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Cost management-final course 1

2. Cost Volume Profit Analysis ( C.V.P. )

Learning Objective
We already know the basic definition & application of P/V ratio, BEP & BES
computation, application of MOS, etc. Here we are discussing some advance
methods of CVP
1. How to compute BE, Margin of safety , Req. sale volume, etc
2. Computation BE with step fixed cost
3. BE under DCF technique
4. BE in Process costing
5. Be with Opportunity cost
6. Potential BE
7. BE Under multi product with common fixed cost
8. BE for perishable product
9. Application of indifference point
Introduction:
Under Marginal costing the product price is determined on the basis of Variable cost of the
product. Such price is selected for the purpose of penetration pricing where the minimum sale
price = variable cost. As the sale price is very low management is always anxious about the
recovery of fixed overhead. So they want to calculate the volume of sales at which fixed cost will
be recovered , profit will arise & the safety margin of the organization , as well as different short-
term decision are to be taken by the management.
Marginal costing is not a distinct method of costing like job costing, process costing, operating
costing, etc. but a special technique used for marginal decision making. Marginal costing is used
to provide a basis for the interpretation of cost data to measure the profitability of different
products, processes and cost centre in the course of decision making. It can, therefore, be used
in conjunction with the different methods of costing such as job costing, process costing, etc., or
even with other technique such as standard costing or budgetary control.
In marginal costing, cost ascertainment in made on the basis of the nature of cost. It gives
consideration to behaviour of costs. In other words, the technique has developed from a
particular concept and expression of the nature and behaviour of costs and their effect upon the
profitability of an undertaking.
Cost-Volume profit analysis:
Cost-volume-profit analysis (as the name suggests) is the analysis of three variable viz., cost,
volume and profit. Such an analysis explores the relationship existing amongst costs, revenue,
activity levels and the resulting profit. It aims at measuring variations of cost with volume. In the
profit planning of a business, cost-volume-profit (C-V-P) relationship is the most significant
factor.
The CVP analysis is an extension of marginal costing. It makes use of principles of marginal
costing. It is an important tool of planning. It is quite useful in making short run decisions.
For this purpose we apply the concept of Marginal Costing. Following definitions are required for
this purpose
Cost management-final course 2
1. Profit Statement Under Marginal Costing
Statement of Profit
Rs. Rs.
Revenue/Sales xxx
Less: Variable cost of production
Material xx
Labour xx
D. Expenses xx
Xx
Add: Opening Finished goods (at MC) xx
Less: Closing Finished goods (at MC) __xx
Variable cost of goods sold xxx
Variable cost of sales
Contribution xx
Less: All types of Fixed cost _xx
( Committed, Discretionary steps ) xx
2. Sales - Variable Cost = Contribution = Fixed Cost + Profit

3. P/V ratio (or C/S ratio) = Contribution Sales
= Contribution per unit Selling price per unit
= Change in Contribution Change in Sales
= Profit Margin of Safety
4. Profit = (Sales P/V ratio) - Fixed Cost = P/V ratio Margin of Safety sales(Rs.)
= Contribution p.u. Margin of safety ( in units)
5. Break-even Point
a. Break Even point (in units) = Fixed Cost Contribution per unit
b. Break Even Sales ( in sales value ) = Fixed Cost P/V ratio
c. with semi - variable cost : apply the concept of apparent BEP

d. Composite BEP i.e. more than one product with common fixed costs
(i) With out limiting factor ( non- attributable to a single product )
BEP in units = Fixed cost Average contribution p.u.
( when sales mix in units are given )
BEP in Rs. = Fixed cost composite p\v ratio
( when sales mix in rupee are given )
where composite p\v ratio = [ Sales Mix P\V Ratio ]
(ii) With limiting factor ( attributable to a single product )
Cost management-final course 3
Find contribution per limiting factor & give rank . Find total
contribution from 1
st
rank product . Calculate the amount of fixed
cost still to recover. Whether it can be recovered by 2
nd
rank product
or not ?
(iii) For Perishable product apply the same concept in case of opening
stock with different variable cost.
e. BEP in case of process costing is expressed in terms of total raw material input
f. In capital budgeting , BEP is that sales volume where discounted Cash in flow =
discounted Cash out flow. In case of perpetuity , the financing charge p.a.= CIF
pa
g. Potential BE : On the basis of sales out of current period production only.
h. Multiple BE : Different BE due to change in sales price, variable costs & fixed
costs for different production level.
i. Cash BEP = Cash fixed cost contribution p.u. So do not consider the sunk cost.
j. BEP for decision making purpose : Accept that proposal where BEP is lowest
provided the profit can not be calculated.
We already know the basic definition & application of P/V ratio, BEP & BES computation,
application of MOS. Here we are discussing some advance methods of CVP i.e. mainly from
Rule 5c
Problem 1
From the under mentioned figures calculate:
(i) P/V ratio and the total fixed expense;
(ii) Profit or loss arising from the sales of Rs. 12,000;
(iii) Sales required to earn a profit of Rs. 2,000;
(iv) Sales required to break-even.

Sales profit
Rs. Rs.
First period 14,433 385
Second period 18,203 1,139
Solution
(i) P/V ratio and total fixed expenses
First Second
Period period increase
Rs. Rs. Rs.
Sales 14,433 18,203 3,770
Less: profit ___385 _1,139 __754
Total costs 14,048 17,064 3,016
Assuming the variable unit cost per unit and fixed expenses to be the same and that the prices
are stable in both the period, the increase in total cost of Rs. 3,016 consists of variable costs
only. For an increase in the sales of Rs. 3,770 the variable cost is Rs. 3,016. Hence P/v ratio is
Cost management-final course 4
100
770 , 3 .
016 , 3 . 770 , 3 .
x
Rs
Rs Rs
= 20%
Taking the figures relating to period 1.
Rs.
Gross margin (Rs. 14,433 20%) 2,887
Less: Profit for period 1 __385
Fixed expenses 2,502
(ii) Profit or loss on sales of Rs. 12,000
Rs.
Gross margin on this sale (Rs. 12,000 20%) 2,400
Less: Fixed expenses 2,502
Loss __102
(iii) Sales required to earn a profit of Rs. 2,000.
Contribution required = fixed expenses + profit
= Rs. 2,502 + Rs. 2,000
= Rs. 4,502
The sales, should produce a gross margin of Rs. 4,502
Hence, sales value = 100
20
502 , 4 .
x
Rs
= Rs. 22,510
(iv) Sales required to break-even:
At BEP gross margin is equal to fixed expenses
So, gross margin required = Rs. 2,502
Sales required = ----------------------- = 100
20
502 , 2 .
x
Rs
______________
Problem 2
Paramount Food products is a new entrant in the market for chocolates. It has introduced a new
product Sweetee. This is a small rectangular chocolate bar. The bars are wrapped in
aluminum foil and packed in attractive cartons containing 50 bars. A carton is, therefore,
considered the basic sales unit. Although management had made detailed estimates of costs
and volumes prior to undertaking this venture, new projects based on actual cost experience are
now required.
Income statements for the last two quarters are each thought to be representative of the costs
and productive efficiency we can expect in the next few quarters. There were virtually no
inventories on hand at the end of each quarter. The income statements reveal the following:
First Quarter Second Quarter
Sales Rs. Rs.
50,000 Rs. 24 12,00,000 16,80,000
70,000 Rs. 24 cost of Goods sold ___7,00,000 __8,80,000
Gross Margin 5,00,000 8,00,000
Net income (loss) before taxes (1,50,000) 1,10,000
Tax (negative) ___(60,000) ___44,000
Rs. 2,502
P/V ratio
Cost management-final course 5
Net income (Loss) __(90,000) __66,000
The firms overall marginal and average income tax rate is 40%. This 40% figures has been
used to estimate the tax liability arising from the chocolate operations.
Required:
(a) Management would like to know the break even point in terms of quarterly carton sales
for the chocolates.
(b) Management estimates that there is an investment of Rs. 30,00,000 in this product line.
What quarterly carton sales and total revenue are required in each quarter to earn an after
tax return of 20% per annum on investment?
(c) The firms marketing people predict that if the selling price is reduced by Rs. 1.50 per
carton (Re. 0.03 off per chocolate bar) and a Rs. 1,50,000 advertising campaign among
school children is mounted, sales will increase by 20% over the second quarter sales.
Solution
Basic calculations
(a) Variance Mfg. Cost per carton = Change in cost/ change in output
=
000 , 50 000 , 70
000 , 00 , 7 000 , 80 , 8

= 1,80,000 20,000 = Rs. 9 per carton

(b) Fixed Mfg. Cost = Fixed manufacturing cost + Variable manufacturing
cost
cost of goods sold = Rs. 7,00,000 Rs. 4,50,000
= Rs. 2,50,000
(c) Variable selling & Admn. cost
per carton = Change in cost/ change in output
=
000 , 50 000 , 70
000 , 50 , 6 000 , 90 , 6

= Rs. 40,000 /Rs. 20,000 = Rs. 2 per carton

(d) Fixed selling and Admn. cost = 6,50,000 1,00,000 = Rs. 5,50,000
(e) Total Fixed costs = Rs. 2,50,000 + Rs. 5,50,000 = Rs. 8,00,000
(f) Quarterly Break even point
(in cartons) = Fixed costs/ contribution per carton
= 8,00,000 /13 = 61,539 cartons
(b) Desired annual return after tax = Rs. 6,00,000
(ii) Desired quarterly return after tax = 6,00,000 /4 = Rs. 1,50,000
(iii) Desired quarterly return before tax
(Tax rate 40%) = 000 , 50 , 2 .
60
100 000 , 50 , 1 .
Rs
x Rs

Quarterly sales for Desired return

In cartons = -----------------------------------------
= cartons 769 , 80
13
000 , 50 , 2 000 , 00 , 8

+
Quarterly sales revenue = 80,769 Rs. 24 = Rs. 19,38,456
(c) New selling price per carton = Rs. 24 Rs. 1.50 = Rs. 22.50
New contribution per unit = Rs. 22.50 Rs. 13 = Rs. 11.50
Fixed Costs + Desired Return
Contribution per carton
Cost management-final course 6
New sales: 70,000 + 14,000 = 84,000 cartons
Total new contribution = 84,000 Rs. 11.50 = Rs. 9,66,000
Less: Fixed costs (8,00,000 + 1,50,000) Rs. 9,50,000
Rs. 16,0000
Less: Tax (40%) ____6,400
Net income after tax ____9,600
The firm made a net income after tax of Rs. 66,000 at a selling price of Rs. 24. The reduction in
selling price increases in sales volume but decreases the net income after tax to Rs. 9,600.
Hence, the plant to reduce the selling price should not be implemented by the management.
_____________
Problem 3 : BE with linear semi-variable cost
Bottom line ltd.. manufactures pressure cookers the selling price of which is Rs. 300/- per unit.
Currently the Capacity utilisation is 60% with a sales turnover of Rs 18 lakhs. The Cc. proposes
to reduce the selling price by 20% but desires to maintain the same profit position by increasing
the output. Assuming that the increased output could be made and sold, determine the level at
which the Co. should operate, to achieve the desired objective.
The following further data are available :
i) Variable cost per unit Rs. 60/-.
ii) Semi-variable cost (including a variable element of Rs. 10/- per unit) Rs. 1,80,000.
iii)Fixed cost Rs.3,00,000 will remain same up to 80% level. Beyond this an additional amount of
Rs. 60,000 will be incurred.
Solution
Present Proposed
Rs./unit Rs. /unit
Selling price/unit 300 240
Less: Variable cost/unit- Variable 60 60
- Semi variable _10 _70 10 _70
(a) Contribution 230 170
(b) Fixed cost: (up to 80%)
Fixed cost 3,00,000
Fixed cost in semi variable 1,20,000
4,20,000
(c) Sales volume 6,000 units
Profit = 6,000 230 4,20,000
= Rs. 9,60,000
Required contribution at present is 13,80,000.
Required sales = (13,80,000 170) = 8,117 = 81.18%
But as it is 80%.
Required contribution (Revised) = Rs. 14,40,000
Required sales = 14,40,000 170 = 8471 = 84.71%
Cost management-final course 7
BE in case of combination of business
Step-1:
Calculate the sales, variable cost, contribution, Fixed cost and profit of the existing
companies at 100% capacity from the given data.
Step-2:
Find the above items for the new companies by adding the results of the existing company
(Prepare one chart for above two steps)
Step-3:
Find the P/V ratio of the new Co. and give answer of the corresponding question.
Problem 4:
I co. & II co. have decided to merge into one company. The operating details of two companies
are as follows:
Company I Company II
Percentage of capacity utilisation 90 60
Sales (Rs.) 5,40,00,000 3,00,00,000
Variable costs (Rs.) 3,96,00,000 2,25,00,000
Fixed costs (Rs.) 80,00,000 50,00,000
Assuming that these two companies merge into one, determine
a. The break-even sales of the merged company :
b. The turnover of the merged company required to earn a profit of Rs. 75,00,000, and
c. The percentage increase in selling price necessary to sustain an increase in fixed overheads
by 5% when the merged company is working at a capacity to earn a profit of Rs. 75,00,000.
Solution
(a) Old Company New Co.
Co1 Co2 Co3
Capacity utilization 100% 100% 100%
Rs. Rs. Rs.
Sales 600 L 500 L 1,100 L
Less: Variable cost 400 L 375 L 815 L
Contribution 160 L 125 L 285 L
Fixed cost 80 L 50 L 130 L
Profit 80 L 75 L 155 L
P/V ratio (Contr. Sales) 26.67% 25% 25.91%
(a) BES of merger Co. = (Fixed cost PV ratio) = 130 25.91% = 5,017,3,678
(b) Contribution at 80% = 285 80% = 228 L
Less: Fixed cost _130 L
Profit 98 L
Profitability =
100
% 80 100 , 1
98
x
x
L
= 11.14%
(b) Rs.
Required profit 75,00,000
Contribution 2,05,00,000
Cost management-final course 8
Required (2,05,00,000 25.91%) = 7,91,20,031 or 791.20 lakhs
Capacity utilization = (791.2 11,00,00,000) = 71.93%
(c) Increase in Fixed cost = 5% of 1,30,00,000 (130 lakhs)
= 6.5 lakhs
Now the present capacity, sale volume 4 profits will remain same at 71.93%.
Increase in fixed cost = Increase in sales price
= Rs. 6,50,000
% increase in sales = (6,50,000 7,91,20,031) 100 = 0.82%
Multi product BES with the help of profit graph
Profit graph
Profit graph is a special type of break even chart which shows the profit or loss at different
levels of output.
In the following example:
OA = Total fixed expenses C = Break even point
Y
B
Profit
0 c
Loss
x
Sales
A
F
Single product profit graph
The profit or loss can be calculated by using following
When sales are at zero, the total loss is equal to fixed expenses which is equal to OF. The loss
diminishes as the output increases , the break even point will occur first and then the firm starts
earning profits as the output increases beyond the break even point.
When more than one products ( say 3 products A, B &C) are manufactured, the Profit graph can
be so drawn as to show the cumulative effects of the profit and losses. It helps to identify multi
product BES & BEP as shown below
Cost management-final course 9

Y C
Profit Line of each product
B
Profit
O X
BEP Sales value
A
Average Profit Line
F
Y
Multi product profit graph
.
To draw the above diagram , following steps are required --
Step-1: Compute P/V ratio for each product & give rank.
Step-2: Calculate cumulative sales & cumulative profit on the basis of the above ranking.
Step-3: Identify the points on the basis of cumulative sales (x) & cumulative profit (y). Join
the points with same line and identify the specific BES.
Step-4: Join the start & end point with a single straight line to find arrange Break even
sales
Problem 5
The following are the cost and the sales data manufacturer selling three products X, Y and Z.
Product Selling price p.u. Variable cost p.u. % of Sales (Rs.)
Rs. Rs.
X 400 325 20
Y 500 350 40
Z 850 740 40
Capacity of the manufacturer : Rs. 80 lakhs sales volume. Annual fixed cost : Rs. 5,50,000.
i) Find the break-even point in rupees.
ii) Calculate his profit or loss at 90% of capacity.
Solution
Note-1: computation of ranks
(a) (b) a-b = c (c) (a) 100
Product Sales/unit VC/unit contribution PV ratio Rank
X 400 325 75 18.35 II
Y 500 350 150 30 I
Z 850 740 110 12.94 III
Cost management-final course 10
Note 2; Calculation of cumulative sales & Profit
Rank Product Sales Sales Contribution Contribution profit
Rs. Rs. Rs. Rs. Rs.
I Y 80 L 40% 32 L 9.6 9.6 4.1
32 L
II X 80L 20% 48L 3 12.6 7.1
III Z 32 L 80 L 4.14 16.74 11.24
Average PV ratio = 0.2 18.75% +0.4 30% +0.4 12.94
= 20.926%
BES = Fixed cost Avg. P/V ratio = 5.5 Lakhs 20.926% = 26,28,309
Problem 6
(a) Calcutta Company Ltd. manufactures and sells four types of products under the
brand names, ACE, UTILITY, LUXURY and SUPREME. The sales mix in value
comprise of:
Brand Percentage
Ace 33.3333%
Utility 41.6667%
Luxury 16.6667%
Supreme __8.3333%
__100%
The total budgeted Sales (100%) are Rs. 6,00,000 per month. The operating costs
are :
ACE 60% of selling price UTILITY 68% of selling price
LUXURY 80% of selling price SUPREME 40% of selling price.
The fixed costs are Rs. 1,59,000 per month. Calculate the break-even point for the
products on an overall basis.
b) It has been proposed to change the sales mix as follows, the total sales per month
remaining Rs. 6,00,000 :
Brand Percentage
ACE 25%
UTILITY 40%
LUXURY 30%
SUPREME ____5%
__100%
Assuming that this proposal is implemented, calculate the new break-even point.
Solution
(a) Computation of the break even point on Overall Basis
ACE UTILITY LUXURY SUPREME Total
Sales Mix 33-1/3% 41-2/3% 16-2/3% 8-1/3% 100%
Rs. Rs. Rs. Rs. Rs.
Sales 2,00,000 2,50,000 1,00,000 50,000 6,00,000
Less: Variable cost (operating)1,20,000 1,70,000 __80,000 __20,000 3,90,000
Contribution 80,000 80,000 20,000 30,000 2,10,000
Contribution
Cost management-final course 11
Overall P/V ratio = 100
Sales
Rs. 2,10,000
= 100
Rs. 6,00,000
= 35%
Break-even Point (Sales Value)
Total Fixed costs
= -----------------
Composite P/V ratio
Rs. 1,59,000
=
35%
= Rs. 4,54,286
(b) Computation of New Break-even Point
ACE UTILITY LUXURY SUPREME Total
Sales Mix 25% 40% 30% 5% 100%
Rs. Rs. Rs. Rs. Rs.
Sales mix 1,50,000 2,40,000 1,80,000 30,000 6,00,000
Less Variable costs 90,000 1,63,200 1,44,000 12,000 4,90,000
----
Contribution 60,000 76,800 36,000 18,000 1,90,800
Rs. 1,90,800
New P/V Ratio = 100 = 31.8%
Rs. 6,00,000
Net Break-even point (Sales value)
Rs. 1,59,000
= = Rs. 5,00,000
31.7%
_______________
Problem 7
Major Ltd. manufactures a single product X whose selling price is Rs. 40 per unit and the variable
cost is Rs. 16 p.u. If the Fixed Costs for this year are Rs. 4,80,000 and the annual sales are at
50% margin of safety, calculate the rate of net return on sales, assuming an income tax level of
40%.
For the next year, it is proposed to add another product line Y whose selling price would be Rs.
50 per unit and the variable cost Rs. 10 per unit. The total fixed costs are estimated at
Rs.6,66,600 . The sales mix of X : Y would be 7: 3 . At what level of sales next year, would the
co. break even? Give separately for both X and Y the break even sales in rupees and quantities.
Solution
(a) Product X Rs. p.u.
Sales 40
Less: Variable cost _16
Contribution 24
P/V ratio = {(Contribution/u Selling price/unit) 100} = ({24 40) 100} = 60%
Cost management-final course 12
BES = 4,80,000 60% = Rs. 8,00,000
Actual sales = 16,00,000 (there is 50% margin of sales)
BES +MOS = Actual Sales
Profit = P/V ratio MOS (is Rs.)
= 60% 8,00,000 = 4,80,000
Net return on sales = {4,80,000 16,00,000 100 (1-0.4)} = 18%
Margin of safety = 50% of sales
PAT Sales = (MOS Sales) P/V ratio (1-t)
= 50% of 60% (1-0.4) = 18%
(b) Y X
Rs. p.u. Rs. p.u.
Selling price/unit 50 40
Less: Variable cost/unit _10 _16
Contribution per unit 40 24
P/V ratio 80% 60%
Case-I:
Sales mix in Rupee terms
Avg. P/V ratio = 66% (7/10 60% +3/10 80%)
BES = 6,66,600 66% = Rs. 10,10,000
BES RS. BEP (in units)
X 70,7,000 40= 17,675
Y 30,3,000 50 =_6,060
10,10,000 23,735
Case-II:
Sales mix in units 7 : 3
Average contribution = {(7 24 +3 40) 10} =28.8
BEP = 6,66,600 28.8 = 23,147
BES Sales
X (7/10) 16,203 64,8,120
Y (3/10) _6,944 34,7,200
23,146 99,5,320
Missing Figure problems:
Problem 8
A single product company furnishes the following data :
Year 1. Year 2
Sales Rs.24,00,000 ?
PV ratio 33 1/3% 30%
Margin of safety 25% 40%
While there was no change in the volume of sales in year 2, the selling price was reduced.
Calculate the sales, fixed costs and profit for year 2.
Cost management-final course 13
Solution Year 1 Year 2
Rs. Rs.
(a) Sales 24,00,000 22,85,715
(b) Variable cost [a (1-P/V)] 16,00,000 16,00,000
(c) Contribution 8,00,000 6,85,715
(d) Fixed cost (Bal fig.) 6,00,000 4,11,425
Profit 2,00,000 2,74,286
= Sales MOS% PV 22,85,715 30% 40%
= 24,00,000 25% 33% = 2,74,286
= 2,00,000
In year 2
Variable cost Sales = 70%
16,00,000 Sales = 70%
Sales = 22,85,715.
Problem 9
Titan Engineering is operating at 70% capacity and presents the following information:
Break even point Rs. 20 crores
P/V ratio 40 per cent
Margin of safety Rs. 50 crores
Titan management has decided to increase production to 95% capacity level with the following
modifications:
(i) The selling price will be reduced by 8 per cent.
(ii) The variable cost will be reduced by 5 per cent on sales.
(iii) The fixed cost will increase by RS. 20 crores, including depreciation on additions, but
(iv) Additional capital of Rs. 50 crores will be needed for capital expenditure and working
capital.
Required:
(a) Indicate the sales figure, with the working, that will be needed to earn Rs. 10 crores over
and above the represent profit and also meet 20% interest on the additional capital.
(b) What will be the revised:
(i) Break even point; (ii) P/V ratio; and (iii) Margin of safety? (CA final, Nov. 1991)
Solution
Statement of revised profit & sale
Present Change Proposed
Rs. (cr.) (Rs. in lakhs)
(a) BES 200 (f b) 244.44
(b) MOS __50 (g d) 66.67
(c) Total sales 250 311.11
(d) P/V ratio ( Note1 ) 40% 45%
(e) Variable cost Sales 60% reduce 55%
5% of sales
(f) Fixed cost (a d) 80 200 Cr. +10 Cr. 110 G
(50 cr. 20%)
(g) Profit (b d) Rs. 20 cr. 10 cr. 30 cr.
Cost management-final course 14
Working note - 1
Total sales = Break even sales + Margin of safety
= Rs. 200 crores + Rs. 50 croes = Rs. 250 crores.
P/V ratio = 40% of sales
Variable cost ( Present) = 60% of sales
( Pro[osed) = 55% of sales
Revised P/V ratio = ( 40 + 5 ) % = 45% of sales
Effect of opportunity cost in break even analysis
When for a new proposal/alternative use current income will be lost or additional cost is to be
incurred then these are known as opportunity cost of the new proposal. In other word the
minimum price for the new proposal = variable cost of the alternative + lost income under present
situation +discretionary fixed cost (if any).
The Lost income is generally loss of contribution.
Problem 10
A newspaper presently sales 1,00,000 copies of its morning daily. It wants to publish evening
daily. Particulars are :
Actual for Morning Estimates for Evening
Sale price Rs.2 per paper Re.0.50 per paper
Variable cost Rs.1.20 per paper Re.0.22 per paper
Fixed cost Rs.2.4 lakhs per week Rs.10,000 per week
Sale of morning daily will fall @ 1 copy for-every 10 copies sold of evening daily. Calculate
break-even sales for evening daily per week. What should the minimum price for evening daily.
Solution
Sales price 2.00
Less: Variable cost 1.20
Contribution 0.80
Sales of morning daily fall @ 1 company for 10 copies sold in the evening.
Contribution lost per copy of evening sales = (0.8 10) = 0.08
Revised Variable cost for evening paper = 22+0.08 = 0.3/paper
Revised contribution = (0.5-0.3) = 0.2/paper.
PV ratio = Contribution/paper Sales/paper = (0.2 0.5) 100 = 40%
Fixed cost P/V ratio
BES = 10,000 40% = Rs. 25,000
Or
Morning daily contribution/unit = 0.8
For evening daily:
Selling price/unit 0.5
Variable cost/unit 0.22
Cost management-final course 15
Opportunity cost (8 10) 0.08
Contribution 0.2
PV ratio 40%
Fixed cost 10,000
BES = (10,000 40%) = Rs. 25,000
Minimum price = Variable cost/unit +Opportunity cost + Fixed cost
= (0.22+0.08) p.u. +Fixed cost 10,000 = 30 P. per unit + 10,000 (Fixed cost).
_____________
Break Even Analysis in Step Fixed Cost situation
Due to presence of step cost more than one BEP can arise as shown below
Rs. Revenue
Slab 4
BEP 2
BEP-1 Slab 3
Slab 2
Slab 1
Sales volume (in units)
So in the above diagram the revenue line may cut the total cost line more than once. This is
known as Multiple BEP situation, as 1
st
BEP, 2
nd
BEP etc. For this purpose we prepare BE
statement as below.
Problem 10
Variable cost/unit = Rs 30
Fixed cost = Rs. 3,000
Step fixed cost = Rs. 1,000 for every 50 units or part there of
Selling price p.u. = Rs. 95
Find a BE statement & find BEP
Solution
Break-even statement
(a) Step/slab 1 2 3 4 5
(b) Prod. range 0-50 51-100 101-150 151-200 201-250
(c) Fixed cost (Rs.) 3,000 3,000 3,000 3,000 3,000
(d) Slab fixed cost (Rs.) 1,000 2,000 3,000 4,000 5,000
(e) Total fixed cost (c+ d) 4,000 5,000 6,000 7,000 8,000
(f) Contribution p/u 65 65 65 65 65
(SP-Vc p.u.)
(g) BEP (e/f) 62 77 93 108 123
Nature of BEP Fict. Real Fict. Fict. Fict.
Cost management-final course 16
Production range in 0-50 but BEP in 62. Iit is a fictitious situation as BEP is outside the range.
When the amount of fixed cost is very high then we have to find the 1
st
slab no. where rev
& total cost line will intersect. Otherwise we can solve it by statement method as a trial-
error method.
Steps to be followed to find the 1
st
slab no .
1. Prepare an algebraic equation in the concept of BE and find the value of x.
2. find slab no where Slab no. or step no. = value of x from above step by units per slab.
3. now identify total fixed cost
4. BEP = Total fixed cost Contribution per unit
Problem 11
Fixed cost = Rs. 3,000
Step fixed cost = Rs. 1,000 for every 50 units or part there of
Contribution p.u. = Rs. 57
Find BEP
Solution
Let X is the product volume which indicate slab in which 1
st
BE occurs
So, total contribution = fixed cost + step or slab fixed cost
57x = 3,000+ {(1,000 50)x}
57x = 3,000 +20x
37 x = 3,000
x = 81.08
Slab no/step no = (81.08 50/slab) = 1.62 i.e. 2
nd
slab.
Total fixed cost 3,000+2 1,000 = Rs. 5,000
Hence BEP = 5,000 57 = 87.71 i.e. 88 units
So, we can apply this technique for any amount of fixed cost and once we get the 1
st
break even
then we prepare the BE statement identify the real and fictitious BEP.
Problem 12
Now assume fixed cost is Rs. 30,00,000.
Step cost 1,000 per 50 units.
Contribution p.u. is Rs. 57.Prepare a break even statement.
Solution
57x = 30,00,000 + {(1,000 50)x}
37x = 30,00,000
x = 81,081.08
Slab no = (81,081.08 50 units/slab) = 1,621.62 i.e. 1,622 slab.
Fixed cost = 30,00,000 +1,622 1,000
= 46,22,000
BEP = (Total fixed cost Contribution/unit) = 46,22,000 57 = 81,088 units
Cost management-final course 17
BE statement
(a) Step/slab 1,621 1,622 1,623 1,624 1,625
(b) Prod. range 81,001-81,050 81,051-81,100 81,101-81,150 81,151-81,200 81,201-81,250
(c) Fixed cost (Rs. in lakhs) 30 30 30 30 30
(d) step fixed cost (Rs.) 16.21 16.22 16.23 16.24 16.25
(e) Total fixed cost (c+ d) 46.21 46.22 46.23 46.24 46.25
(f) Contribution p/u 57 57 57 57
(SP-Vc/u)
(g) BEP (e/f) 81,071 81,088 81,106 81,123 81,141
Nature of BEP Fict. Real Real Fict. Fict.
Problem 13
If required profit is Rs. 5,00,000 in the last case ( Problem 12, ) find the required sales volume.
Let volume = x for required profit.
Total contribution = Total Fixed cost + req. profit
57x = 30,00,000+ {(1,000 50)x} +5,00,000
37x = 35,00,000
x = 94,594.59
Step no. = (94,594.59 50) = 1,892
Fixed cost = 30,00,000+ 1,892 1,000
= 48,92,000
Contribution = 53,92,000
Required sales = 53,92,000 57 = 94,597 units.
Problem 14
Kalyan University conducts a special course on Computer Application for a month during
summer. For this purpose, it invites applications from graduates. An entrance test is given to the
candidates and based on the same, a final selection of a hundred candidates is made. The
Entrance Test consists of four objective type examinations and is spread over four days, one
examination per day. Each candidate is charged a fee of Rs. 500 for taking up the entrance test.
The following data was gathered for the past tow years.
Statement of Net Revenue from the Entrance Test For the Course of Computer Application
2004 2005
Gross Revenue (Fees Collected) Rs. 10,00,000 Rs. 15,00,000
Costs: Valuation 4,00,000 6,00,000
Question Booklets 2,00,000 3,00,000
Hall Rent at Rs. 20,000 per day 80,000 80,000
Salary 60,000 60,000
Supervision Charges (one supervisor for every
100 candidates at the Rate of Rs. 500 per day) 40,000 60,000
Total Cost 8,40,000 11,60,000
Net Revenue 1,60,000 3,40,000
You are required to compute:
(a) The budgeted net revenue if 4,000 candidates take up the entrance test in 2006.
Cost management-final course 18
(b) The break-even number of candidates.
(c) The number of candidates to be enrolled if the net income desired is Rs. 20,000
Solution
(a) Budgeted net revenue statement for 4,000 candidates in 06
Gross revenue (Fees collected) (4,000 500) 20,00,000
Costs: Valuation 8,00,000
Question booklets 4,00,000
Hall rent @ Rs. 20,000/day 80,000
Salary 60,000
Supervision charges 80,000
(500 40 4)
Net revenue _5,20,000
(b) Total contribution = 20,00,000 12,80,000 = Rs. 7,20,000
Contribution per candidate = 7,20,000 4,000 = Rs. 180
BEP (in units) = (F.C. Contribution per unit) = 2,00,000 180 = 1,112 units.
For BEP
(500-300)x = 2,00,000 +{(2,000 100) x}
Slab no. = 1,112 100 = 12
th
slab
Fixed cost = 2,00,000+ 12 2,000
= 2,24,000
BEP = 2,24,000 200 = 1,120 candidates
(c) Revised income = 20,000
200x = 2,00,000 + (2,000 100) +20,000
x = 1,233
Slab no = 1,233 100 = 13
th
slab.
Total fixed cost = 2,20,000 + 13 2,000
= 2,46,000
Resale = 2,46,000 200 = 1,230 candidates.
Problem 15
Satish Enterprises are leading exporters of Kids Toys. J. Ltd. of U.S.A. have approached Satish
Enterprises for exporting a special named Jumping Monkey. The order will be valid for next
three years at 3,000 toys per month. The export price of the toy will be \$4.
Cost data per toy is as follows:
Rs.
Materials 60
Labour 25
Primary packing of the toy 15
The toys will be packed in lots of 50 each. For this purpose a special box, which will contain the
50 toys will have to be purchased, cost being Rs. 400 per box.
Satish Enterprises will also have to import a special machine for making the toys. The cost of the
machine is Rs. 24,00,000 and duty thereon will be at 12%. The machine will have an effective
Cost management-final course 19
life of 3 years and depreciation is to be charged on straight-line method. Apart from depreciation,
annual fixed overheads is estimated at Rs. 4,00,000 for the first year with 6% increase in the
second year. Fixed overheads are incurred uniformly over the year.
Assuming the average conversion rate to be Rs. 50 per \$, you are required to:
(i) Prepare monthly and yearly profitability statements for the first year and second year
assuming the production at 3,000 toys per month.
(ii) Compute a monthly and yearly break-even units in respect of the first year.
(iii) In what contingency can there be a second break-even point for the month and for the year
as a whole?
(iv) Have you any comments to offer on the above?
Solution
(i) Profit Statement of Satish Enterprise for first and second year on monthly and yearly basis
First year Second year
Monthly Yearly Monthly Yearly
Rs. Rs. Rs. Rs.
Sales revenue (A): 600 7,200 600 7,200
(3,000 units Rs. 200)
Material cost 180 2,160 180 2,160
(3,000 units Rs. 60)
Labour cost 75 900 75 900
(3,000 units Rs. 25)
Variable overheads 60 720 60 720
(3,000 units Rs. 20)
Primary packing cost 45 540 45 540
(3,000 units Rs. 15)
Boxes costs 24 288 24 288

,
`

.
|
units
units
50
000 , 3
Rs. 400
Total fixed overhead 108 1,296 110 1,320
(Refer to working note 1)
,
`

.
|
months
Rs
12
296 , 1 .

,
`

.
|
months
Rs
12
320 , 1 .
Total cost (B) 492 5,904 494 5,928
Profit: C = {(A B)} 108 1,296 106 1,272
Working note:
1. Fixed overhead: First year: (Rs.) Second year: (Rs.)
Depreciation 8,96,000 8,96,000

'

'
+
years
duty Rs Rs
3
000 , 88 , 2 . 000 , 00 , 24 .
Cost management-final course 20
(ii) Statement of monthly break-even units of the first year
Levels-no. of units 1351-1,400 1401-1,450 1,451-1,500 1501 1550
(Refer to working note) Rs. Rs. Rs. Rs.
Fixed costs: (A)
Total fixed overheads p.m. 1,08,000 1,08,000 1,08,000 1,08,000
(Refer to working note)
Semi-variable costs:
(Special boxes cost) (B) 11,200 11,600 12,000 12,400
(28 boxes (29 boxes (30 boxes (31 boxes
Rs. 400) Rs. 400) Rs. 400) Rs. 400)
Total fixed & semi-variable 1,19,200 1,19,600 1,20,000 1,20,400
Cost: (A +B)
Break-even level of units: 1,490 1,495 1,500 1,505
(Total fixed & semi variable cost/
Contribution per unit) (Rs. 1,19,200/ (1,19,600/ (1,20,000/ (1,20,400/
Rs. 80) Rs. 80) Rs. 80) Rs. 80)
The first and second break-even level of units viz. 1,490 and 1,495 units falls outside the range
of 1,351 1,400 and 1,401 1,450 units respectively. Here a monthly break-even level of units is
1,500 units which lies in the range of 1,451 1,500 units.
Statement of yearly break-even points of the first year
Levels-no. of units 17851-17900 17901-17950 17951-18000 18001-18050
Rs. Rs. Rs. Rs.
Fixed costs: (A) 12,96,000 12,96,000 12,96,000 12,96,000
Semi-variable costs: 1,43,200 1,43,600 1,44,000 1,44,400
(Special boxes cost) : (B) (358 boxes (359 boxes (360 boxes (361 boxes
400) 400) 400) 400)
Total fixed & semi-variable
Costs: (A +B) 14,39,200 14,39,600 14,40,000 14,40,400
Break-even level units: 17,990 17,995 18,000 18,005
(14,39,200/ (14,39,600/ (14,40,000/ (14,40,000/
Rs. 80) Rs. 80) Rs, 80) Rs. 80)
Here the break-even level of units (on yearly basis) is 18,000 units, which lies in the range of
17951-18,000 units as well. The other two figures do not lie in the respective range, so they are
rejected.
Working Notes:
Rs.
1. Fixed overheads in the first year 12,96,000
Contribution per unit (S.P. per unit V.C. per unit)
(Rs. 200 Rs. 120) 80
Hence the break-even no. of units will be above 1,350 units
,
`

.
|
80 .
000 , 108 .
Rs
Rs
2. If the no. of toys goes beyond 1,500 number, one more box will be required to accommodate
each 50 additional units of toys. In that case the additional cost of a box will be Rs. 400/-.
This amount can be recovered by the additional contribution of 5 toys. Hence, the second
break-even point in such a contingency is 1,505 toys. (Refer to 1(b) (ii) last column of first
statement).
Cost management-final course 21
If the number of toys goes beyond 18,000 number, one more box will be required. The
additional cost of this box will be Rs. 400; which can be recovered by the additional
contribution of 5 toys. Hence the second break-even point is 18,005 toys (Refer to 1(b) (ii)
last column of 2
nd
statement).
3. Comments: Yearly break-even point of 18,000 units of toys in the first instance is equal to 12
times the monthly break-even point of 1,500 units, because the monthly and yearly figure of
break-even point fell on the upper limit of the respective range.
_________________
Problem 16 ( with opp. cost & sunk cost )
You have been approached by a friend who is seeking your advice as to whether he should give
up his job as an engineer, with a current salary of Rs. 15,000 per month and go into business on
his own, assembling and selling a component which he has invented. He can procure the parts
required to manufacture the component from a supplier.
It is very difficult to forecast the sales potential of the component, but after some research, your
friend has estimated the sales as follows:
(i) Between 600 to 900 components per month at a selling price of Rs. 250 per component.
(ii) Between 901 to 1,250 components per month at a selling price of Rs. 220 components for
the entire lot.
The costs of the parts required would be Rs. 140 for each completed component. However if
more than 1,000 components are produced in each month, a discount of 5% would be received
from the supplier of parts on all purchases.
Assembly costs would be Rs. 60,000 per month up to 750 components. Beyond this level of
activity assembly costs would increase to Rs. 70,000 per month.
Your friend has already spent Rs. 30,000 on development, which he would written-off over the
first five years of the venture.
Required:
(i) Calculate for each of the possible sales levels at which your friend could expect to benefit by
going into the venture on his own.
(ii) Calculate the break-even point of the venture for each of the selling price.
Solution
Working note-1: identification of range of production
(a) Selling price/unit Rs 250 220
Volume 600-900 901-1,250
(b) Variable cost/unit Rs 140 133
Volume 600-1,000 1,001-1,250
(c) Fixed cost Rs 75,000 85,000
(60,000+15,000) 600-750 1,001-1,250
Cost management-final course 22
Statement of Break even
(a) Prod. range/unit 600-750 751-900 901-1,000 1,001-1,250
Rs. Rs. Rs. Rs.
(b) Selling price/unit 250 250 220 200
(c) Less: VC/unit 140 140 140 133
(d) Contribution/unit 110 110 80 87
(e) Fixed cost 75,000 85,000 85,000 85,000
(f) BEP 682 773 1,063 978
Nature of BEP Real Real Fictitious. Fictitious.
Max Profit (110 750-75,000) 7,500 14,000 -- 23,750
The product should be launched and production volume should set at 1,250 units. This type of
BEP is called cash BEP as the non cash items are already eliminated.
Note ; Rs. 30,000 spent on development--- sunk cost
Current salary of Rs. 15,000 opp. cost
Problem 17
Navbharat Commerce college, Bombay has six sections of B. Com, and two sections of M. Com
with 40 and 30 students per section respectively. The college plans one day pleasure trip around
the city for the students once in an academic session during winter break to visits part, Zoo,
planetarium and aquarium.
A transporter used to provide the required number of buses at a flat rate of Rs. 700 per bus for
the aforesaid purpose. In addition, a special permit fee of Rs. 50 per bus is required to be
deposited with city Municipal Corporation. Each bus is 52 setters. Two seats are reserved for
teachers who accompany in each bus. Each teacher is paid daily allowance of Rs. 100 for the
day. No other costs in respect of teachers are relevant to the trip.
The approved caterers of the college supply breakfast, lunch and afternoon tea respectively at
Rs. 7, Rs. 30 and Rs. 3 per student.
No entrance fee is charged at the park. Entrance fees come to Rs. 5 per student both for the zoo
and the aquarium. As regards planetarium the authorities charges block entrance fees as under
for group of students of educational institutions depending upon the number of students is group:

No. of students in a group Block entrance fee
Rs.
Up to 100 200
101 200 300
201 & above 450
Cost of prizes to be awarded to the winners in different games being arranged in the park
depend up on the strength of students in a trip. Cost of prizes to be distributed are:
Number of students in a trip cost of Prizes
Rs.
Up to 50 900
51-125 1,050
126 150 1,200
151 200 1,300
201 250 1,400
251 & above 1,500
Cost management-final course 23
To meet the above costs the college collects Rs. 65 from each student who wish to join the trip.
The college releases subsidy of Rs. 10 per student in the trip towards it.
You are required to:
(a) Prepare a tabulated Statement showing total costs at the levels of 60, 120, 180, 240 and 300
students indicating each item of cost.
(a) Compute average cost per student at each of the above levels.
(b) Calculate the number of students to break even for the trip as the college suffered loss during
the previous year despite 72% of the students having joined the trip.
Solution
(a) Statement showing total costs indicating each item of cost
No. of students 60 120 180 240 300
Rs. Rs. Rs. Rs. Rs.
Variable costs:
Breakfast 420 840 1,260 1,680 2,100
Lunch 1,800 3,600 5,400 7,200 9,000
Tea 180 360 540 720 900
Entrance fee for Zoo & aquarium 300 600 900 1,200 1,500
Total: (A) 2,700 5,400 8,100 10,800 13,500
Semi variable costs:
Rent of buses 1,400 2,100 2,800 3,500 4,200
(Ref. To working note 1)
Special permit fee 100 150 200 250 300
(Ref. To working note 2)
Daily allowance paid to teachers 400 600 800 1,000 1,200
(Ref. To working note 3)
Block entrance fee 200 300 300 450 450
(Ref. To given table)
Cost of prizes 1,050 1,050 1,300 1,400 1,500
(Ref. To given table) ________
Total: (B) ____3,150 4,200 5,400 6,600 7,650
Grand Total : (A) + (B) ____5,850 9,600 13,500 17,400 21,150
(b) Average cost per student at each of the above levels
No. of students: (A) 60 120 180 240 300
Total costs (Rs.) : (B) 5,850 9,600 13,500 17,400 21,150
[Refer to (a) part]
Average cost (Rs.): (B)/(A) 97.50 80 75 72.50 70.50
(c) Statement showing number of students to break-even
No. of students in the trip 51-100 101-125 126-150 151-200 201-250 251-300
No. of buses 2 3 3 4 5 6
Semi-variable costs
Bus rent (Rs.) 1,400 2,100 2,100 2,800 3,500 4,200
Permit fee (Rs.) 100 150 150 200 250 300
Block entrance fee (Rs.) 200 300 300 300 450 450
Daily allowance
Paid to teachers (Rs.) 400 600 600 800 1,000 1,200
Cost of prizes ___1,050 1,050 1,200 1,300 1,400 1,500
Total cost (Rs.) 3,150 4,200 4,350 5,400 6,600 7,650
No. of students to break-even: 105 140 145 180 220 255
(Total semi-variable cost/ (3,150/ (4,200/ (4,350/ (5,400/ (6,600/ (7,650/
contribution per student) 30) 30) 30) 30) 30) 30)
Cost management-final course 24
(Refer to working note 4)
As the figure of 105 and 140 students fall outside the limits (No. of students in the trip.), therefore
there are four break-even points in this case viz., 145, 180, 220 and 255 students. The college
authorities should keep these figures in mind while hiring 3, 4, 5 and 6 buses respectively to
avoid losses.
The college incurred loss during the previous year as they hired 5 buses and 72% of total
students (216 out of 300 students) joined the trip. The break-even in case college authorities
hires 5 buses for the trip comes to 220 students.
Working notes:
1. No. of buses required and rent of buses @ Rs. 700/- per bus
No. of students 60 120 180 240 300
No. of buses 2 3 4 5 6
Rent of buses (Rs.) 1,400 2,100 2,800 3,500 4,200
(No. of buses Rs. 700)
2. Special permit fee:
(No. of buses Rs. 50) 100 150 200 250 300
3. Allowance paid to teachers (Rs.) 400 600 800 1,000 1,200
(No. of buses Rs. 200)
4. Contribution per student towards semi-variable costs Rs.
Collection from each student 65
Subsidy provided by the college _10
75
Less: Variable cost per student _45
Contribution per student _30
BEP in process costing .
In this case the BEP is computed on the basis on input in process 1
Problem 18
In an oil-mill three processes are required to convert the raw material to chaff , oil & meal. In the
first process (cleaning) the chaff is separated. In the second process (pressing) oil and cakes are
produced.
The oil is transferred to finished stock and the cake is transferred to third process
(grinding)where it is dried and ground into meal. For an input of 1000 kg. raw material, output are
450 litres of oil, 50 kg. chaff and 400 kg. meals.
Raw materials purchase prices is Rs. 12 per kg. The Selling price of oil is Rs. 80 per litre. Selling
prices of the chaff and meals are Rs. 20 and Rs. 200 per kg. respectively.
The processing costs are as follows :-
Variable costs Total fixed costs per month
Rs.
Process A Rs. 10,000 per 1,000 kg. 1,32,000
Process B Rs. 25,000 per 1,000 kg. cleaned material
transferred to this process 3,00,000
Process C Rs. 32,000 per 1,000 kg. of meal 4,00,000
There is no opening and closing stocks in any process. How many kg. of raw material input per
month must be processed in order to break-even ?
Cost management-final course 25
Solution 950 kg. Cake
Raw Material
1,000 kg.
Chaff sold @ Rs. 20/kg. Oil sold @ Rs. 80/litre meal sold @ 200/kg.
50 chaff 450 liter 400 kg.
Contribution statement
Revenue:
P1 i.e. chaff (50 20) 1,000
P2 i.e. oil (450 80) 36,000
P3 meal (400 200) 8,00,000 1,17,000
Les Variable cost
P1 10,000
P2 {(25,000 1000) 950} 23,750
P3 {(32,000 1,000) 400} 12,800
Raw material 11,550 58,100
Contribution 58,900
Contribution per unit of raw material = Rs 58.90
So BE input 8,32,000 58.9 = 14,125.63 kg
Break-even point following DCF technique
Case-1:
At break even ( Life of project should be known)
Discounted cash outflow = Discounted cash inflow.
Or Investment of Y0 = [(Sp/u- VC/u) no of units Fixed cost (only cash nature)]
If the sales volume, VC/u & Fixed cost are equal p.a. then--
investment at Y0 = [(SP-VC) units Fixed cost] Annuity value.
No. of units at BE = [ (Inv. at y0 Annuity value)+Fixed cost] Contribution per unit.
Case-2:
When life of the project is unknown (not given in the problems). Then apply the concept of
perpetuity. I.e.
Cash inflow p.a. must equal to financial charges to break even.
Investment at y0 Rate of return = (SP - VC) units Fixed cost (cash)
No of units at BE = -----------------------------------------------------------------------
Note: Investment at y0 = Total investment at Y0 + interest on investment paid during
construction period.
P1
P3
FG
P2
Investment at y0 rate of return +Fixed cost
Contribution per unit
Cost management-final course 26
Problem 19
The investment for a project is Rs. 20 cr. The sale price p.u. Rs.400 & variable cost is Rs.240.
the fixed cost p.a. is Rs. 23,00,000. The required rate of return is 12%.
Find BEP for an life of 6 yrs.
If the project building period is 2 years with 60% of capital will be invested in 1
st
year, what is the
project BEP production & sale volume?
Solution
(a) Investment = Rs. 20 crores
Rs.
Selling price/units 400
Variable cost/unit 240
Contribution p.u. 160
Fixed cost = 23 lakhs; Life 6 years; Rate of return = 12%
BEP = {(20 cr. 4.114)+ 23 lakhs} 160 = 3,18,408 units
(b) All cash flow are occur at the end of the year (assumption of DCF technique)
Interest at y0 = 20 Cr. +12 Cr. 12%
= Rs. 21.44 Cr.
BEP = {(21.44 cr. 4.1114)+ 23 lakhs)} 160
= 3,40, 299 units
Problem 20
A public company responsible for the supply of domestic gas has been approached by several
prospective customers in a rural area adjacent to a high-pressure main. As a condition of its
license to operate as a utility, the company is obliged to respond positively to current needs
provided the financial viability of the company is not put at risk. New customers are charged Rs.
250 each for connection to the system.
Once a meter is installed, a standing charge of Rs.10 per quarter is billed. Charges for gas are
levied at Rs.400 per 1,000 metered units.
A postal survey of the area containing, according to the rating authority, 5,000 domestic units,
elicited a 40% response rate. 95% of those who responded confirmed that they wished to
become gas users and expressed their willingness to pay the connection charge.
Although it is recognized that a small percentage of those willing to pay for connection may not
actually choose to use gas, it is expected that the average household will burn 50 metered units
per month. There will be some seasonal differences.
The companys marginal cost of capital is 17% pa and supplies of bulk gas cost the company
Rs.0.065 per metered unit. Wastage of 15% has to be allowed for determine what the maximum
capital project cost can be to allow the company to provide the service required.
Solution
Note-1:
No. of customer 5,000 40% 95% = 1,900
Note-2 :
Consumption of gas1,900 50 12 mt. = 11,40,000 mt.
Gas supply 11,40,000 (100 85) = 13,41,176 mt
Cost management-final course 27
Note-3:
Cash inflow:
One time (y0) = 250 1,900 4,75,000
Cash p.a. (in last year) Rs.
Rent 1,900 4 10/Q 76,000
Consumption charge 11,40,000 0.4 4,56,000
5,32,000
Less: Cost of company (13,41,176 0.065) 87,176
Cash inflow P.a. 4,44,824
By following the concept of perpetuity
(Investment-4,75,000) 17% = 4,44,824
Investment Rs. 30,91,612
BEP for a perishable product
1
st
Calculate the contribution from the sale of opening stock then compare it with the fixed
cost.
If the fixed cost is not yet recovered then it will recovered from current year production &
sales.
Problem 21
A Company produces formulations having a shelf life of one year. The company has an opening
stock of 15,000 boxes on 1/1/2006 and expects to produce 75,000 boxes as was in the just
ended year of 2005. Expected Sale would be 78,000 boxes. Costing department has worked
out escalation in cost by 25% on variable cost and 12% on fixed cost for the year 2006.
Fixed costs are estimated at Rs.16,80,000. New price for 2006 is Rs.70/- per box while the sale
price in 2005 was Rs. 60. Variable cost of the opening stock is Rs. 20 per box.
Find actual BEP.
Solution
Last year Current year
2005 2006
Opening stock -- 15,000
Production 75,000 75,000
Sales -- 78,000
Closing stock 15,000 12,000
Rs. Rs.
Sales price/unit 60 70
Less: Variable cost/unit _20 __25
Contribution 40 45
Fixed cost (16,80,000 112) 100 16,80,000
= 15,00,000
Contribution from the sale of opening stock (70-20) = Rs. 50 In 2006
Cost management-final course 28
Rs
Fixed cost 16,80,000
Less: Contribution from opening stock sales _7,50,000
Rest. Fix 9,30,000
Required production & sales = 9,30,000 45 = 20,667 units
BEP (Actual) = 15,000 +20,667 = 35,667 units.
Potential Break-even point
When Break even is expressed only out of current year production or sales then it is
known as potential Break even. In this case sale of opening stock should not be consider
BEP = -----------------------------------------------------------------------------
Step-1: Calculate potential sale value of current year production i.e. if current year
production is fully sold out then what should be the revenue generation.
Step-1: Potential sales = (Sales COGS) COP
Less: Variable cost of production & sale
Potential contribution
Calculate PV ratio= potential contribution potential Sale
Potential BES = total fixed cost PV ratio
Problem 23
N.R.I Ltd. produces an unique product, the potential demand for which would diminish with any
prolonged period of business recession. A review of the price product over the past six months
has become necessary in order to determine future market strategy. A cost and profit statement
has been prepared for this purpose.
You are required to calculate the Break even point for total sales, actual and potential. Why
should the above procedure be adopted instead of the usual way of finding the B. E. Point ?
Cost and Profit statement for the six months January - June 2007
Rs. Rs.
Net Sales 24,50,000
Stock 1
st
January 2004 4,00,000
Direct Labour 8,95,000
Direct Material 7,45,800
Indirect expenses :
Variable 2,38,700
Fixed 3,58,000
26,37,500
Less stock 30
th
June 2005 8,00,000
Cost of Goods Sold 18,37,500
Gross profit 6,12,500
Selling & Distribution Expenses :
Variable 1,00,000
Fixed 2,00,000 3,00,000
Fixed cost of current years
Contribution p.u. in current year production & sales
Cost management-final course 29
Profit before Tax 3,12,500
Tax provision 1,26,200
Net Profit for 6 months 1,86,300
Increase in stock should be assumed as potential sales within the period.
Solution
Cost of production = (8,95,000+7,45,800 +2,38,700 + 3,58,000)
= Rs. 22,37,500
Potential sales = {(Sales COGS) COP} Rs.
= (24,50,000 18,37,500) 22,37,500 = 29,83,334
Less: Total variable cost (8,95,000+7,45,800 +2,38,700) (-) 18,79,500
Less: Selling & distribution overhead {(1,00,000 24,50,000) 29,83,334} (-) 1,21,769
Contribution 9,82,065
Potential P/V ratio = {(9,82,065 29,83,334) 100} = 32.92%
Potential BES = Fixed cost P/V ratio = 5,58,000 32.92%
= Rs.1,69,5,019
Cost Indifference Points BEP on basis of costs only
Where there are difference production facility available for a single job we always select that
production facility where the total cost is minimized.
Indifference production volume = change in fixed cost save in variable cost p.u.
Problem 24
Machine x Machine y
Variable cost/unit Rs 40 35
Fixed cost Rs. 10,000 12,500
Rs Total Cost of x
P
Total Cost y
12,500
10,000
units
indifference production volume
At P, TCx = Tcy
40q +10,000 = 35q +12,500
Where q is the required volume
q = (2,500 5) = (Charge in Fixed cost gain in variable cost) = 500 units
Cost management-final course 30
Problem 25
M companys services department is evaluating new copying machines to replace the firms
current copier, which is worn out. The analysis of alternative machines has been narrowed to
three and the estimated costs of operating them are shown below:
________ Cost per 100 copies
Machine A Machine B Machine C
Rs. Rs. Rs.
Materials costs 60 40 20
Labour cost 80 30 20
Annual Lease cost 30,000 58,000 1,00,000
Required:
(i) Compute the cost indifference points for the three alternatives.
(ii) What do the cost indifference points suggest as a course of action in this regard?
(iii) If the management expects to need 87,000 copies next year, which copier would be most
economical?
Solution
(i) Computation of cost indifference points for the three alternatives:
Cost indifference point for two machines viz.
A & B = ---------------------------------------------
=
) 30 40 .( ) 80 60 .(
000 , 30 . 000 , 58 .
+ +

Rs Rs
Rs Rs
=
) 100 ( 70 .
000 , 28 .
copies perunitof Rs
Rs
Cost indifference point for two machines viz.
B & C =
) 20 20 .( ) 30 40 .(
000 , 58 . 000 , 00 , 1 .
+ +

Rs Rs
Rs Rs
=
) 100 ( 30 .
000 , 42 .
copies perunitof Rs
Rs
= 1,400 Nos. (Multiple of 100 copies)
C & A =
) 20 20 .( ) 80 60 .(
000 , 30 . 000 , 00 , 1 .
+ +

Rs Rs
Rs Rs
=
) 100 ( 100 .
000 , 70 .
copies perunitof Rs
Rs
= 700 nos. (Multiple of 100 copies)
(ii) From the above computations, it is clear that at activity level below the indifference point the
alternative (machine) with lower fixed cost and higher variable costs should be used. In case the
activity level exceeds the indifference point, a machine with lower variable cost per unit (or higher
contribution per unit) and higher fixed cost, is more profitable to operate. At the activity level
equal to the indifference point both machines are on equal footing.
Hence, from the above we conclude as follows:
From 0 to 400 Nos. (multiple of 100 copies) use machine A
From 400 to 1,400 Nos. (Multiple of 100 copies) use machine B
Difference in fixed cost
Difference in variable cost per unit
Cost management-final course 31
Above 1,400 Nos. (multiple of 100 copies) use Machine C.
(iii) if the management needs 87,000 copies next year, i.e., 870 Nos. (Multiple of 100 copies) it is
clear that machine B would be most economical.
__________________
Problem 26
Standard Pumps Ltd. is manufacturing Petrol and Diesel operated pumps . The company wants
to have a customer survey before marketing the pumps . You are asked to workout the
economics of choice between the two types of pumps . The company provides you the following
data .
Petrol Operated Pump X Diesel Operated Pump Y
Selling Price Rs. 80,000 1,24,000
Cost of fuel per Liter Rs. 40.00 25.00
Operating Hours per Liter 20.00 40.00
Using above data answer following questions :-----
a. How many hours the pumps should run so that the customer willing to buy is indifferent in
choice between X and Y ? Assume that fuel cost has linear function with respect to time .
b. Assuming the price of X remains unchanged , and the customer wants to run the pump
for 12,800 hours , how much he will be willing to pay for Y ?
c. If Standard Pump Ltd. offers to convert a Petrol operated Pump to Diesel operated one
after 18,000 hrs. of operation of the former , how much customer will be willing to pay for
this modification of the pump?
d. If there is a saving of Rs.33,500 in operating cost of Y over its life , how many hours the
customer should expect to run the pumps so as to be indifferent in choice ?
e. If there is a restriction on the fuel supply to the extent of 750 litres for both Petrol and
Diesel , what will be customers preference either for Petrol operated or Diesel operated
one ?
f. Do you suggest any other point that should be considered for choice between alternatives
apart from above ?
Solution ; ( TC = total cost )
(a)
Petrol: X Diesel: Y Gain
Purchase price Rs. 80,000 1,24,000 ( 44,000)
Fuel cost Rs./lt. Rs. 40 25
Hr./lt. 20 40
Fuel cost/hr. Rs. 40 20 =2 25 40 = 0.625 1.375
In. pt = 44,000 1.375 = 32,000 hrs
(b) X Y
Purchase price 80,000 1,24,000
Fuel cost Rs./lt. 40 25
Hrs. 1,28,000 12,800
Purchase 1,44,000 ?
Indifference point = 12,800
TCx =TCy at 12,800
Cost management-final course 32
80,000 +2 12,800 = PP of Y + 0.625 12,800
Purchase Price of Y = Rs. 97,600
(c) Pump x is already purchased so, the customers expectation to run the pump at most 3,200 hrs.
Pumps has already run for 18,000 hrs. following this conversion, the user has a gain of at the rate
of 1.375 for 14,000 hrs. of rest life. Maximum opportunity gain.
14,000 1.375 = 19,250.
Hence, maximum discretionary cost for conversion = Rs. 19,250.
(d) Saving of Rs. 33,500 of y
TCx TCy = 33,500
Or, Indifference point 32,000 hrs. & then y have again of Rs. 1.375/hr.
Hrs. to run = 33,500 1.375 = 24,363.6 above 32,000 hrs.
Required hrs. = 32,000 +24,363.6 = 56,363.6 hrs.
(e) If a problem of fuel indifference, so we have to calculate cost/hr. as at same volume of fuel, pump
will run for difference hour.
X y
(a) Fuel 750 lt. 750 lt.
(b) Cost/lt. Rs. 40 25
(c) Fuel cost Rs. 30,000 18,750
(d) purchase price Rs. 80,000 1,24,000
(e) Total cost Rs. 1,10,000 1,42,750
(f) Hrs. 750 20 =15,000 750 40 = 30,000
Cost/hr. Rs. 7.33 4.75
So, y is to two selected.
(f) Other points is to be considered.
(a) Availability of spare parts & AMC.
(b) Resale value
(c) Life of the assets
(d) Prestige value or esteem value
(e) Pollution factor
Points to remember before examination
1. Analysis the problem very carefully
2. analysis of given data into its fixed & variable component
3. application of proper BE rule