Hilton Chapter 08 Solutions - 2

CHAPTER 8
Cost-Volume-Profit Analysis
ANSWERS TO REVIEW QUESTIONS

8-1 a. In the contribution-margin approach, the break-even point in units is calculated
using the following formula:
fixed expenses
Break-even point =
unit contribution margin
b. In the equation approach, the following profit equation is used:
⎛ unit sales volume ⎞ ⎛ unit variable sales volume ⎞ fixed

⎜⎜ × ⎟⎟ − ⎜⎜ × ⎟⎟ − = 0
⎝ sales price in units ⎠ ⎝ expense in units ⎠ expenses
This equation is solved for the sales volume in units.
c. In the graphical approach, sales revenue and total expenses are graphed. The
break-even point occurs at the intersection of the total revenue and total expense
lines.
8-2 The term unit contribution margin refers to the contribution that each unit of sales
makes toward covering fixed expenses and earning a profit. The unit contribution
margin is defined as the sales price minus the unit variable expense.
8-3 In addition to the break-even point, a CVP graph shows the impact on total expenses,
total revenue, and profit when sales volume changes. The graph shows the sales
volume required to earn a particular target net profit. The firm's profit and loss areas
are also indicated on a CVP graph.
8-4 The safety margin is the amount by which budgeted sales revenue exceeds break-
even sales revenue.
8-5 An increase in the fixed expenses of any enterprise will increase its break-even
point. In a travel agency, more clients must be served before the fixed expenses are
covered by the agency's service fees.
8-6 A decrease in the variable expense per pound of oysters results in an increase in the
contribution margin per pound. This will reduce the company's break-even sales
volume.
McGraw-Hill/Irwin © 2005 The McGraw-Hill Companies, Inc.

Managerial Accounting, 6/e 8-1
8-7 The president is correct. A price increase results in a higher unit contribution
margin. An increase in the unit contribution margin causes the break-even point to
decline.
The financial vice president's reasoning is flawed. Even though the break-even
point will be lower, the price increase will not necessarily reduce the likelihood of a
loss. Customers will probably be less likely to buy the product at a higher price.
Thus, the firm may be less likely to meet the lower break-even point (at a high price)
than the higher break-even point (at a low price).
8-8 When the sales price and unit variable cost increase by the same amount, the unit
contribution margin remains unchanged. Therefore, the firm's break-even point
remains the same.
8-9 The fixed annual donation will offset some of the museum's fixed expenses. The
reduction in net fixed expenses will reduce the museum's break-even point.
8-10 A profit-volume graph shows the profit to be earned at each level of sales volume.
8-11 The most important assumptions of a cost-volume-profit analysis are as follows:
(a) The behavior of total revenue is linear (straight line) over the relevant range. This
behavior implies that the price of the product or service will not change as sales
volume varies within the relevant range.
(b) The behavior of total expenses is linear (straight line) over the relevant range.
This behavior implies the following more specific assumptions:
(1) Expenses can be categorized as fixed, variable, or semivariable.
(2) Efficiency and productivity are constant.
(c) In multiproduct organizations, the sales mix remains constant over the relevant
range.
(d) In manufacturing firms, the inventory levels at the beginning and end of the
period are the same.
8-12 Operating managers frequently prefer the contribution income statement because it
separates fixed and variable costs. This format makes cost-volume-profit
relationships more readily discernible.

8-2 Solutions Manual
8-13 The gross margin is defined as sales revenue minus all variable and fixed
manufacturing expenses. The total contribution margin is defined as sales revenue
minus all variable expenses, including manufacturing, selling, and administrative
expenses.
8-14 East Company, which is highly automated, will have a cost structure dominated by
fixed costs. West Company's cost structure will include a larger proportion of
variable costs than East Company's cost structure.
A firm's operating leverage factor, at a particular sales volume, is defined as its

total contribution margin divided by its net income. Since East Company has
proportionately higher fixed costs, it will have a proportionately higher total
contribution margin. Therefore, East Company's operating leverage factor will be
higher.
8-15 When sales volume increases, Company X will have a higher percentage increase in
profit than Company Y. Company X's higher proportion of fixed costs gives the firm
a higher operating leverage factor. The company's percentage increase in profit can
be found by multiplying the percentage increase in sales volume by the firm's
operating leverage factor.
8-16 The sales mix of a multiproduct organization is the relative proportion of sales of its
products.
The weighted-average unit contribution margin is the average of the unit

contribution margins for a firm's several products, with each product's contribution
margin weighted by the relative proportion of that product's sales.
8-17 The car rental agency's sales mix is the relative proportion of its rental business
associated with each of the three types of automobiles: subcompact, compact, and
full-size. In a multi-product CVP analysis, the sales mix is assumed to be constant
over the relevant range of activity.
8-18 Cost-volume-profit analysis shows the effect on profit of changes in expenses, sales
prices, and sales mix. A change in the hotel's room rate (price) will change the
hotel's unit contribution margin. This contribution-margin change will alter the
relationship between volume and profit.

8-19 Budgeting begins with a sales forecast. Cost-volume-profit analysis can be used to
determine the profit that will be achieved at the budgeted sales volume. A CVP
analysis also shows how profit will change if the sales volume deviates from
budgeted sales.
Cost-volume-profit analysis can be used to show the effect on profit when

variable or fixed expenses change. The effect on profit of changes in variable or
fixed advertising expenses is one factor that management would consider in making
a decision about advertising.
8-20 The low-price company must have a larger sales volume than the high-price
company. By spreading its fixed expense across a larger sales volume, the low-price
firm can afford to charge a lower price and still earn the same profit as the high-price
company. Suppose, for example, that companies A and B have the following
expenses, sales prices, sales volumes, and profits.
Company A Company B
Sales revenue:
350 units at $10............................................... $3,500
100 units at $20............................................... $2,000
Variable expenses:
350 units at $6................................................. 2,100
100 units at $6................................................. 600
Contribution margin ............................................. $1,400 $1,400
Fixed expenses..................................................... 1,000 1,000
Profit ...................................................................... $ 400 $ 400
8-21 The statement makes three assertions, but only two of them are true. Thus the
statement is false. A company with an advanced manufacturing environment
typically will have a larger proportion of fixed costs in its cost structure. This will
result in a higher break-even point and greater operating leverage. However, the
firm's higher break-even point will result in a reduced safety margin.
8-22 Activity-based costing (ABC) results in a richer description of an organization's cost

behavior and CVP relationships. Costs that are fixed with respect to sales volume
may not be fixed with respect to other important cost drivers. An ABC system
recognizes these nonvolume cost drivers, whereas a traditional costing system does
not.

SOLUTIONS TO EXERCISES
EXERCISE 8-23 (20 MINUTES)
fixed expenses
1. Break-even point (in units) =
$54,000
= = 13,500 pizzas
$10 − $6

2. Contribution-margin ratio =
unit sales price
$10 − $6
= = .4
$10
fixed expenses
3. Break-even point (in sales dollars) =
contribution-margin ratio
$54,000
= = $135,000
.4
4. Let X denote the sales volume of pizzas required to earn a target net profit of
$60,000.
$10X – $6X – $54,000 = $60,000
$4X = $114,000
X = 28,500 pizzas

Total Break-Even
Sales Variable Contribution Fixed Net Sales
Revenue Expenses Margin Expenses Income Revenue
1 $360,000 $120,000 $240,000 $90,000 $150,000 $135,000 a
2 55,000 11,000 44,000 25,000 19,000 31,250b
3 320,000 c 80,000 240,000 60,000 180,000 80,000
4 160,000 130,000 30,000 30,000d -0- 160,000
Explanatory notes for selected items:
a$135,000 = $90,000 ÷ (2/3), where 2/3 is the contribution-margin ratio.
b$31,250 = $25,000/.80, where .80 is the contribution-margin ratio.
cBreak-even sales revenue ................................................................................ $80,000

Fixed expenses.................................................................................................. 60,000
Variable expenses ............................................................................................. $20,000
Therefore, variable expenses are 25 percent of sales revenue.
When variable expenses amount to $80,000, sales revenue is $320,000.
d$160,000 is the break-even sales revenue, so fixed expenses must be equal to the
contribution margin of $30,000 and profit must be zero.

1. Cost-volume-profit graph:
Dollars per year

Total revenue
$600,000
Break-even point: Total expenses

$500,000 20,000 tickets Profit
area
Variable
$400,000 • expense
(at 30,000
tickets)
$300,000
Loss area
$200,000 Annual
fixed
expenses
$100,000
Tickets
sold per
5,000 10,000 15,000 20,000 25,000 30,000 year

EXERCISE 8-25 (CONTINUED)
2. Stadium capacity................................................. 6,000

Attendance rate ................................................... × 2/3
Attendance per game.......................................... 4,000
Break - even point (tickets) 20,000
= =5
Attendance per game 4,000
The team must play 5 games to break even.

1. Profit-volume graph:
Dollars per year
$300,000
$200,000
$100,000
Break-even point: Profit
20,000 tickets area
0 • Tickets sold
5,000 10,000 15,000 20,000 25,000 per year
Loss
area
$(100,000)
$(200,000)
Annual fixed
expenses
$(300,000)
$(360,000)

2. Safety margin:
Budgeted sales revenue

(10 games × 6,000 seats × .45 full × $20) ................................................ $540,000
Break-even sales revenue
(20,000 tickets × $20)................................................................................. 400,000
Safety margin ................................................................................................... $140,000
3. Let P denote the break-even ticket price, assuming a 10-game season and 40 percent
attendance:
(10)(6,000)(.40)P – (10)(6,000)(.40)($12) – $360,000 = 0

24,000P = $408,000
P = $17 per ticket

fixed costs
1. Break-even point (in units) =
2,000,000p
= = 4,000 components
1,500p − 1,000p
p denotes Argentina’s peso, worth 1.003 U.S. dollars on the day this exercise was
written.
(2,000,000p ) (1.05)
2. New break-even point (in units) =
1,500p − 1,000p
2,100,000 p
= = 4,200 components
500p
3. Sales revenue (7,000 × 1,500p) ................................................. 10,500,000p

Variable costs (7,000 × 1,000p) ........................................................ 7,000,000p
Contribution margin.......................................................................... 3,500,000p
Fixed costs......................................................................................... 2,000,000p
Net income ......................................................................................... 1,500,000p
2,000,000p
4. New break-even point (in units) =
1,400p − 1,000p
= 5,000 components
5. Analysis of price change decision:

Price
1,500p 1,400p
Sales revenue: (7,000 × 1,500p) ....................... 10,500,000p
(8,000 × 1,400p) ....................... 11,200,000p
Variable costs: (7,000 × 1,000p) ....................... 7,000,000p
(8,000 × 1,000p) ....................... 8,000,000p
Contribution margin ........................................... 3,500,000p 3,200,000p
Fixed expenses .................................................. 2,000,000p 2,000,000p
Net income (loss)................................................ 1,500,000p 1,200,000p
The price cut should not be made, since projected net income will decline by
300,000p.

1. (a) Traditional income statement:

PACIFIC RIM PUBLICATIONS, INC.
INCOME STATEMENT
FOR THE YEAR ENDED DECEMBER 31, 20XX
Sales .......................................................................... $1,000,000
Less: Cost of goods sold ......................................... 750,000
Gross margin ................................................................ $ 250,000
Less: Operating expenses:
Selling expenses ............................................ $75,000
Administrative expenses ............................... 75,000 150,000
Net income .................................................................... $ 100,000
(b) Contribution income statement:

PACIFIC RIM PUBLICATIONS, INC.
INCOME STATEMENT
FOR THE YEAR ENDED DECEMBER 31, 20XX
Sales .......................................................................... $1,000,000
Less: Variable expenses:
Variable manufacturing.................................. $500,000
Variable selling ............................................... 50,000
Variable administrative .................................. 15,000 565,000
Contribution margin..................................................... $ 435,000
Less: Fixed expenses:
Fixed manufacturing ...................................... $ 250,000
Fixed selling.................................................... 25,000
Fixed administrative....................................... 60,000 335,000
Net income .................................................................... $ 100,000
contribution margin
2. Operating leverage factor (at $1,000,000 sales level) =
net income
$435,000
= = 4.35
$100,000

⎛ percentage increase ⎞ ⎛ operating ⎞

3. Percentage increase in net income = ⎜⎜ ⎟⎟ × ⎜⎜ ⎟⎟
⎝ in sales revenue ⎠ ⎝ leverage factor ⎠
= 12% × 4.35
= 52.2%
4. Most operating managers prefer the contribution income statement for answering this
type of question. The contribution format highlights the contribution margin and
separates fixed and variable expenses.

Answers will vary on this question, depending on the airline selected as well as the year of
the inquiry. In a typical year, most airlines report a breakeven load factor of around 65
percent.

1.
Sales Unit Unit
Bicycle Type Price Variable Cost Contribution Margin
High-quality $1,000 $600 ($550 + $50) $400
Medium-quality 600 300 ($270 + $30) 300
2. Sales mix:
High-quality bicycles.......................................................................................... 30%

Medium-quality bicycles .................................................................................... 70%
3. Weighted-average unit
contribution margin = ($400 × 30%) + ($300 × 70%)
= $330
fixed expenses
4. Break - even point (in units) =
weighted - average unit contribution margin
$148,500
= = 450 bicycles
$330
Break-Even Sales
Bicycle Type Sales Volume Sales Price Revenue
High-quality bicycles 135 (450 × .30) $1,000 $135,000
Medium-quality bicycles 315 (450 × .70) 600 189,000
Total $324,000
5. Target net income:

$148,500 + $99,000
Sales volume required to earn target net income of $99,000 =
$330
= 750 bicycles
This means that the shop will need to sell the following volume of each type of
bicycle to earn the target net income:
High-quality............................................................................ 225 (750 × .30)
Medium-quality ...................................................................... 525 (750 × .70)

1. The following income statement, often called a common-size income statement,

provides a convenient way to show the cost structure.
Amount Percent
Revenue.......................................................... $1,500,000 100
Variable expenses ......................................... 900,000 60
Contribution margin ...................................... $600,000 40
Fixed expenses.............................................. 450,000 30
Net income ..................................................... $ 150,000 10
2.
Decrease in Contribution Margin Decrease in
Revenue Percentage Net Income
$300,000* × 40%† = $120,000
*$300,000 = $1,500,000 × 20%

†40% = $600,000/$1,500,000
contribution margin
3. Operating leverage factor (at revenue of $1,500,000) =
net income
$600,000
= =4
$150,000
⎛ percentage increase ⎞ ⎛ operating leverage ⎞

4. Percentage change in net income = ⎜⎜ ⎟⎟ × ⎜⎜ ⎟⎟
⎝ in revenue ⎠ ⎝ factor ⎠
= 25% × 4
= 100%

Requirement (1) Requirement (2)

Revenue........................................................ $1,875,000 $1,500,000
Less: Variable expenses ........................... 1,125,000 1,800,000
Contribution margin .................................... $ 750,000 $ (300,000)
Less: Fixed expenses................................ 675,000 350,000
Net Income (loss)......................................... $ 75,000 $ (650,000)
fixed expenses
1. Break - even volume of service revenue =
contribution margin ratio
$200,000
= = $800,000
.25
target after - tax net income

2. Target before - tax income =
1 − tax rate
$120,000
= = $200,000
1 − .40

fixed expenses +
3. Service revenue required to earn (1 − t )
=
target after-tax income of contribution margin ratio
$120,000 $120,000
$200,000 +
= 1 − .40 = $1,600,000
.25
4. A change in the tax rate will have no effect on the firm's break-even point. At the break-
even point, the firm has no profit and does not have to pay any income taxes.

SOLUTIONS TO PROBLEMS
PROBLEM 8-34 (30 MINUTES)
1. Break-even point in sales dollars, using the contribution-margin ratio:

fixed expenses
Break - even point =
contribution - margin ratio
$540,000 + $216,000 $756,000
= =
$30 − $12 − $6 .4
$30
= $1,890,000
2. Target net income, using contribution-margin approach:

fixed expenses + target net income
Sales units required to earn income of $540,000 =
$756,000 + $540,000 $1,296,000
= =
$30 − $12 − $6 $12
= 108,000 units
3. New unit variable manufacturing cost = $12 × 110%

= $13.20
Break-even point in sales dollars:
$756,000 $756,000
Break - even point = =
$30.00 − $13.20 − $6.00 .36
$30
= $2,100,000

PROBLEM 8-34 (CONTINUED)
4. Let P denote the selling price that will yield the same contribution-margin ratio:
$30.00 − $12.00 − $6.00 P − $13.20 − $6.00
=
$30.00 P
P − $19.20
.4 =
P
.4P = P − $19.20
$19.20 = .6P
P = $19.20/.6
P = $32.00
Check: New contribution-margin ratio is:
$32.00 − $13.20 − $6.00
= .4
$32.00

fixed costs
1. Break - even point (in units) =
$702,000
= = 135,000 units
$25.00 − $19.80
fixed cost
2. Break - even point (in sales dollars) =
$702,000
= = $3,375,000
$25.00 − $19.80
$25.00
fixed costs + target net profit

3. Number of sales units required to =
earn target net profit unit contribution margin
$702,000 + $390,000
= = 210,000 units
$25.00 − $19.80
4. Margin of safety = budgeted sales revenue – break-even sales revenue
= (140,000)($25) – $3,375,000 = $125,000
5. Break-even point if direct-labor costs increase by 10 percent:
New unit contribution margin = $25.00 – $8.20 – ($4.00)(1.10) – $6.00 – $1.60

= $4.80
fixed costs
Break-even point =
new unit contribution margin
$702,000
= = 146,250 units
$4.80


6. Contribution margin ratio =
sales price
$25.00 − $19.80
Old contribution-margin ratio =
$25.00
= .208
Let P denote sales price required to maintain a contribution-margin ratio of .208. Then
P is determined as follows:
P − $8.20 − ($4.00)(1.10) − $6.00 − $1.60
= .208
P
P − $20.20 = .208P
.792P = $20.20
P = $25.51 (rounded)
Check: New contribution- $25.51 − $8.20 − ($4.00)(1.10) − $6.00 − $1.60
=
margin ratio $25.51
= .208 (rounded)

1. Break-even point in units, using the equation approach:
$24X – ($15 + $3)X – $1,800,000 = 0

$6X = $1,800,000
$1,800,000
X =
$6
= 300,000 units
2. New projected sales volume = 400,000 × 110%

= 440,000 units
Net income = (440,000)($24 – $18) – $1,800,000
= (440,000)($6) – $1,800,000
= $2,640,000 – $1,800,000 = $840,000
3. Target net income = $600,000 (from original problem data)
New disk purchase price = $15 × 130% = $19.50
Volume of sales dollars required:
fixed expenses + target net profit

Volume of sales dollars required =
$1,800,000 + $600,000 $2,400,000
= =
$24 − $19.50 − $3 .0625
$24
= $38,400,000

4. Let P denote the selling price that will yield the same contribution-margin ratio:
$24 − $15 − $3 P − $19.50 − $3
=
$24 P
P − $22.50
.25 =
P
.25P = P − $22.50
$22.50 = .75P
P = $22.50/.75
P = $30
Check: New contribution-margin ratio is:
$30 − $22.50
= .25
$30

1. Unit contribution margin:

Sales price………………………………… $32.00
Less variable costs:
Sales commissions ($32 x 5%)…… $ 1.60
System variable costs……………… 8.00 9.60
Unit contribution margin……………….. $22.40
Break-even point = fixed costs ÷ unit contribution margin

= $1,971,200 ÷ $22.40
= 88,000 units
2. Model A is more profitable when sales and production average 184,000 units.
Model A Model B
Sales revenue (184,000 units x $32.00)……... $5,888,000 $5,888,000

Sales commissions ($5,888,000 x 5%)… $ 294,400 $ 294,400
System variable costs:……………………
184,000 units x $8.00…………………. 1,472,000
184,000 units x $6.40…………………. 1,177,600
Total variable costs……………………….. $1,766,400 $1,472,000
Contribution margin…………………………... $4,121,600 $4,416,000
Less: Annual fixed costs…………………….. 1,971,200 2,227,200
Net income……………………………………… $2,150,400 $2,188,800
3. Annual fixed costs will increase by $180,000 ($900,000 ÷ 5 years) because of

straight-line depreciation associated with the new equipment, to $2,407,200
($2,227,200 + $180,000). The unit contribution margin is $24 ($4,416,000 ÷ 184,000
units). Thus:
Required sales = (fixed costs + target net profit) ÷ unit contribution margin
= ($2,407,200 + $1,912,800) ÷ $24
= 180,000 units
4. Let X = volume level at which annual total costs are equal

$8.00X + $1,971,200 = $6.40X + $2,227,200
$1.60X = $256,000
X = 160,000 units

1. Closing of mall store:
Loss of contribution margin at Mall Store ...................................................... $(108,000)

Savings of fixed cost at Mall Store (75%) ....................................................... 90,000
Loss of contribution margin at Downtown Store (10%) ................................ (14,400)
Total decrease in operating income................................................................ $ (32,400)
2. Promotional campaign:
Increase in contribution margin (10%)............................................................ $10,800

Increase in monthly promotional expenses ($180,000/12)............................ (15,000)
Decrease in operating income ......................................................................... $(4,200)
3. Elimination of items sold at their variable cost:
We can restate the November 20x4 data for the Mall Store as follows:
Mall Store
Items Sold at
Their
Variable Cost Other Items
Sales .................................................................................... $180,000* $180,000*
Less: variable expenses .................................................... 180,000 72,000
Contribution margin ........................................................... $ -0- $108,000
If the items sold at their variable cost are eliminated, we have:

Decrease in contribution margin on other items (20%)............................... $(21,600)
Decrease in fixed expenses (15%)................................................................. 18,000
Decrease in operating income ....................................................................... $ (3,600)
*$180,000 is one half of the Mall Store's dollar sales for November 20x4.

1. Sales mix refers to the relative proportion of each product sold when a company
sells more than one product.
2. (a) Yes. Plan A sales are expected to total 65,000 units (19,500 + 45,500), which
compares favorably against current sales of 60,000 units.
(b) Yes. Sales personnel earn a commission based on gross dollar sales. As the
following figures show, Cold King sales will comprise a greater proportion of
total sales under Plan A. This is not surprising in light of the fact that Cold
King has a higher selling price than Mister Ice Cream ($43 vs. $37).
Current Plan A
Sales Sales
Units Mix Units Mix
Mister Ice Cream.......... 21,000 35% 19,500 30%

Cold King...................... 39,000 65% 45,500 70%
Total ........................ 60,000 100% 65,000 100%
(c) Yes. Commissions will total $267,800 ($2,678,000 x 10%), which compares
favorably against the current flat salaries of $200,000.
Mister Ice Cream sales: 19,500 units x $37 ............ $ 721,500

Cold King sales: 45,500 units x $43 ........................ 1,956,500
Total ...................................................................... $2,678,000

(d) No. The company would be less profitable under the new plan.
Current Plan A
Sales revenue:
Mister Ice Cream: 21,000 units x $37; 19,500 units x $37.............. $ 777,000 $ 721,500
Cold King: 39,000 units x $43; 45,500 units x $43.......................... 1,677,000 1,956,500
Total revenue ............................................................................... $2,454,000 $2,678,000
Less variable cost:
Mister Ice Cream: 21,000 units x $20.50; 19,500 units x $20.50.... $ 430,500 $ 399,750
Cold King: 39,000 units x $32.50; 45,500 units x $32.50................ 1,267,500 1,478,750
Sales commissions (10% of sales revenue) ................................... 267,800
Total variable cost ....................................................................... $1,698,000 $2,146,300
Contribution margin................................................................................ $ 756,000 $ 531,700
Less fixed cost (salaries)........................................................................ 200,000 ----___
Net income ............................................................................................... $ 556,000 $ 531,700
3. (a) The total units sold under both plans are the same; however, the sales mix
has shifted under Plan B in favor of the more profitable product as judged by
the contribution margin. Cold King has a contribution margin of $10.50
($43.00 - $32.50), and Mister Ice Cream has a contribution margin of $16.50
($37.00 - $20.50).
Plan A Plan B
Sales Sales
Units Mix Units Mix
Mister Ice Cream.............. 19,500 30% 39,000 60%

Cold King.......................... 45,500 70% 26,000 40%
Total ............................ 65,000 100% 65,000 100%

(b) Plan B is more attractive both to the sales force and to the company.
Salespeople earn more money under this arrangement ($274,950 vs.
$200,000), and the company is more profitable ($641,550 vs. $556,000).
Current Plan B
Sales revenue:
Mister Ice Cream: 21,000 units x $37; 39,000 units x $37 ............. $ 777,000 $1,443,000
Cold King: 39,000 units x $43; 26,000 units x $43 ......................... 1,677,000 1,118,000
Total revenue............................................................................... $2,454,000 $2,561,000
Less variable cost:
Mister Ice Cream: 21,000 units x $20.50; 39,000 units x $20.50 ... $ 430,500 $ 799,500
Cold King: 39,000 units x $32.50; 26,000 units x $32.50 ............... 1,267,500 845,000
Total variable cost ...................................................................... $1,698,000 $1,644,500
Contribution margin ............................................................................... $ 756,000 $ 916,500
Less: Sales force compensation:
Flat salaries ....................................................................................... 200,000
Commissions ($916,500 x 30%)....................................................... 274,950
Net income............................................................................................... $ 556,000 $ 641,550

1. Current income:
Sales revenue………………………... $4,032,000

Less: Variable costs………………… $1,008,000
Fixed costs……………………. 2,736,000 3,744,000
Net income……………………………. $ 288,000
CompTronics has a contribution margin of $72 [($4,032,000 - $1,008,000) ÷ 42,000

sets] and desires to increase income to $576,000 ($288,000 x 2). In addition, the
current selling price is $96 ($4,032,000 ÷ 42,000 sets). Thus:
Required sales = (fixed costs + target net profit) ÷ unit contribution margin
= ($2,736,000 + $576,000) ÷ $72
= 46,000 sets, or $4,416,000 (46,000 sets x $96)
2. If operations are shifted to Mexico, the new unit contribution margin will be $74.40
($96.00 - $21.60). Thus:
Break-even point = fixed costs ÷ unit contribution margin

= $2,380,800 ÷ $74.40
= 32,000 units
3. (a) CompTronics desires to have a 32,000-unit break-even point with a $72 unit
contribution margin. Fixed costs must therefore drop by $432,000 ($2,736,000 -
$2,304,000), as follows:
Let X = fixed costs

X ÷ $72 = 32,000 units
X = $2,304,000
(b) As the following calculations show, CompTronics will have to generate a

contribution margin of $85.50 to produce a 32,000-unit break-even point.
Based on an $96.00 selling price, this means that the company can incur
variable costs of only $10.50 per unit. Given the current variable cost of
$24.00 ($96.00 - $72.00), a decrease of $13.50 per unit ($24.00 - $10.50) is
needed.
Let X = unit contribution margin

$2,736,000 ÷ X = 32,000 units
X = $85.50

PROBLEM 8-40 (CONTINUED
4. (a) Increase
(b) No effect
(c) Increase
(d) No effect
1. Break-even sales volume for each model:

annual rental cost
Break-even volume =
(a) Standard model:

$16,000
Break - even volume = = 25,000 tubs
$3.50 − $2.86
(b) Super model:

$22,000
Break - even volume = = 27,500 tubs
$3.50 − $2.70
(c) Giant model:

$40,000
Break - even volume = = 40,816 tubs (rounded)
$3.50 − $2.52

Dollars per year (in

thousands)
$40
Profit
$20
Break-even point:
40,816 tubs
Profit
area Tubs sold
0 • per year
10 20 30 40 50 (in thousands)
Loss
area
Loss
($20)
Fixed rental cost: $40,000 per year

($40)

3. The sales price per tub is the same regardless of the type of machine selected.
Therefore, the same profit (or loss) will be achieved with the Standard and Super
models at the sales volume, X, where the total costs are the same.
Variable Cost Total
Model per Tub Fixed Cost
Standard ..................................................... $2.86 $16,000
Super........................................................... 2.70 22,000
This reasoning leads to the following equation: 16,000 + 2.86X = 22,000 + 2.70X
Rearranging terms yields the following: (2.86 – 2.70)X = 22,000 – 16,000

.16X = 6,000
X = 6,000/.16
X = 37,500
Or, stated slightly differently:
Volume at which both machines fixed cost differential

produce the same profit =
variable cost differential
$6,000
=
$.16
= 37,500 tubs
Check: the total cost is the same with either model if 37,500 tubs are sold.
Standard Super
Variable cost:
Standard, 37,500 × $2.86........................... $107,250
Super, 37,500 × $2.70 ................................ $101,250
Fixed cost:
Standard, $16,000 ...................................... 16,000
Super, $22,000............................................ 22,000
Total cost.......................................................... $123,250 $123,250
Since the sales price for popcorn does not depend on the popper model, the sales
revenue will be the same under either alternative.

1. CVP graph:
Total revenue
Dollars per year
(in millions)
20
18 Profit
Break-even point: area
16 80,000 units or
$8,000,000 of sales
14
Total expenses
12
10
8
6
Loss
4 area
Fixed expenses
2
Units sold per year
50 100 150 200 (in thousands)

2. Break-even point:
contribution margin $12,000,000
Contribution - margin ratio = = = .75
sales $16,000,000
fixed expenses $6,000,000
Break - even point = =
contribution - margin ratio .75
= $8,000,000
3. Margin of safety = budgeted sales revenue – break-even sales revenue

= $16,000,000 – $8,000,000 = $8,000,000
4. Operating leverage factor contribution margin (at budgeted sales)

=
(at budgeted sales) net income (at budgeted sales)
$12,000,000
= =2
$6,000,000
5. Dollar sales required to fixed expenses + target net profit

=
earn target net profit contribution - margin ratio
$6,000,000 + $9,000,000
= = $20,000,000
.75
6. Cost structure:
Amount Percent
Sales revenue........................................................ $16,000,000 100.0
Variable expenses ................................................ 4,000,000 25.0
Contribution margin ............................................. $12,000,000 75.0
Fixed expenses ..................................................... 6,000,000 37.5
Net income ............................................................ $ 6,000,000 37.5

1. Plan A break-even point = fixed costs ÷ unit contribution margin

= $33,000 ÷ $33*
= 1,000 units
Plan B break-even point = fixed costs ÷ unit contribution margin

= $99,000 ÷ $45**
= 2,200 units
* $120 - [($120 x 10%) + $75]

** $120 - $75
2. Operating leverage refers to the use of fixed costs in an organization’s overall cost
structure. An organization that has a relatively high proportion of fixed costs and
low proportion of variable costs has a high degree of operating leverage.

3. Calculation of contribution margin and profit at 6,000 units of sales:
Plan A Plan B
Sales revenue: 6,000 units x $120………………. $720,000 $720,000

Cost of purchasing product:
6,000 units x $75…………………….…… $450,000 $450,000
Sales commissions: $720,000 x 10%……... 72,000 ----__
Total variable cost……………………….. $522,000 $450,000
Contribution margin……………………………… $198,000 $270,000
Fixed costs…………………………………………. 33,000 99,000
Net income…………………………………………. $165,000 $171,000
Plan A has a higher percentage of variable costs to sales (72.5%) compared to Plan
B (62.5%). Plan B’s fixed costs are 13.75% of sales, compared to Plan A’s 4.58%.
Operating leverage factor = contribution margin ÷ net income

Plan A: $198,000 ÷ $165,000 = 1.2
Plan B: $270,000 ÷ $171,000 = 1.58 (rounded)
Plan B has the higher degree of operating leverage.
4 & 5. Calculation of profit at 5,000 units:

Plan A Plan B
Sales revenue: 5,000 units x $120………………. $600,000 $600,000

Cost of purchasing product:
5,000 units x $75………………………….. $375,000 $375,000
Sales commissions: $600,000 x 10%……... 60,000 ---- __
Total variable cost……………………….. $435,000 $375,000
Contribution margin……………………………… $165,000 $225,000
Fixed costs………………………………………… 33,000 99,000
Net income…………………………………………. $132,000 $126,000

Plan A profitability decrease:

$165,000 - $132,000 = $33,000; $33,000 ÷ $165,000 = 20%
Plan B profitability decrease:

$171,000 - $126,000 = $45,000; $45,000 ÷ $171,000 = 26.3% (rounded)
PneumoTech would experience a larger percentage decrease in income if it adopts

Plan B. This situation arises because Plan B has a higher degree of operating
leverage. Stated differently, Plan B’s cost structure produces a greater percentage
decline in profitability from the drop-off in sales revenue.
Note: The percentage decreases in profitability can be computed by multiplying the

percentage decrease in sales revenue by the operating leverage factor. Sales
dropped from 6,000 units to 5,000 units, or 16.67%. Thus:
Plan A: 16.67% x 1.2 = 20.0%

Plan B: 16.67% x 1.58 = 26.3% (rounded)
6. Heavily automated manufacturers have sizable investments in plant and equipment,

along with a high percentage of fixed costs in their cost structures. As a result,
there is a high degree of operating leverage.
In a severe economic downturn, these firms typically suffer a significant

decrease in profitability. Such firms would be a more risky investment when
compared with firms that have a low degree of operating leverage. Of course, when
times are good, increases in sales would tend to have a very favorable effect on
earnings in a company with high operating leverage.

1. Break-even point in units:

fixed costs
Break-even point =
Calculation of contribution margins:
Labor- Computer-
Intensive Assisted
Production Manufacturing
System System
Selling price ...................................... $45.00 $45.00
Variable costs:
Direct material .............................. $8.40 $7.50
Direct labor ................................... 10.80 9.00
Variable overhead ........................ 7.20 4.50
Variable selling cost .................... 3.00 29.40 3.00 24.00
Contribution margin per unit $15.60 $21.00
(a) Labor-intensive production system:
$1,980,000 + $750,000
Break - even point in units =
$15.60
$2,730,000
=
$15.60
= 175,000 units
(b) Computer-assisted manufacturing system:
$3,660,000 + $750,000
Break - even point in units =
$21
$4,410,000
=
$21
= 210,000 units

2. Zodiac’s management would be indifferent between the two manufacturing methods

at the volume (X) where total costs are equal.
$29.40X + $2,730,000 = $24X + $4,410,000
$5.40X = $1,680,000
X = 311,111 units*
*Rounded
3. Operating leverage is the extent to which a firm's operations employ fixed operating
costs. The greater the proportion of fixed costs used to produce a product, the
greater the degree of operating leverage. Thus, the computer-assisted
manufacturing method utilizes a greater degree of operating leverage.
The greater the degree of operating leverage, the greater the change in
operating income (loss) relative to a small fluctuation in sales volume. Thus, there
is a higher degree of variability in operating income if operating leverage is high.
4. Management should employ the computer-assisted manufacturing method if annual

sales are expected to exceed 311,111 units and the labor-intensive manufacturing
method if annual sales are not expected to exceed 311,111 units.
5. Zodiac’s management should consider many other business factors other than
operating leverage before selecting a manufacturing method. Among these are:
• Variability or uncertainty with respect to demand quantity and selling price.
• The ability to produce and market the new product quickly.
• The ability to discontinue production and marketing of the new product while
incurring the least amount of loss.

1. In order to break even, during the first year of operations, 10,220 clients must visit the
law office being considered by Steven Clark and his colleagues, as the following
calculations show.
Fixed expenses:
Advertising................................................................................ $ 980,000
Rent (6,000 × $56)..................................................................... 336,000
Property insurance................................................................... 54,000
Utilities ...................................................................................... 74,000
Malpractice insurance.............................................................. 360,000
Depreciation ($120,000/4) ........................................................ 30,000
Wages and fringe benefits:
Regular wages
($50 + $40 + $30 + $20) × 16 hours × 360 days ......... $806,400
Overtime wages
(200 × $30 × 1.5) + (200 × $20 × 1.5) .......................... 15,000
Total wages............................................................. $821,400
Fringe benefits at 40% ....................................................... 328,560 1,149,960
Total fixed expenses ...................................................................... $2,983,960

Break-even point:
0 = revenue – variable cost – fixed cost
0 = $60X + ($4,000 × .2X × .3)* – $8X – $2,983,960
0 = $60X + $240X – $8X – $2,983,960
$292X = $2,983,960
X = 10,220 clients (rounded)
*Revenue calculation:
$60X represents the $60 consultation fee per client. ($4,000 × .2X × .30) represents
the predicted average settlement of $4,000, multiplied by the 20% of the clients
whose judgments are expected to be favorable, multiplied by the 30% of the
judgment that goes to the firm.
2. Safety margin:
Safety margin = budgeted sales revenue − break-even sales revenue
Budgeted (expected) number of clients = 50 × 360 = 18,000
Break-even number of clients = 10,220 (rounded)
Safety margin = [($60 × 18,000) + ($4,000 × 18,000 × .20 × .30)]

– [($60 × 10,220) + ($4,000 × 10,220 × .20 × .30)]
= [$60 + ($4,000 × .20 × .30)] × (18,000 – 10,220)
= $300 × 7,780
= $2,334,000

$1,250,000 − $750,000
1. Unit contribution margin =
25,000 units
= $20 per unit
fixed costs
Break - even point (in units) =
$300,000
= = 15,000 units
$20
2. Number of sales units required fixed costs + target net profit

to earn target net profit =
$300,000 + $280,000
= = 29,000 units
$20
new fixed costs

3. New break - even point (in units) =
new unit contribution margin
$300,000 + ($36,000/6) *
= = 19,125 units
$20 − $4 †
*Annual straight-line depreciation on new machine

†$4.00 = $9.00 – $5.00 increase in the unit cost of the new part
4. Number of sales units required new fixed costs + target net profit
to earn target net profit, given =
manufacturing changes new unit contribution margin
$306,000 + $200,000 *
=
$16
= 31,625 units
*Last year's profit: ($50)(25,000) – $1,050,000 = $200,000


5. Contribution - margin ratio =
sales price
$20
Old contribution - margin ratio = = .40
$50 *
*Sales price, given in problem.
Let P denote the price required to cover increased direct-material cost and maintain
the same contribution margin ratio:
P − $30 * − $4 †
= .40
P
P − $34 = .40P
.60P = $34
P = $56.67 (rounded)
*Old unit variable cost = $30 = $750,000 ÷ 25,000 units

†Increase in direct-material cost = $4
Check:
$56.67 − $30 − $4
New contribution - margin ratio =
$56.67
= .40 (rounded)

1. Memorandum
Date: Today
To: Vice President for Manufacturing, Saturn Game Company
From: I.M. Student, Controller
Subject: Activity-Based Costing
The $300,000 cost that has been characterized as fixed is fixed with respect to sales
volume. This cost will not increase with increases in sales volume. However, as the activity-
based costing analysis demonstrates, these costs are not fixed with respect to other
important cost drivers. This is the difference between a traditional costing system and an
ABC system. The latter recognizes that costs vary with respect to a variety of cost drivers,
not just sales volume.
2. New break-even point if automated manufacturing equipment is installed:
Sales price....................................................................................................... $52

Costs that are variable (with respect to sales volume):
Unit variable cost (.8 × $750,000 ÷ 25,000)............................................ 24
Unit contribution margin ............................................................................... $28
Costs that are fixed (with respect to sales volume):

Setup (300 setups at $100 per setup)............................................ $ 30,000
Engineering (800 hours at $56 per hour) ...................................... 44,800
Inspection (100 inspections at $90 per inspection)..................... 9,000
General factory overhead............................................................... 332,200
Total............................................................................................ $416,000
Fixed selling and administrative costs ............................................... 60,000
Total costs that are fixed (with respect to sales volume) ........... $476,000
fixed costs
$476,000
=
$28
= 17,000 units

3. Sales (in units) required to show a profit of $280,000:
Number of sales units required fixed cost + target net profit

to earn target net profit =
$476,000 + $280,000
=
$28
= 27,000 units
4. If management adopts the new manufacturing technology:
(a) Its break-even point will be higher (17,000 units instead of 15,000 units).
(b) The number of sales units required to show a profit of $280,000 will be lower
(27,000 units instead of 29,000 units).
(c) These results are typical of situations where firms adopt advanced manufacturing
equipment and practices. The break-even point increases because of the
increased fixed costs due to the large investment in equipment. However, at
higher levels of sales after fixed costs have been covered, the larger unit
contribution margin ($28 instead of $20) earns a profit at a faster rate. This results
in the firm needing to sell fewer units to reach a given target profit level.

5. The controller should include the break-even analysis in the report. The Board of
Directors needs a complete picture of the financial implications of the proposed
equipment acquisition. The break-even point is a relevant piece of information. The
controller should accompany the break-even analysis with an explanation as to
why the break-even point will increase. It would also be appropriate for the
controller to point out in the report that the advanced manufacturing equipment
would require fewer sales units at higher volumes in order to achieve a given
target profit, as in requirement (3) of this problem.
To withhold the break-even analysis from the controller's report would be a

violation of the following ethical standards:
(a) Competence: Prepare complete and clear reports and recommendations after
appropriate analysis of relevant and reliable information.
(b) Integrity: Communicate unfavorable as well as favorable information and

professional judgments or opinions.
(c) Objectivity: Communicate information fairly and objectively. Disclose fully all
relevant information that could reasonably be expected to influence an intended
user's understanding of the reports, comments, and recommendations presented.

1. $810,000
Unit contribution margin = = $450 per ton
1,800
fixed costs
Break - even volume in tons =
$495,000
= = 1,100 tons
$450
2. Projected net income for sales of 2,100 tons:
Projected contribution margin (2,100 × $450)........................................ $945,000

Projected fixed costs ................................................................................ 495,000
Projected net income................................................................................ $450,000
3. Projected net income including foreign order:

Variable cost per ton = $990,000/1,800 = $550 per ton
Sales price per ton for regular orders = $1,800,000/1,800 = $1,000 per ton
Foreign Regular
Order Sales
Sales in tons...................................................................... 1,500 1,500
Contribution margin per ton:
Foreign order ($900 – $550) ....................................... × $350
Regular sales ($1,000 – $550).................................... × $450
Total contribution margin ................................................ $525,000 $675,000
Contribution margin on foreign order........................................................ $ 525,000

Contribution margin on Regular sales....................................................... 675,000
Total contribution margin............................................................................ $1,200,000
Fixed costs.................................................................................................... 495,000
Net income .................................................................................................... $ 705,000

4. New sales territory:
To maintain its current net income, Central Pennsylvania Limestone Company just
needs to break even on sales in the new territory.
fixed costs in new territory

Break - even point in tons =
unit contribution margin on sales in new territory
$123,000
= = 307.5 tons
$450 − $50
5. Automated production process:

$495,000 + $117,000
Break - even point in tons =
$450 + $50
$612,000
= = 1,224 tons
$500
Break - even point in sales dollars = 1,224 tons × $1,000 per ton
= $1,224,000
6. Changes in selling price and unit variable cost:

New unit contribution margin = ($1,000)(90%) − ($550 + $80)
= $270
$270
New contribution margin ratio =
($1,000)(90%)
= .30
fixed costs + target net profit

Dollar sales required to earn target net profit =
$495,000 + $189,000
=
.30
= $2,280,000

1.
TOLEDO TOOL COMPANY
BUDGETED INCOME STATEMENT
FOR THE YEAR ENDED DECEMBER 31, 20X4
Hedge Line
Clippers Trimmers Leaf Blowers Total
Unit selling price ............................ $84 $108 $144
Variable manufacturing cost......... $39 $ 36 $ 75
Variable selling cost....................... 15 12 18
Total variable cost.......................... $54 $ 48 $ 93
Contribution margin per unit ........ $30 $ 60 $ 51
Unit sales ........................................ × 50,000 × 50,000 × 100,000
Total contribution margin ......... $1,500,000 $3,000,000 $5,100,000 $9,600,000
Fixed manufacturing overhead..... $6,000,000

Fixed selling and
administrative costs.................. 1,800,000
Total fixed costs ........................ $7,800,000
Income before taxes....................... $1,800,000
Income taxes (40%)........................ 720,000
Budgeted net income..................... $1,080,000
2.
(a) (b)
Unit Sales
Contribution Proportion (a) × (b)
Hedge Clippers .......................................... $30 .25 $ 7.50
Line Trimmers............................................ 60 .25 15.00
Leaf Blowers .............................................. 51 .50 25.50
Weighted-average unit
contribution margin............................. $48.00
total fixed costs
Total unit sales to break even =
$7,800,000
= = 162,500 units
$48

Sales proportions:
Sales Total Unit Product Line

Proportion Sales Sales
Hedge Clippers .............................................. .25 162,500 40,625
Line Trimmers................................................ .25 162,500 40,625
Leaf Blowers .................................................. .50 162,500 81,250
Total................................................................ 162,500
3.
(a) (b)
Unit Sales
Contribution Proportion (a) × (b)
Hedge Clippers ................................................. $30 .20 $ 6.00
Line Trimmers*.................................................. 57 .20 11.40
Leaf Blowers ....................................................
† 36 .60 21.60
Weighted-average unit contribution margin.. $39.00
*Variable selling cost increases. Thus, the unit contribution decreases to

$57 [$108 – ($36 + $12 + $3)].
†The variable manufacturing cost increases 20 percent. Thus, the unit contribution
decreases to $36 [$144 – (1.2 × $75) – $18].
total fixed costs
Total unit sales to break even =
$7,800,000
= = 200,000 units
$39
Sales proportions:
Sales Total Unit Product Line

Proportions Sales Sales
Hedge Clippers................................................ .20 200,000 40,000
Line Trimmers ................................................. .20 200,000 40,000
Leaf Blowers.................................................... .60 200,000 120,000
Total.................................................................. 200,000

sales − variable costs

1. (a) Unit contribution margin =
units sold
$2,000,000 − $1,400,000
= = $6 per unit
100,000
fixed costs
$420,000
= = 70,000 units
$6
contribution margin
(b) Contribution - margin ratio =
sales revenue
$2,000,000 − $1,400,000
= = .3
$2,000,000
fixed costs
Break - even point (in sales dollars) =
$420,000
= = $1,400,000
.3

fixed costs +
2. Number of units of sales required (1 − t )
=
to earn target after-tax net income unit contribution margin
$180,000
$420,000 +
(1 − .4) $720,000
= =
$6 $6
= 120,000 units
3. If fixed costs increase by $63,000:

$420,000 + $63,000
Break - even point (in units) = = 80,500 units
$6

Dollars per year
$1,500,000
$1,000,000
$500,000 Profit
Break-even point: area
70,000 units
Units sold
0 • per year
Loss 25,000 50,000 75,000 100,000
area
$(500,000)
$(1,000,000)
$(1,500,000)


fixed costs +
5. Number of units of sales (1 − t )
required to earn target =
after-tax net income
$180,000
$420,000 +
(1 − .5) $780,000
= =
$6 $6
= 130,000 units

$120.00 − $79.20
1. Contribution margin ratio = = .34
$120.00

fixed expenses +
2. Number of units of sales required (1 − t)
to earn target after-tax income =
$33,120
$475,200 +
(1 − .40) $530,400
X= =
$120.00 − $79.20 $40.80
X = 13,000 units
3. Break-even point (in units) for the $554,400

touring model = = 10,500 units
$132.00 − $79.20
Let Y denote the variable cost of the mountaineering model such that the break-even
point for the mountaineering model is 10,500 units.
Then we have:
$475,200
10,500 =
$120.00 − Y
(10,500) × ($120.00 − Y ) = $475,200
$1,260,000 − 10,500Y = $475,200
10,500Y = $784,800
Y = $74.74 (rounded)
Thus, the variable cost per unit would have to decrease by $4.46 ($79.20 – $74.74).

4. $475,200 × 110%
New break - even point =
$120.00 − ($79.20)(90%)
$522,720
=
$48.72
= 10,729 units (rounded)
5. Weighted-average unit
contribution margin = (50% × $52.80) + (50% × $40.80)
= $46.80
fixed costs
Break-even point =
$514,800
= = 11,000 units (or 5,500 of each type)
$46.80
1. SUMMARY OF EXPENSES
Expenses per Year

(in thousands)
Variable Fixed
Manufacturing .................................................................... $ 10,800 $3,510
Selling and administrative................................................. 3,600 2,880
Interest ................................................................................ 810
Costs from budgeted income statement..................... $ 14,400 $7,200
If the company employs its own sales force:
Additional sales force costs ......................................... 3,600
Reduced commissions [(.15 – .10) × $24,000] ............ (1,200)
Costs with own sales force............................................... $ 13,200 $10,800
If the company sells through agents:
Deduct cost of sales force ............................................ (3,600)
Increased commissions [(.225 – .10) × $24,000]......... 3,000
Costs with agents paid increased commissions............ $ 16,200 $7,200

total fixed expenses

Break-even sales dollars =
total variable expenses
Contribution-margin ratio = 1 −
sales revenue
$14,400,000
(a) Contribution margin ratio = 1 −
$24,000,000
= 1 − .60
= .40
$7,200,000
Break - even sales dollars =
.40
= $18,000,000
$13,200,000
(b) Contribution margin ratio = 1 −
$24,000,000
= 1 − .55
= .45
$10,800,000
Break - even sales dollars =
.45
= $24,000,000
total fixed costs + target income before income taxes

2. Required sales dollars =
$16,200
Contribution margin ratio = 1 −
$24,000
= 1 − .675
= .325
$7,200,000 + $2,400,000
Required sales dollars to break even =
.325
$9,600,000
=
.325
= $29,538,462 (rounded)

3. The volume in sales dollars (X) that would result in equal net income is the volume
of sales dollars where total expenses are equal.
Total expenses with agents paid = total expenses with own sales force
increased commission
$16,200,000 $13,200,000
X + $7,200,000 = X + $10,800,000
$24,000,000 $24,000,000
.675 X + $7,200,000 = .55 X + $10,800,000
.125 X = $3,600,000
X = $28,800,000
Therefore, at a sales volume of $28,800,000, the company will earn equal before-tax
income under either alternative. Since before-tax income is the same, so is after-tax
net income.

1. a. In order to break even, Columbus Canopy Company must sell 500 units. This
amount represents the point where revenue equals total costs.
Revenue = variable costs + fixed costs

$800X = $400X + $200,000
$400X = $200,000
X = 500 units
b. In order to achieve its after-tax profit objective, Columbus Canopy Company

must sell 2,500 units. This amount represents the point where revenue equals
total costs plus the before-tax profit objective.
Revenue = variable costs + fixed costs + before - tax profit

$800X = $400X + $200,000 + [$480,000 ÷ (1 − .4)]
$800X = $400X + $200,000 + $800,000
$400X = $1,000,000
X = 2,500 units
2. To achieve its annual after-tax profit objective, management should select the first
alternative, where the sales price is reduced by $80 and 2,700 units are sold during
the remainder of the year. This alternative results in the highest profit and is the
only alternative that equals or exceeds the company’s profit objective. Calculations
for the three alternatives follow.

Alternative (1):
Re venue = ($800)(350) + ($720)( 2,700)

= $2,224,000
Variable cost = $400 × 3,050
= $1,220,000
Before - tax profit = $2,224,000 − $1,220,000 − $200,000
= $804,000
After - tax profit = $804,000 × (1 − .4)
= $482,400
Alternative (2):
Re venue = ($800)(350) + ($740)( 2,200)

= $1,908,000
Variable cost = ($400)(350) × ($350)( 2,200)
= $910,000
Before - tax profit = $1,908,000 − $910,000 − $200,000
= $798,000
After - tax profit = $798,000 × (1 − .4)
= $478,800
Alternative (3):
Re venue = ($800)(350) + ($760)( 2,000)

= $1,800,000
Variable cost = $400 × 2,350
= $940,000
Before - tax profit = $1,800,000 − $940,000 − $180,000
= $680,000
After - tax profit = $680,000 × (1 − .4)
= $408,000

SOLUTIONS TO CASES
CASE 8-54 (50 MINUTES)
1. The break-even point is 16,900 patient-days calculated as follows:
SUSQUEHANNA MEDICAL CENTER

COMPUTATION OF BREAK-EVEN POINT
IN PATIENT-DAYS: PEDIATRICS
FOR THE YEAR ENDED JUNE 30, 20X6
Total fixed costs:

Medical center charges........................................................................................... $3,480,000
Supervising nurses ($30,000 × 4) ........................................................................ 120,000
Nurses ($24,000 × 10) ...................................................................... 240,000
Aids ($10,800 × 20) ...................................................................... 216,000
Total fixed costs .............................................................................................. $4,056,000
Contribution margin per patient-day:
Revenue per patient-day......................................................................................... $360
Variable cost per patient-day:
($7,200,000 ÷ $360 = 20,000 patient-days)
($2,400,000 ÷ 20,000 patient-days).................................................................... 120
Contribution margin per patient-day ..................................................................... $240
Break-even point total fixed costs $4,056,000

in patient-days = =
contribution margin per patient - day $240
= 16,900 patient days

CASE 8-54 (CONTINUED)
2. Net earnings would decrease by $728,000, calculated as follows:
SUSQUEHANNA MEDICAL CENTER

COMPUTATION OF LOSS FROM RENTAL
OF ADDITIONAL 20 BEDS: PEDIATRICS
FOR THE YEAR ENDED JUNE 30, 20X6
Increase in revenue
(20 additional beds × 90 days × $360 charge per day) .................................... $ 648,000
Increase in expenses:
Variable charges by medical center
(20 additional beds × 90 days × $120 per day) ............................................ $ 216,000
Fixed charges by medical center

($3,480,000 ÷ 60 beds = $58,000 per bed)
($58,000 × 20 beds)......................................................................................... 1,160,000
Salaries
(20,000 patient-days before additional 20 beds + 20 additional
beds × 90 days = 21,800, which does not exceed 22,000 patient-days;
therefore, no additional personnel are required) ......................................... -0-
Total increase in expenses...................................................................................... $1,376,000
Net change in earnings from rental of additional 20 beds ................................... $ (728,000)

CASE 8-55 (50 MINUTES)
1. Break-even point for 20x4, based on current budget:

$15,000,000 − $9,000,000 − $3,000,000
Contribution - margin ratio = = .20
$15,000,000
fixed expenses
Break - even point =
$150,000
= = $750,000
.20
2. Break-even point given employment of sales personnel:

New fixed expenses:
Previous fixed expenses ......................................................................... $ 150,000

Sales personnel salaries (3 x $45,000)................................................... 135,000
Sales managers’ salaries (2 × $120,000)................................................ 240,000
Total ........................................................................................................... $ 525,000
New contribution-margin ratio:
Sales .......................................................................................................... $15,000,000

Cost of goods sold................................................................................... 9,000,000
Gross margin ............................................................................................ $ 6,000,000
Commissions (at 5%) ............................................................................... 750,000
Contribution margin................................................................................. $ 5,250,000
$5,250,000
$15,000,000
fixed expenses
Estimated break - even point =
$525,000
= = $1,500,000
.35

3. Assuming a 25% sales commission:
New contribution-margin ratio:
Sales .......................................................................................................... $15,000,000

Cost of goods sold................................................................................... 9,000,000
Gross margin ............................................................................................ $ 6,000,000
Commissions (at 25%) ............................................................................. 3,750,000
Contribution margin................................................................................. $ 2,250,000
$2,250,000
$15,000,000
fixed expenses +
Sales volume in dollars (1 − t )
=
required to earn after-tax contribution - margin ratio
net income
$1,995,000
$150,000 +
(1 − .3) $3,000,000
= =
.15 .15
= $20,000,000
Check:
Sales ..................................................................... $ 20,000,000

Cost of goods sold (60% of sales)..................... 12,000,000
Gross margin ....................................................... $ 8,000,000
Selling and administrative expenses:
Commissions................................................. $ 5,000,000
All other expenses (fixed) ............................ 150,000 5,150,000
Income before taxes............................................ $ 2,850,000
Income tax expense (30%).................................. 855,000
Net income ........................................................... $ 1,995,000

4. Sales dollar volume at which Lake Champlain Sporting Goods Company is

indifferent:
Let X denote the desired volume of sales.
Since the tax rate is the same regardless of which approach management chooses,
we can find X so that the company’s before-tax income is the same under the two
alternatives. (In the following equations, the contribution-margin ratios of .35 and
.15, respectively, were computed in the preceding two requirements.)
.35X – $525,000 = .15X – $150,000

.20X = $375,000
X = $375,000/.20
X = $1,875,000
Thus, the company will have the same before-tax income under the two alternatives
if the sales volume is $1,875,000.
Check:
Alternatives
Employ
Sales Pay 25%
Personnel Commission
Sales .............................................................................. $1,875,000 $1,875,000
Cost of goods sold (60% of sales).............................. 1,125,000 1,125,000
Gross margin ................................................................ $ 750,000 $ 750,000
Selling and administrative expenses:
Commissions............................................................ 93,750* 468,750†
All other expenses (fixed)........................................ 525,000 150,000
Income before taxes..................................................... $ 131,250 $ 131,250
Income tax expense (30%)........................................... 39,375 39,375
Net income .................................................................... $ 91,875 $ 91,875
*$1,875,000 × 5% = $93,750
†$1,875,000 × 25% = $468,750

CURRENT ISSUES IN MANAGERIAL ACCOUNTING
ISSUE 8-56
“PLANES, TRAINS AND POLITICIANS,” BUSINESS WEEK, OCTOBER 7, 2002, P. 49, ALLAN
SLOAN.
The break-even point is the volume of operating activity at which revenue and expenses
are equal. Amtrak was originally established to provide a public service, namely low-
cost transportation. It traditionally had a price structure that depended on tax-base
funding to fund fixed infrastructure expenses. It is only in recent years that the
government has acted to transition Amtrak to a self-sufficient operation. The airlines, by
contrast, were from the outset privately owned, for-profit businesses. However, since
the earliest days the airlines have struggled to be profitable; they are now asking for a
massive subsidy to offset losses, which have accumulated because of overexpansion,
huge debt, high labor costs, and the effects of September 11, 2001, along with other
security issues. Now, both these industries should be encouraged to cut costs in order
to break even. It is not an impossible mission; Southwest and JetBlue have both
successfully achieved this goal.
ISSUE 8-57
“TO REDRESS INDUSTRY BLUES, DELTA TURNS TO SONG,” THE WALL STREET
JOURNAL, JAN 29, 2003, P. A3, NICOLE HARRIS; “COSTLY RACE IN THE SKY: SAME
ROUTE, SAME PLANE, YET UNITED'S FLIGHT COSTS MORE TO OPERATE THAN
JETBLUE'S,” THE WALL STREET JOURNAL, SEPTEMBER 9, 2002, P. B1, SUSAN CAREY.
Labor costs are a significant proportion of any airline’s cost structure. Major airlines,
such as United Airlines, have developed very high labor costs because (1) most of their
staff belong to labor unions, which have strong wage and benefits negotiation power;
and (2) wages tend to be tied to seniority rather than productivity. By comparison, the
low cost competitors such as Jet Blue pay their air and ground crews lower wages and
benefits. As a result, labor costs account for 47% of revenue at United, but just 25% at
Jet Blue, allowing the latter to operated profitably.
Another significant source of costs for airlines is ground crews. The larger airlines have
pioneered a “hub-and-spoke” model, which allows them to increase passenger loads by
funneling all flights through major hubs. By contrast, the low-cost airlines have tended
to offer “point-to-point” services, which may offer lower passenger volumes, but also
require smaller ground crews. The point-to-point model provides an added cost
advantage to the low-cost airlines, allowing them to offer lower prices to customers.

ISSUE 8-58
“IT’S TIME TO CASH IN SOME CHIPS, BIG BLUE”, BUSINESS WEEK, JUNE 3, 2002, P. 43,
SPENCER E. ANTE.
The cost structure is the relative proportion of fixed to variable costs. Because
semiconductor manufacturing requires capital-intensive, high-technology, equipment, it
is characterized by very high fixed costs. In organizations like these, profit is very
sensitive to changes in volume. For this reason, analysts are concerned that IBM
should be making significant efforts to reduce fixed costs (by shutting down
manufacturing lines) rather than making minor adjustments to labor levels.
ISSUE 8-59
"RELIANCE GROUP MAY SEE SHIELD FROM CREDITORS," THE WALL STREET JOURNAL,
AUGUST 15, 2000, DEVON SPURGON, GREGORY ZUCKERMAN, AND FRANCINE L. POPE.
Managers apply operating leverage to convert small changes in sales into large changes
in a firm’s profitability. Fixed costs are the lever that managers use to take a small
increase in sales and obtain a much larger increase in net income. Having a cost
structure with relatively high fixed costs provides rewards and risks to a firm. With a
high degree of operating leverage, each additional sale decreases the average cost per
unit. Each dollar of revenue becomes pure profit once the fixed costs are covered. This
is beneficial if sales are increasing; however, the reverse is true if sales are decreasing.
With decreasing sales, the fixed costs do not decrease, and profit declines significantly
more than revenue.
In the article, high operating leverage was not working to benefit Reliance Group
Holdings, Inc. Consequently, its stock rating was downgraded.
ISSUE 8-60
“LEVI WILL CUT 20% OF WORK FORCE, SHUT SIX PLANTS IN RESTRUCTURING,” THE
WALL STREET JOURNAL, APRIL 9, 2002, TERI AGINS.
The cost structure is the relative proportion of fixed to variable costs. Outsourcing can
lead to lower fixed costs, if it enables a company to divest of fixed assets (such as plant
and equipment) or eliminate salaried personnel (such as department supervisors). As
fixed costs are reduced, the company moves toward a cost structure with a larger
proportion of variable costs.


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CHAPTER 8

ANSWERS TO REVIEW QUESTIONS

b. In the equation approach, the following profit equation is used:

⎛ unit sales volume ⎞ ⎛ unit variable sales volume ⎞ fixed

This equation is solved for the sales volume in units.

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8-11 The most important assumptions of a cost-volume-profit analysis are as follows:

(1) Expenses can be categorized as fixed, variable, or semivariable.

(2) Efficiency and productivity are constant.

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A firm's operating leverage factor, at a particular sales volume, is defined as its

The weighted-average unit contribution margin is the average of the unit

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Cost-volume-profit analysis can be used to show the effect on profit when

8-22 Activity-based costing (ABC) results in a richer description of an organization's cost

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unit contribution margin

$10X – $6X – $54,000 = $60,000

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Explanatory notes for selected items:

a$135,000 = $90,000 ÷ (2/3), where 2/3 is the contribution-margin ratio.

b$31,250 = $25,000/.80, where .80 is the contribution-margin ratio.

cBreak-even sales revenue ................................................................................ $80,000

Therefore, variable expenses are 25 percent of sales revenue.

When variable expenses amount to $80,000, sales revenue is $320,000.

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Dollars per year

Break-even point: Total expenses

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2. Stadium capacity................................................. 6,000

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Dollars per year

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Budgeted sales revenue

(10)(6,000)(.40)P – (10)(6,000)(.40)($12) – $360,000 = 0

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3. Sales revenue (7,000 × 1,500p) ................................................. 10,500,000p

5. Analysis of price change decision:

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1. (a) Traditional income statement:

(b) Contribution income statement:

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⎛ percentage increase ⎞ ⎛ operating ⎞

EXERCISE 8-29 (30 MINUTES)

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High-quality bicycles.......................................................................................... 30%

5. Target net income:

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1. The following income statement, often called a common-size income statement,

*$300,000 = $1,500,000 × 20%

⎛ percentage increase ⎞ ⎛ operating leverage ⎞

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Requirement (1) Requirement (2)

EXERCISE 8-33 (20 MINUTES)

target after - tax net income

target after - tax net income

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1. Break-even point in sales dollars, using the contribution-margin ratio:

2. Target net income, using contribution-margin approach:

3. New unit variable manufacturing cost = $12 × 110%

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McGraw-Hill/Irwin © 2005 The McGraw-Hill Companies, Inc.

fixed costs + target net profit