 0.3043478*($40 ÷ $140) = 0.3043478 × 0.285714= 0.08695652 0.21739130
0.21739130
Breakeven point in overall dollars ($) = $400,000 ÷ 0.21739130

= $1,840,000
b. Breakdown of total breakeven sales dollars, by product:
Product A: Mix % × Breakeven sales, in $

0.6956522 × $1,840,000 = $1,280,000
Product B: Mix % × Breakeven sales, in $
0.3043478 × $1,840,000 = $560,000
4. For the multiproduct firm, there is no breakeven point independent of the sales mix
assumption. For the multiproduct firm, we assume that the outputs are sold in some
standard mix, based either on relative physical units or relative sales dollars. If the
individual products differ in terms of their contribution margins per unit (or contribution
margin ratios), then the weighted-average contribution margin (and weighted-average
contribution margin ratio) will vary in response to changes in the sales mix. This, in
turn, affects the breakeven point since that point is defined as the ratio of fixed costs to
the weighted-average contribution margin per unit (or, the weighted-average
contribution margin ratio). Of course, if the unit contribution margins are the same for
each product, then the assumed mix has no mathematical impact on the breakeven
calculation.
5. Change in the breakeven point (in total units) in response to a 10% change in fixed
costs:
New level of fixed costs = $400,000 + $40,000 = $440,000

Original level of fixed costs = $400,000
Change in fixed costs = $40,000
Percentage change in fixed costs = $40,000 ÷ $400,000 = 10.00%
New breakeven point = $440,000 ÷ $20.00 per unit = 22,000 units

Original breakeven point = 20,000 units
Change in breakeven point = 2,000 units
Percentage change in breakeven point = 2,000 ÷ 20,000 = 10.00%
As seen from the above, the percentage change in fixed costs (here 10 percent led to
an identical percentage change in the breakeven point. Because of the linear cost
functions assumed in a conventional CVP model, this finding can be generalized as
follows: with everything else held constant, a given percentage change (+ or −) in the
amount of fixed costs leads to an equivalent percentage change in the breakeven point.
Problem 9-40: CVP Analysis (Service Sector)
General Hospital’s Cardiac Diagnostic Screening Center (CDSC) is contemplating purchasing a blood gas analysis
machine at a cost of $960,000. Useful life for this machine is 10 years. The screening center currently serves 3,000
patients per year, 40 percent of whom need blood gases analysis data as part of their diagnostic tests. The blood
samples are presently sent to a private laboratory that charges $200 per sample. In-house variable expenses are
estimated to be $125 per sample if CDSC purchases the analysis machine.
Data
Lab charge (per test) $200.00 per test
Purchase cost of machine $960,000
Variable cost of lab machine $125.00 per test
Number of patients per year 3,000
Percent of patients with tests 40%
Life of machine (years) 10
Required
1. Determine the indifference point between purchasing the machine (insourcing) or using the private laboratory
(outsourcing).
2. Use Goal Seek to determine the point of indifference (# of tests per year).
3. Determine how many additional patients would be needed so that CDSC would be indifferent between
purchasing the analysis machine and the $200 lab charge.
4. Assuming the current service level of 3,000 patients per year with 40 percent requiring blood gas testing,
how much would the private laboratory have to charge per sample to make CDSC indifferent between
purchasing the analysis machine and using the private laboratory services?
5. What other considerations are relevant to this decision?
Solution
1. Indifference point (in # of tests per year): insourcing vs. outsourcing
a. Pro rated per-year fixed cost of blood gases machine:

Cost of machine $960,000
Life of machine 10
Pro-rated cost per year $96,000
b. Saving per sample in direct costs if gases analysis machine is purchased:
Existing (external) charge per test $200.00
Insourcing variable cost per test $125.00
Difference in variable cost per test $75.00
c. Indifference point= ∆ FC ÷ ∆ variable cost per unit
∆ FC = $96,000
∆ variable cost per unit = $75.00
\ indifference point = 1,280 tests per year
Alternatively, the indifference point can be defined as the point, X, where total annual costs under the
two decision alternatives are equal:
Variable
costs (per
Fixed costs test)
Total costs, insourcing alternative: $96,000 $125.00
Total costs, outsourcing alternative: N/A $200.00
Indifference point, X, is defined as:

$200 X = $125 X + $96,000 = 1,280 tests per year
2. Using Goal Seek to determine the indifference point in terms of # of tests per year:
Variable
Fixed (per test)
Total costs, insourcing alternative: $96,000 $125.00
Total costs, outsourcing alternative: N/A $200.00
Step One: Define the cost function (Cell D63)
Volume (# of tests per year) = 1,280
Total costs, insourcing alternative = $256,000
Total costs, outsourcing alternative $256,000
Cost differential = $0
Step Two: Run Goal Seek
Step Three: Results
3. Number of additional patients needed to reach indifference point
Current number of patients per year = 3,000

Percentage needing blood gas analysis = 40%
Current no. of patients per year needing blood gas analysis = 1,200
Indifference level (from parts 1 or 2 above) = 1,280
Additional no. of blood gases analysis tests needed = 80
% of patients needing blood gas analysis = 40%
no. of new patients needed in order to reach indifference point = 200
Assuming the 40% ratio holds for all patients
4. The external price per test needed to make the lab indifferent between the two decision alternatives (i.e., insource vs. outsource):
Let p = Required charge (service fee)

Current number of tests performed per year = 1,200
p × 1,200 = ($125 per test × 1,200 tests per year) + $96,000
p = ($150,000 + $96,000) ÷ 1,200 tests per year 246,000
$205.00 per test
5. Additional factors to be considered before making a decision:
a. Time value of money (opportunity cost of capital).

b. Quality and reliability of the in-house testing alternative versus outsourcing the testing procedure
c. Are there alternative, more pressing needs for the proposed $960,000 outlay? Put another way, is the
proposed capital expenditure strategically important to the organization?
d. Operating risk--increasing operating leverage (i.e., the proportion of fixed costs in the organization's cost
structure) exposes the hospital to greater fluctuations in its operating income; operating income for
organizations with greater amounts of operating leverage is more sensitive to changes in sales volume.
e. Would the purchase of the machine now provide a disincentive to invest in this area in the future?
Here is a link to a Microsoft tutorial on Goal Seek

Problem 9-42: CVP Analysis; Sensitivity Analysis; Multiple Products
GoGo Juice is a combination gas station and convenience store located at a busy intersection. Recently a national chain opened a similar
store only a block away; consequently sales have decreased for GoGo. In an effort to reclaim lost sales, GoGo has implemented a
promotional effort: for every $10 purchase at GoGo, the customer receives a $1 coupon for the purchase of gasoline. The average gasoline
customer purchases 15 gallons of gasoline at $2.50 per gallon. The results of an average month, prior to this coupon promotion are shown
below. Not included on the chart is the monthly cost of printing the coupons that is estimated to be $500. Coupons are issued on the basis
of total purchases regardless of whether the purchases are paid in cash or paid by redeeming coupons. Assume that coupons are
distributed to customers for 75 percent of the total sales. Also assume that all coupons distributed are used to purchase gasoline.
Data
Gasoline Food Other Total
Sales Revenue $100,000 $60,000 $40,000 $200,000
Cost of sales 1.875 60% 50%
Other Costs (per month):
Labor--Attendants $10,000
Supervision 2,500
Rent, Power, .. 40,000
Depreciation 7,500
Coupon printing 500
Total other costs $ 60,500 per average month
Coupon distribution rate 75.00%

Assumed weighted-avg. CM ratio 35%
Assumed sales increase 20%
Sales dollars per $1 coupon given $10.00
Price per gallon of gasoline $2.50
Required (Round final dollar amounts to whole dollars)
1. If GoGo Juice implements the promotional coupon effort, calculate the profit (loss) before tax if the sales
volume remains constant and the coupons are used to purchase gasoline. Assume the product mix
(percentages of gasoline, food, and beverages; and other products) remains the same. Prepare a contribution
income statement to support your answer.
2. Calculate the breakeven sales (in dollars) for GoGo Juice if the promotional effort is implemented. Assume
that the product mix remains constant. Use the weighted-average contribution margin ratio approach to
generate your answer. (Hint: sales mix for this purpose is defined on the basis of relative sales dollars, not
units.)
3. Based on the assumed sales mix (determined on the basis of relative sales dollars, not units), determine the
composition of total breakeven sales dollars across the three product lines: gas, food and beverages, and other
products.
4. Disregarding your responses to Requirements 1 and 2 above, assume the weighted contribution margin, after
implementation of the coupon program, is 35 percent. Calculate the before tax profit (loss) for GoGo Juice,
assuming sales increase 20 percent due to the new program. Assume that the sales mix in terms of relative
sales dollars remains constant.
5. GoGo Juice is considering using sensitivity analysis in combination with cost-volume-profit analysis. Discuss this
plan. Include in your discussion at least three factors that make sensitivity analysis prevalent in decision making.
6. Provide a brief description of the methods that can be used to deal with uncertainty in the profit-planning
process, as discussed in the chapter.
Solution
1. GoGo Juice’s profit (loss) before tax, from implementing the promotional coupon with no change in sales volume and sales mix is
($6,500). See below.
Gasoline Food Other Total

Sales revenue $100,000 $60,000 $40,000 $200,000
Coupons redeemed 15,000 15,000
Cost of sales 75,000 36,000 20,000 131,000
Contribution margin $10,000 $24,000 $20,000 $54,000
Fixed costs 60,500
Pre-tax profit (loss) ($6,500)
Excel Formula
2. The breakeven point in total sales dollars for GoGo:
Weighted-average contribution margin ratio = Total contribution margin ÷ Total sales

= $54,000 ÷ $200,000 = 27.0% 27.00%
Breakeven in dollars = Fixed costs ÷ Weighted-average contribution margin ratio

= $60,500 ÷ 0.27 = $224,074
3. Composition of the total breakeven sales dollars, on the basis of sales mix determined on the basis of
relative sales dollars, not units, for each of the three product lines:
2. The breakeven point in total sales dollars for GoGo:
Weighted-average contribution margin ratio = Total contribution margin ÷ Total sales

= $54,000 ÷ $200,000 = 27.0%
Breakeven in dollars = Fixed costs ÷ Weighted-average contribution margin ratio

= $60,500 ÷ 0.27 = $224,074 $224,074
3. Composition of the total breakeven sales dollars, on the basis of sales mix determined on the basis of
relative sales dollars, not units, for each of the three product lines:
$224,074
Total breakeven sales dollars (see requirement 2 above)
Sales mix percentages (based on relative sales dollars): 0.50
Gasoline: $100,000 ÷ $200,000 = 0.50
Food/beverage: $ 60,000 ÷ $200,000 = 0.30 0.30
Other: $ 40,000 ÷ $200,000 = 0.20 0.20
Allocation of total breakeven sales dollars:

Gasoline: 0.50 × $224,074 = $112,037
Food/beverage: 0.30 × $224,074 = 67,222 $112,037
Other: 0.20 × $224,074 = 44,815 $67,222
Total = $224,074 $44,815
4.
Sales revenue ($200,000 × 1.2) $240,000 $240,000
Variable costs (sales − CM) 156,000 $156,000
Contribution margin ($240,000 × 35%) 84,000
84,000
Fixed costs 60,500
Profit before tax $23,500 60,500
$ 23,500
5. Sensitivity analysis is used to deal more effectively with uncertainty or risk. Sensitivity analysis is a what-if type of analysis used to
determine the outcome if any parameters change from the initial assumptions. For example, revenues or costs could be changed from
the initial assumptions and a new break even sales volume calculated.
At least three factors that make sensitivity analysis prevalent in decision making include the following:
• The availability of computers and spreadsheet software has made it very quick and easy to compute the impact of changing one or
more assumptions in a financial model.
• As the business environment is becoming more dynamic and competitive, sensitivity analysis provides management with an
understanding of the impact of changes in the environment. The increased emphasis on productivity, competition, changing consumer
demand, shorter product life cycle times, and faster obsolescence of technology makes sensitivity analysis more widely used.
• Sensitivity analysis aids management in identifying the key variables and assumptions that affect financial results, so the variables can
be monitored or a decision made to obtain additional information on these variables.
6. Overview of methods presented in the chapter, for dealing with uncertainty in the profit-planning process:
· Conventional measures associated with CVP analysis:

o Degree of operating leverage (DOL)
o Margin of safety (MOS) and margin of safety ratio (MOS%)
· Sensitivity analysis:
o Simple “what-if” analysis/analyses
o Preparation of decision tables/decision trees/expected values (based on probability information regarding one
or more variables in the CVP model)
o If one refers to the supplemental material, then Monte Carlo simulation analysis could be mentioned
Problem 9-44: CVP Analysis; Uncertainty; Sensitivity Analysis
Don Carson and two colleagues are considering the opening of a law office in a large metropolitan area to make
inexpensive legal services available to people who cannot otherwise afford these services. They intend to provide easy
access for their clients by having the office open 360 days per year, 16 hours each day from 7:00 a.m. to 11:00 p.m. A
lawyer, paralegal, legal secretary, and clerk-receptionist would staff the office for each of the two 8–hour shifts.
To determine the feasibility of the project, Don hired a marketing consultant to assist with market projections. The
consultant’s results show that if the firm spends $500,000 on advertising the first year, the number of new clients
expected each day would have the following probability distribution:
Number of New Clients per Day Probability

10 0.10
20 0.30
40 0.40
60 0.20
Don and his associates believe these numbers to be reasonable and are prepared to spend the $500,000 on
advertising. Other pertinent information about the operation of the office follows.
The only charge to each new client would be $30 for an initial consultation. The firm will accept, on a contingency
basis, all cases that warrant further legal work, with the firm earning 30 percent of any favorable settlements or
judgments. Don estimates that 20 percent of new client consultations will result in favorable settlements or judgments
averaging $15,000 each. He does not expect repeat clients during the first year of operations.
The hourly wages for the staff are projected to be $185 for the lawyer, $50 for the paralegal, $30 for the legal secretary,
and $20 for the clerk-receptionist. Fringe benefits expense will be 40 percent of the wages paid. A total of 400 hours of
overtime is expected for the year; this will be divided equally between the legal secretary and the clerk-receptionist
positions. Overtime will be paid at one and one-half times the regular wage, and the fringe benefit expense will apply to
the full wages.
Don has located 6,000 square feet of suitable office space that rents for $48 per square foot annually. Associated
expenses will be $22,000 for property insurance and $32,000 for utilities. The group must purchase malpractice
insurance expected to cost $180,000 annually.
The initial investment in office equipment will be $60,000; this equipment has an estimated useful life of four years. The
cost of office supplies has been estimated to be $10 per expected new client consultation.
Data
No. of operating days per year 360
Hours of operation per day 16
Proposed advertising outlay $500,000
Rate of favorable settlements 20%
Earnings percentage 30%
Average settlement $15,000
Client initial consultation fee $30
Office supplies $10
Hourly wage--lawyer $185
Hourly wage--paralegal $50
Hourly wage--legal secretary $30
Hourly wage--clerk-receptionist $20
Fringe benefits (per dollar) 40%
Total Overtime hours--year one 400
Division of overtime:
Legal Secretary 50%
Clerk-Receptionist 50%
Overtime Premium 50%
Office-related costs:
square footage of office 6,000
Office rent--per square foot $48
Fixed costs (per year):
Property insurance $22,000
Utilities $32,000
Malpractice insurance $180,000
Office equipment:
Purchase price $60,000
Useful life (years) 4
Office supplies (per new client consul.) $10
Probability Distribution (demand):

Number of new clients per day Probability
10 0.10
20 0.30
40 0.40
60 0.20
Required
1. Determine how many new clients must visit the law office that Don and his colleagues are considering
for the venture to break even its first year of operations. (For purposes of this calculation, treat all labor costs
as fixed with respect to number of new clients.)
2. Using the probability information provided by the marketing consultant, determine whether it is feasible for
the law office to achieve breakeven operations. Specifically, calculate and interpret the expected value of
new clients for year one, based on the probability data given above.
3. Explain how Don and his associates could use sensitivity analysis to assist in this analysis.
Solution
1. Number of new clients required during the first year of operations to break even:
First-year fixed expenses:

Advertising $500,000
Rent (6,000 × $48) $288,000
Property insurance $22,000
Utilities $32,000
Malpractice insurance $180,000
Depreciation--office equipment $15,000
Wages & fringe benefits:
Regular wages (@360 days and 16 hours/day) $1,641,600
Overtime wages 15,000
Fringe benefits on total wages 662,640
Total $3,356,240
Breakeven calculation:
$0 = Total revenue − Variable costs − Fixed costs (from above)
$0 = (Revenue from initial consultation + Revenue from estimated settlements) − Variable costs − Fixed costs
Let Q = number of new clients in year one
$0 = ($30Q + [$15,000 × 0.30 × 0.20 ×Q]) − $10Q − $3,356,240 ###
$0 = ($30Q + $900Q − $10Q) − $3,356,240
Q = 3,649
$3,356,240 ÷ $900in=year one (rounded up)
new clients
3,648.087 new clients in year one (exact, not rounded)
2. Based on the report of the marketing consultant, the expected number of new clients during the first year is 12,600 (see
below). Therefore, it is feasible for the law office to break even during the first year of operations since the breakeven
point (calculated above) is 3,648 new clients in year one.
Expected number of new clients, year 1 = ∑(event)(prob.) I, where i = 1, 4
Event Prob. Event × Prob
10 0.10 1.00
20 0.30 6.00
40 0.40 16.00
60 0.20 12.00
35.00 clients per day
Therefore, the expected number of new clients for the first year (360 days/year) = 12,600
Since there is uncertainty in the prediction of the number of client per year, based on a probability distribution, further
sensitivity analysis should be considered, with the objective of determining the potential loss if, in fact, the number of new
clients falls short of the forecast.
3. Sensitivity analysis is used to deal more effectively with uncertainty or risk. Sensitivity analysis is a "what-if” type of analysis
used to determine the outcome if any parameters change from the initial assumptions. For example, revenues or costs could
be changed from the initial assumptions and a new breakeven sales volume calculated.
The availability of spreadsheet software has made it very quick and easy to compute the impact of changing one or more
assumptions in a financial model. At least three factors that make sensitivity analysis prevalent in decision making including
the following:
As the business environment is becoming more dynamic and competitive, sensitivity analysis provides management with an
understanding of the impact of changes in the environment. The increased emphasis on productivity, competition, changing
consumer demand, shorter product life cycle times, and faster obsolescence of technology makes sensitivity analysis more
prevalent.
Sensitivity analysis aids management in identifying the key variables and assumptions that affect financial results, so the
variables can be monitored or a decision made to obtain additional information.
The use of probability distributions to determine expected values is an excellent way to conduct a sensitivity analysis. This
approach allows Don to see the distribution of costs and profits as they are affected by the distribution of potential demand
(number of clients). Don can enhance this analysis by using standard deviations to measure the dispersion of the distributions,
as a means to get at the degree of uncertainty–higher standard deviations for greater uncertainty .
Other approaches to sensitivity analysis include Excel-based analysis, graphical analysis, the use of operating leverage, and
the contribution margin ratio.
Problem 9-46: CVP Analysis; Strategy; Uncertainty
Computer Graphics (CG) is a small manufacturer of electronic products for computers with graphics capabilities. The company has
succeeded by being very innovative in product design. As a spin-off of a large electronics manufacturer (ElecTech), CG
management has extensive experience in both marketing and manufacturing in the electronics industry. A long list of equity
investors is betting that the firm will really take off because of the growth of specialized graphics software and the increased
demand for computers with enhanced graphics capability. A number of market analysts say, however, that the market for the firm’s
products is somewhat risky, as it is for many high-tech start-ups because of the number of new competitors entering the market,
and CG’s unproven technology.
CG’s main product is a circuit board (CB3668) used in computers with enhanced graphics capabilities. Prices vary depending on
the terms of sale and the size of the purchase; the average price for CB3668 is $100. If the firm is successful, it might be able to
raise prices, but it might have to reduce the price because of increased competition. The firm expects to sell 150,000 units in the
coming year, and sales are expected to increase in the following years. The future for CG looks very bright indeed, but it is new
and has not developed a strong financial base. Cash flow management is a critical feature of the firm’s financial management, and
top management must watch cash flow numbers closely.
At present, CG is manufacturing the CB3668 in a plant leased from ElecTech using some equipment purchased from ElecTech.
CG manufactures about 70 percent of the parts in this circuit board.
CG management is considering a significant reengineering project to significantly change the plant and manufacturing process.
The project’s objective is to increase the number of purchased parts (to about 55%) and to reduce the complexity of the
manufacturing process. This would also permit CG to remove some leased equipment and to sell some of the most expensive
equipment in the plant.
The per unit manufacturing costs for 150,000 units of CB3668 follow:
General, selling, and administrative costs are $10 variable cost per unit and $1,250,000 fixed; these costs are not expected to
differ for either the current or the proposed manufacturing plan.
Data
Expected selling price per unit $100.00

Expected sales volume (in units) 150,000
Per-Unit Costs at Above Volume
Current Proposed
Materials and purchased parts $6.00 $15.00
Direct labor 12.50 13.75
Variable overhead 25.00 30.00
Fixed overhead 40.00 20.00
Manufacturing information for CB3668:
Number of setups 3,000 2,300
Batch size 50 50
Cost per setup $300 $300
Machine hours 88,000 55,000
General, Selling, and Administrative (GSA) Costs:
Variable cost (per unit sold) $10.00
Fixed (per year) $1,250,000
Required
1. Compute the contribution margin and breakeven in units for CB3668, both before and after the proposed
reengineering project. Assume all setup costs are included in fixed overhead.
2. Determine the number of sales units at which CG would be indifferent as to the current manufacturing plan or
the proposed plan.
3. Use Goal Seek in Excel to confirm your answers to requirement 2.
4. Briefly comment on CG’s strategy.
5. Should CG undertake the proposed reengineering plan? Support your answer with sensitivity analysis and a
discussion of short-term and long-term considerations.
Solution
1. Contribution margin per unit, breakeven points (in units)
Current Proposed Difference
Materials and purchased parts $6.00 $15.00
Variable SG&A costs 10.00 10.00
Total variable cost per unit $53.50 $68.75 $15.25
Selling price per unit $100.00 $100.00

CM per unit $46.50 $31.25
Total Fixed Cost:

Fixed SG&A $1,250,000 $1,250,000
Fixed manufacturing:
Fixed cost/unit $40.00 $20.00
Number of units 150,000 150,000
Total $6,000,000 $3,000,000
Total fixed cost per year $7,250,000 $4,250,000 $3,000,000
Breakeven Point (units):

Total fixed cost per year $7,250,000 $4,250,000
÷ Contribution margin per unit $46.50 $31.25
B/E (in units) 155,914 136,000
2. Indifference Point: The indifference point in volume, Q, is defined as the point where operating income is
the same under both plans. Since total revenue is assumed not to vary by choice of production plan, this is
operating profit equality is achieved when the total relevant costs are the same for each decision alternative.
Total relevant cost, current plan = Total relevant cost, proposed plan
($43.50 × Q) + $6,000,000 = $58.75Q + $3,000,000
$15.25Q = $3,000,000
Q= 196,722 units per year (rounded up)
Note that at the current level of 150,000 units per year, the firm would prefer the low fixed cost
strategy, that is, the new production plan.
3. Use Goal Seek to confirm the indifference point identified above in requirement 2.
Volume level (units per year) = 196,721.31 (exact)
Current Proposed
Relevant Costs:
Direct Materials $6.00 $15.00
Direct labor $12.50 $13.75
Variable overhead $25.00 $30.00
Total variable cost per unit $43.50 $58.75
Fixed Cost (Mfg. Ovh.) $6,000,000 $3,000,000
Difference in relevant Cost = $0
The above result was obtained by the following:
4. CG’s strategy is best described as differentiation, since the firm has succeeded by innovation in product
design. Further, the firm operates in an industry in which innovation and product design are critical to success.
An important element of the firm’s strategy is also the fact that the technology, as for many firms in the industry, is
not proven. That is, there is a significant level of risk that the firm’s product will fail to meet customers'
expectations. The overall strategy then must both support the firm’s innovative image and also protect against the
possibility of loss due to a failure of the technology – that is, simultaneously, the firm must advance and market its
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5. The calculations in part 2 above support a decision to go to the new plan; at the current level of 150,000 units,
costs are lower for the new plan, and will continue to be lower for the new plan as long as volume stays below
196,722 units.
4. CG’s strategy is best described as differentiation, since the firm has succeeded by innovation in product
design. Further, the firm operates in an industry in which innovation and product design are critical to success.
An important element of the firm’s strategy is also the fact that the technology, as for many firms in the industry, is
not proven. That is, there is a significant level of risk that the firm’s product will fail to meet customers'
expectations. The overall strategy then must both support the firm’s innovative image and also protect against the
possibility of loss due to a failure of the technology – that is, simultaneously, the firm must advance and market its
technological prowess and develop a plan to deal with the possibility that the technology might fail.
5. The calculations in part 2 above support a decision to go to the new plan; at the current level of 150,000 units,
costs are lower for the new plan, and will continue to be lower for the new plan as long as volume stays below
196,722 units.
Thinking strategically, the new plan is also preferred since it is an appropriate response to the firm’s risk, as noted
in requirement 3 above. By reducing operating leverage (that is, by reducing manufacturing fixed costs from
$6,000,000 to $3,000,000) the firm is less exposed to a possible failure of the innovation and then drop in sales.
The reduction in fixed costs also helps the firm to manage cash flows. Thus, the new plan is more consistent with
the firm’s strategy of developing an innovative product and also dealing with the risk of potential loss because of
a possible failure of the technology in the market place.
Also, one could look at the proposal as consistent with the firm’s core strength, which appears to be product
innovation. There is no evidence that the firm is particularly innovative or cost-effective in manufacturing. Thus, a
strategy which focuses less on manufacturing would be consistent with this strategy; more focus should be
retained in product design and development.
Sensitivity analysis: Uncertainty is important in this case, CG Graphics should use one or more of the tools
discussed in the chapter. Shown below is a calculation of the indifference point and a table of expected profits at
various demand levels. Note that the current method looks good if projected demand rises
Sensitivity Analysis
Current Proposed Difference
Materials and purchased parts $ 6.00 $ 15.00
Variable SG&A 25.00 30.00
Total variable cost $ 53.50 $ 68.75 $ 15.25
Price 100 100

CM per unit $ 46.50 $ 31.25
Total fixed cost per year $ 7,250,000 $ 4,250,000 $ 3,000,000
Breakeven 155,914 136,000
Current level of demand 150,000 150,000
Operating profit $ (275,000) $ 437,500
Indifference point 196,722
Assumed Levels
of Demand Profit:Current Profit:Proposed Iteration
30,000 $ (5,855,000) $ (3,312,500) 1
60,000 $ (4,460,000) $ (2,375,000) 2
90,000 $ (3,065,000) $ (1,437,500) 3
120,000 $ (1,670,000) $ (500,000) 4
150,000 $ (275,000) $ 437,500 5
180,000 $ 1,120,000 $ 1,375,000 6
210,000 $ 2,515,000 $ 2,312,500 7
240,000 $ 3,910,000 $ 3,250,000 8
270,000 $ 5,305,000 $ 4,187,500 9
300,000 $ 6,700,000 $ 5,125,000 10
Here is a link to a Microsoft tutorial on Goal Seek

Problem 9-48: Multiple-Product CVP Analysis; Sensitivity Analysis
Hartford Publishing Company (HPC) specializes in international business news publications. Its principal product is HPC- Monthly, which is
mailed to subscribers the first week of each month. A weekly version, called HPC-Weekly, is also available to subscribers over the Web at a
higher cost. Sixty percent of HPC’s subscribers are nondomestic customers. The company experienced a fast growth in its first few years of
operation, but sales have begun to slow in recent years as new competitors have entered the market. HPC has the following cost structure and
sales revenue for its subscription operations on a yearly basis. All costs and all subscription fees are in U.S. dollars.
Data
Fixed Costs per year $378,000
Variable Costs:
Mailing $0.70 per issue
Commission $3.50 per subscription
Administrative $2.00 per subscription
Sales Mix (based on # of subscriptions):
HPC-Weekly 25%
HPC-Monthly 75%
Selling Price:
HPC-Weekly $52.00 per subscription
HPC-Monthly $20.00 per subscription
Targeted after-tax profit, as a percent of sales dollars = 10.00%

Income tax rate (average) = 30.00%
Required
1. Contribution margin per unit for weekly and for monthly subscriptions
2. Contribution margin ratio for weekly and for monthly subscriptions
3 a. HPC’s breakeven point in sales units and sales dollars. Use the weighted-average contribution margin approach and show calculations.
(Hint: When calculating the weighted-average contribution margin per unit, the weights in the calculation are based on relative units sold. When
calculating the weighted-average contribution margin ratio, the weights are based on relative sales dollars, not units, of the individual products.)
b. At the overall breakeven point in units, what is the breakeven amount (in units) for each individual product?
c. What is the breakeven amount (in sales dollars) for each product?
4. Explain the following quote: "For the multiproduct (or multiservice) firm, there is no breakeven point independent of the sales mix assumption."
5. Prepare a data table for the breakeven volume and percentage change in the breakeven point from the base
case (above) for each 1% change in sales mix over for HPC Weekly over the range 20% to 30%
6. What is the required sales level (in units), at the assumed sales mix, to reach a before-tax profit of $75,000?
7. What is the required sales level (in units), at the assumed sales mix, to reach an after-tax profit equal to 10% of sales revenue? (Show calculations.)
8. What are the critical success factors for HPC? For its domestic subscribers? For its international subscribers?
Solution
1. Contribution margin per unit for weekly and for monthly subscriptions.
Weekly Monthly
Subscription Price $52.00 $20.00
Less: Variable costs $41.90 $13.90
Contribution margin per subscription $10.10 $6.10
2. Contribution margin ratio (CMR) for weekly and for monthly subscriptions
Weekly Monthly
Contribution margin per unit $10.10 $6.10
÷ Subscription (selling) price $52.00 $20.00
Contribution margin ratio (CMR) 19.42% 30.50%
3. HPC's overall breakeven point in sales units and sales dollars.
Breakeven point in units:

Fixed costs per year = $378,000
Weighted average contribution margin per unit = $7.10
Breakeven point in sales units 53,240
Breakdown of overall breakeven point: % # Units

Weekly Subscriptions = 25% 13,310
Monthly Subscriptions = 75% 39,930
Total = 100% 53,240
Breakeven point in dollars:

Weighted-average selling price/unit: Weight Selling Price Product
Weekly subscriptions 25% $52.00 $13.00
Monthly subscriptions 75% $20.00 $15.00
100% $28.00
Breakeven ($):
Total breakeven units (subscriptions) 53,240
× Weighted-average selling price per unit $28.00
Total B/E ($) = $1,490,720
Breakeven point in dollars--alternative solution:

Breakeven in $ = F ÷ Weighted-average contribution margin ratio
Weighted-average contribution margin ratio:

weight cm ratio product
Weekly Subscriptions 46.43% 19.42% 9.02%
Monthly Subscriptions 53.57% 30.50% 16.34%
100.00% 25.36%
Breakeven ($) = Annual fixed costs ÷ Weighted-average contribution margin ratio
Annual fixed costs = $378,000

÷ Weighted-average contribution margin ratio 25.36%
Breakeven point in total sales dollars = $1,490,704
Composition of sales, by product:

Sales mix, in terms of dollars: Sales Price Units Dollars
Weekly subscriptions $52.00 13,310 $692,120
Monthly subscriptions $20.00 39,930 $798,600
53,240 1,490,720
Composition of sales, by product--alternative solution:

Product Sales Mix % Allocation
Weekly subscriptions 46.43% $692,113
Monthly subscriptions 53.57% $798,592
100.00% $1,490,705
4
One option for multiproduct CVP analysis is to trace and/or allocate total fixed costs across the products and
then prepare a separate CVP model for each product/service. Regardless of the ability to allocate such costs
across products, this approach fails to capture demand interdependencies among products. Thus, for either
of these two reasons, the conventional approach to multiproduct (or multiservice) CVP analysis is to prepare
a single model under the assumption that the products are sold in specified sales mix.
If the products in question have different contribution margins per unit (or different contribution margin ratios)
then there is no unique breakeven point for the firm. In fact, there is an infinite number of breakeven points.
As the assumed sales mix changes, so too will the overall breakeven point for the firm. The breakeven point
moves in response to shifts in the sales mix: as the mix shifts to more profitable products, the breakeven
point decreases, and vice versa. Thus, "for the multiproduct firm, there is no breakeven point independent
of the sales mix assumption."
5. Data Table: Breakeven Volumes and Percentage Changes in BE Point with changes in sales mix over
the range 20% to 30% for HPC Weekly.
Sales mix (based on units sold) Weighted-

HPC Weekly HPC Monthly avg. CM/unit
20% 80% $6.90
21% 79% $6.94
22% 78% $6.98
23% 77% $7.02
24% 76% $7.06
Base Case 25% 75% $7.10
26% 74% $7.14
27% 73% $7.18
28% 72% $7.22
29% 71% $7.26
30% 70% $7.30
% Change in
Wtd-avg.
B/E % change CM/unit (from
Weighted-average contribution margin per unit BE (units) from base case base)
$6.90 54,783 2.90% -2.82%
$6.94 54,467 2.31% -2.25%
$6.98 54,155 1.72% -1.69%
$7.02 53,846 1.14% -1.13%
$7.06 53,541 0.57% -0.56%
$7.10 53,239 0.00% 0.00%
$7.14 52,941 -0.56% 0.56%
$7.18 52,646 -1.11% 1.13%
$7.22 52,355 -1.66% 1.69%
$7.26 52,066 -2.20% 2.25%
$7.30 51,781 -2.74% 2.82%
The above data table provides the results of a sensitivity analysis. Specifically, we are looking at the
sensitivity of the breakeven point vis-à-vis the assumption regarding sales mix for the two products.
Based on the above results, management will form a judgment as to the sensitivity of the BE point to
changes in the sales mix. The greater the perceived sensitivity, the greater the uncertainty in the
calculations (and therefore in the CVP model). Given greater uncertainty, management may
invest resources to provide a more refined estimate of sales mix.
6. Required sales (in units) to reach a target before-tax profit of $75,000 for the given sales mix (25%:75%):
Targeted before-tax profit target, πB = $75,000

Fixed costs (F) = $378,000
F + πB = $453,000
Weighted-average CM per unit = $7.10
Breakeven point in sales units = 63,803 (rounded up)
Although not required in the problem, we provide the following breakdown by product:
Sales of HPC-Weekly 25% 15,951

Sales of HPC-Monthly 75% 47,852
7. Required sales (in units) to reach a targeted after-tax profit = 10% of sales for the given sales mix.
Let Q = the required sales volume (in units) to achieve the profit objective
πB = Total sales − Total variable costs − Total fixed costs (F)
πB = πA ÷ (1 − t), where t = Tax rate
πA /(1 − t) = Total sales − Total variable costs − F
(0.10 × (Price per unit × Q))/(1 − t) = Total contribution margin − F
(0.10 × (Price per unit × Q))/(1 − t) = (CM per unit × Q) − F
(0.10 × $28.00/unit × Q)/(1 − 0.30) = ($7.10 × Q) − $378,000
$4.00 × Q = ($7.10 × Q) − $378,000
$3.10 × Q = $378,000
Q = $378,000 ÷ $3.10/unit = 121,936 units (rounded up)
8. What are the CSFs for the company, in terms of both domestic and international sales?
The point of this question is to get the students started to think about the competitive context in which the firm
operates. There are many different relevant points that could be made. If the discussion is slow to start, ask
them to think about what a firm like HPC must do to be competitive.
There are a number of critical success factors that are likely to be important for both domestic and foreign
subscriptions. These would include quality of presentation and timeliness and accuracy of information, as well
as competitive price. However, other factors will differ across countries. For example, in some countries the
costs of distribution including selling and handling costs are quite high, so that it is critical in these countries
to devise new ways to deliver the subscriptions profitably. Other factors include changes in literacy rates, the
business climate, and investment opportunities in different countries.
Problem 9-50: CVP Analysis; Sustainability; Uncertainty
With gasoline prices increasing rapidly in recent years, consumers have moved to high miles-per-gallon (mpg) vehicles,
in particular hybrid vehicles that rely on a battery as well as a gasoline engine for even greater mpg. The new vehicles
save money on gas, but also reduce the motorist's "carbon footprint" in an environment of global warming. To encourage
the purchase of fuel-efficient vehicles such as hybrids, the government may provide incentives, include income tax
credits, which represent dollar-for-dollar reductions in the tax liability of the individual in the year of purchase.
As both a cost-conscious and an environmentally conscious consumer, you are currently evaluating whether to
purchase a hybrid vehicle. Assume that you have narrowed your decision down to two choices, a gasoline-powered
vehicle or its equivalent hybrid (e.g., Honda Accord versus Accord hybrid). Relevant information regarding each of these
two vehicles, as well as additional information pertinent to your decision is given below.
Assume, further, that you plan to keep your auto for five years and that, based on recent experience,
will likely drive the car 20,000 miles per year (100,000 miles in total).
Data
Cost Tax Credit mpg
Gasoline model $27,000 $0 30.0
Hybrid model $38,000 $4,000 40.0
Estimated usage (in years), both models = 5

Estimated miles driven per year = 20,000
Required
1. Generate a cost function for each decision alternative, where the dependent variable, Y, is "lifetime cost" and the
independent variable, Q, is "lifetime miles driven."
2. Calculate the breakeven price for gas (per gallon) between the gasoline-powered model and the hybrid model.
3. Prepare a graph for lifetime cost (Y) for each of the two autos as a function of price per gallon of gas (X), based on
100,000 lifetime miles for each auto. Use the following value of X (price per gallon of gas) to generate each cost function:
X
$2.50
$2.75
$3.00
$3.25
$3.50
$3.75
$4.00
$4.25
$4.50
$4.75
Solution
1. Lifetime cost functions: let Y = lifetime cost, and v = cost per gallon of gas
Regular model:
Lifetime cost (Y) = Fixed costs + Variable costs
Lifetime cost (Y) = $27,000 + (v × [100,000 miles ÷ 30.0 mpg])
Lifetime cost (Y) = $27,000 + (3,333 gals. × v)
Hybrid model:
Lifetime cost (Y) = Fixed Cost + Variable Cost
Lifetime cost (Y) = ($38,000 - $4,000) + (v × [100,000 miles ÷ 40.0 mpg])
Lifetime cost (Y) = $34,000 + (2,500 gals. × v)
2. Breakeven gas price (point of cost indifference): let "v" = Breakeven price per gallon
Lifetime cost--Gas model = Lifetime cost--Hybrid model
$27,000 + (3,333 gals. × v ) = $34,000 + (2,5000 gals. × v)
v = [$34,000 − $27,000] ÷ [3,333 gals. − 2,500 gals.]
= $7,000 ÷ 833 gals. = $ 8.40 per gallon (rounded)
3. Lifetime cost graph: Gasoline-Powered Model versus Hybrid Model
X (price Lifetime Cost

per gal.) Gas Model Hybrid Difference
$2.50 $35,333 $40,250 $4,917
$2.75 $36,167 $40,875 $4,708
$3.00 $37,000 $41,500 $4,500
$3.25 $37,833 $42,125 $4,292
$3.50 $38,667 $42,750 $4,083
$3.75 $39,500 $43,375 $3,875
$4.00 $40,333 $44,000 $3,667
$4.25 $41,167 $44,625 $3,458
$4.50 $42,000 $45,250 $3,250
$4.75 $42,833 $45,875 $3,042
Lifetime Costs: Gas-Powered vs. Hybrid Model

$50,000
$45,000
$40,000
$35,000
$30,000
$2.50 $2.75 $3.00 $3.25 $3.50 $3.75 $4.00 $4.25 $4.50 $4.75
Gas Model Hybrid Model
Based on the above analysis and graph, we see that for these two alternatives (gas-powered vs. hybrid model), and
100,000 miles total usage over a five-year period, the difference in the lifetime costs remain fairly constant, ranging from $4,900
down to $3,000. From this we can conclude the difference in lifetime costs is fairly insensitive to the predicted
cost of gas per gallon.

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9-2 What is the contribution margin ratio and how is it used?

9-4 Why do management accountants use sensitivity analysis?

9-8 What is operating leverage, and for what is it used?

selling price per unit, p = $100

Total Contribution Margin:

charge per patient per visit, p = $30.00

fixed costs per quarter, F = $400,000

required unit sales:

pre-tax profit target = $500 = $400/(1 - 20%)

required sales volume, per week = 140

Degree of Operating Leverage (DOL) = Contribution Margin ÷ operating income

Contribution Margin = $8,000,000

DOL = CM ÷ Operating Income = 3.2

2. costs of using Machine A = costs of using Machine B

When 197,143 switches are needed, the Vista Company is indifferent as to

An alternative way to determine the indifference point is:

Fixed costs of Machine B − Fixed costs of Machine A

= $69,000 ÷ $0.35/unit = 197,143 units

3. Total costs if volume = 200,000 units/year: 200,000

costs when using machine B:

costs when using machine A:

4. Recommendation to management--which of the alternatives would you recommend, and why?

Source: "Show me the money," https://www.economist.com/whichmba/mba-rankings/salary

3. Total sales − Total variable cost = Total contribution margin

4. Contribution margin ratio (CMR) = $347,692 ÷ $1,390,769 = 0.25

Breakeven point = Fixed costs = $240,000 = $960,000.00

Solution Excel Formulas

Ricoh Cost = HP Cost

2. The breakeven price (P) can be determined as follows:

[($0.10 × 600,000) - $12,400] - ($0.075 × 600,000) = $2,600

[($0.10 × 600,000) - $12,400] - ($0.075 × 600,000) = $2,600 $2,600 three-year savings

Sales Increase 10%

A's calculated % change in profit 14.29%

Company A's % change in operating profit = DOL × % change in sales

Sales volume change -10%

DOL 2.00 2.50

Percentage change in sales volume -10% -10%

Old income $ 30,000 $ 30,000

Assumed decrease in demand 10%

Contribution Income Statements

DOL @ current sales volume = 2.67

### ### Per unit ### ###

See tab labeled "Ex. 9-34 Goal Seek"

Units Price/Cost Total

Step #1: Access Goal Seek

Step #2: Inputs

Step #3: Run Goal Seek

Brighter Cleaner Total

cm ratio 0.60 0.55

1. Breakeven point in terms of number of units:

Brighter Cleaner Sum

Total fixed costs to be recovered $265,200

2. Breakdown of units into individual products:

3. Total sales revenue needed to breakeven:

Overall breakeven point in sales dollars:

Fixed costs per year: $400,000

Standard "sales basket:"