Chapel

CHAPTER 20
COST-VOLUME-PROFIT ANALYSIS
OVERVIEW OF BRIEF EXERCISES, EXERCISES, PROBLEMS, AND CRITICAL
THINKING CASES
Brief Learning
Exercises Topic Objectives Skills
B. Ex. 20.1 Cost behavior patterns 1 Analysis
B. Ex. 20.2 Cost classifications 1 Analysis
B. Ex. 20.3 Using a cost formula 1, 9 Analysis
B. Ex. 20.4 Using a cost formula 1, 4, 5, 9 Analysis
B. Ex. 20.5 Computing required sales volumes 4–6 Analysis
B. Ex. 20.6 Computing required sales volumes 4–6 Analysis
B. Ex. 20.7 Contribution margins and selling prices 1, 4–6 Analysis
B. Ex. 20.8 Evaluating marketing strategies 7 Analysis
B. Ex. 20.9 Selecting an activity base 1 Judgment, analysis
B. Ex. 20.10 CVP with multiple products 8 Analysis
Learning
Exercises Topic Objectives Skills
20.1 Accounting terminology 1, 2, 4 Analysis
20.2 High-low method of cost estimation 1, 9 Analysis
20.3 Determining required sales volumes 4, 5 Analysis
20.4 Computing break-even points 4–6 Analysis
20.5 Solving for missing information 1, 4 Analysis
20.6 Ethical implications of CVP 5–7 Judgment, communication
20.7 Using CVP 4–6 Analysis
20.8 Using CVP 4–6 Analysis
20.9 Understanding break-even relationships 1, 2, 4–6 Analysis
20.10 Margin of safety 4, 5 Analysis
20.11 Applying CVP 1, 2, 4–6 Analysis
20.12 Solving for missing information 5, 6 Analysis
20.13 Formulating bid prices using CVP 1, 4–6 Analysis
20.14 CVP with multiple products 7, 8 Analysis
20.15 Estimating semivariable costs 9 Analysis
© The McGraw-Hill Companies, Inc., 2012

CH 20-Overview
Problems Learning
Sets A, B Topic Objectives Skills
20.1 A,B Establishing selling prices 4–7 Analysis, communication
20.2 A,B Estimating costs and profitability 1, 4, 5 Analysis
20.3 A,B Preparing a break-even graph 3–6, 9 Analysis, communciation
20.4 A,B Preparing a break-even graph 3, 4, 6, 9 Analysis, communication
20.5 A,B CVP analysis 3–7, 9 Analysis, communication
20.6 A,B Cost analysis 4–7, 9 Analysis, communication
20.7 A,B Cost analysis 4, 6, 7 Analysis, communication
20.8 A,B CVP with multiple products 4–8 Analysis, communication
CRITICAL THINKING CASES

20.1 CVP from differing perspectives 1 Judgment, communication
20.2 Evaluating marketing strategies 1, 4, 5, 6, 7 Communication, analysis
costing information
20.3 Deciding whether to file a Form 8-K 1 Analysis, judgment,
Ethics, Fraud & Corporate Governance communication
20.4 Real World: Ford Motor Company 8 Communication,
Internet technology, research

CH 20-Overview (p.2)
DESCRIPTIONS OF PROBLEMS AND CRITICAL THINKING CASES
Below are brief descriptions of each problem, case, and the first Internet assignment. These descriptions
are accompanied by the estimated time (in minutes) required for completion and by a difficulty rating.
The time estimates assume use of the partially filled-in working papers.
Problems (Sets A and B)
20.1 A,B Thermal Tent, Inc./Satka, Inc. 25 Medium
Use of cost-volume-profit relationships in a pricing decision. Student is
to compute the unit sales prices necessary to achieve a target operating
income. Also determine whether the company can break even if sales
price is reduced to achieve market penetration.
20.2 A,B Blaster Corporation/Snug-As-A-Bug 25 Medium

Illustrates a pricing decision: compute the unit sales price necessary to
achieve a target income at a given unit sales volume. Also compute the
number of units that must be sold annually to break even at an alternative
unit sales price.
20.3 A,B Stop-n-Shop/Moor-n-More 30 Medium

A profit-volume problem requiring an annual profit graph. Draw a profit-
volume graph on an annual basis. Compute the contribution margin and
break-even point. Consider the effect of a change in employee
compensation and determine sales necessary to produce a given income.
20.4 A,B Rainbow Paints/Green Thumb 30 Medium

Create a cost-volume-profit graph for a retail business. Compute the
break-even sales volume and the operating income likely to result at the
highest and lowest expected sales volume.
20.5 A,B Simon Teguh/Ed Winslow 40 Strong

Draw a monthly cost-volume-profit graph for a vending machine
business. Determine the break-even point and the sales volume needed to
provide the owner with a given return on investment. Also consider the
effect of a change in costs upon the break-even point.
20.6 A,B Precision Systems/Electro Systems 30 Strong

Compute the increase in selling price necessary to maintain contribution
margin ratio after increase in direct labor cost. Compute sales volume
after wage increase in order to earn a given net income. Consider the
effect of expansion on maximum income that can be earned.

Description Problems
20.7 A,B Percula Farms/Dorsal Ranch 35 Strong
Students must analyze two alternative production strategies and
determine which factors or costs have the greatest influence on operating
income. Given two investment options, students must first intuitively
decide which should result in the greatest increase to operating income,
and then perform calculations to confirm their answer.
20.8 A,B Lifefit Products/HomeTeam Sports 35 Strong

Calculate break-even in dollars and in units for a multiple product
company. Determine operating income required for a desired margin of
safety. Determine sales level required for a desired level of income if
fixed costs are reduced.

Desc. Problems (p.2)
CRITICAL THINKING CASES
20.1 Multiple Perspectives—Attend Our Seminar 20 Medium

Students play the role of a cost-volume-profit seminar leader. They are
asked to motivate individuals to attend their seminar by showing them
how the information can be of benefit. This is a good group problem that
encourages students to think beyond the mechanics of cost-volume-profit
analysis.
20.2 Don’t Mess with the Purple Cow 40 Strong

Students are asked to evaluate two alternative marketing proposals and
make a recommendation to management. The problem contains an
interesting twist: neither proposal is as profitable as the status quo—but
students’ attention is not specifically directed toward this vital issue. A
lesson in the fact that real-life problems do not come with “instructions”
that make the answers clear.
20.3 Filing Form 8-K 10 Easy

Ethics, Fraud and Corporate Governance
Students are asked to determine whether a company should file a Form 8-
K and whether it is legal and/or ethical to withold certain information.
20.4 Ford Motor Company 15 Easy

Internet
Using information contained the company's 10-K the student is asked to
analyze changing trends in the sales mix at Ford and throughout the
entire U.S. Automobile industry, in general.

Desc. of Cases
SUGGESTED ANSWERS TO DISCUSSION QUESTIONS
1. It is important for management to understand cost-volume-profit relationships in order to do a

better job of planning business operations. Cost-volume-profit analysis is a useful tool for
forecasting the impact of various strategies upon operating income.
2. An activity base is a measure of a type of business activity that “drives” variable costs. The
activity base allows us to quantify the expected relationships between variable costs and the
underlying type of business activity, such as units of production, total sales, or quantities of
materials used in production. These relationships, in turn, assist us in evaluating the
reasonableness of the costs incurred in prior periods and also in forecasting future costs at various
levels of business activity.
3. a. Total variable costs increase in approximate proportion to an increase in activity.
b. As total variable costs rise in approximate proportion to an increase in activity, variable costs
per unit of activity remain relatively constant.
c. Total fixed costs tend to remain constant despite increases in the level of business
activity—so long as the level of activity remains within the relevant range.
d. Because total fixed costs remain constant, fixed costs per unit of activity decline as the
volume of activity increases. In short, the fixed costs are spread over a greater number of
units of activity—therefore, lower fixed costs per unit.
4. Two factors make the simplifying assumption of straight-line cost-volume relationships useful.
First, unusual patterns of cost behavior (stair-step or curvilinear) tend to offset one another when
individual cost elements are combined into total cost figures. Second, most managerial decisions
are based on projected volume variations within a fairly narrow range. Within this relevant
range, straight-line cost-volume relationships are often good approximations of actual operating
conditions.
5. The relevant range represents the operating levels (for example, between 40% and 80% of full
capacity) over which output is likely to vary and for which the assumptions made about cost
behavior are reasonably realistic. When the level of activity falls outside the relevant range,
assumptions as to the total amount of fixed costs, the amount of variable costs per unit, and the
degree of variability of semivariable costs may have to be changed.
6. a. Under the high-low method, the levels of a semivariable cost and of the related activity base
are observed at the highest and lowest points of activity within the relevant range. The
variable portion of the semivariable cost is then determined by dividing the change in the
semivariable cost by the change in the activity base between these high and low measurement
points. (This is the slope of the line between these two points.)
b. The fixed portion of the semivariable cost is determined by starting with the total
semivariable cost at either the high or low level of activity, and subtracting the variable
portion of the cost as computed at that level of activity. (The fixed portion is the intersection
of the line with the y -axis.)

Q1-6
7. a. The contribution margin is the dollar amount by which revenue exceeds variable costs. Thus,
it is the amount of revenue that is available to cover fixed costs and to contribute to operating
income. Unit contribution margin = unit sales prices  variable costs per unit.
b. The contribution margin ratio is the contribution margin stated as a percentage of sales
revenue. Consequently, it represents the percentage of sales revenue available to cover fixed
costs and to contribute to operating income. Contribution margin ratio = unit contribution
margin/unit sales price.
c. The average contribution margin ratio is similar in concept to the contribution margin ratio
except that it is used in multiproduct environments. Consequently, it takes into account each
product’s individual contribution margin ratio as well as the relative sales mix of all products
sold.
8. The important relationships shown in a cost-volume-profit graph are changes in revenue, costs,
and operating income in relation to changes in the volume of business activity. The point at which
a business moves from a loss to a profit position (the break-even point) is also shown, but this is
relatively less important because the objective of business endeavor is to earn a high rate of return
on investment, not to break even.
9. At the break-even point, a company earns a total contribution margin exactly equal to its fixed
costs. By dividing the unit contribution margin into this required total contribution margin, we can
determine the number of units that must be sold to enable the company to cover its fixed costs.
10. The margin of safety is the dollar amount by which actual sales volume exceeds the break-even
point.
11. A change in product (sales) mix to a higher proportion of export sales may result in a lower level
of net income if the contribution margin ratio on export sales is lower than the average
contribution margin ratio on all sales. This is often the case with export sales made by American
companies, because sales to foreign customers are made at lower prices. Foreign sales must
compete with prices charged by producers of other nations, whose production costs are often
much lower than those of domestic steel companies. In addition, substantial freight charges are
incurred on foreign sales; if the seller pays these charges, the contribution margin is reduced
because freight is a variable expense; if the buying company pays the freight charges, it will
generally insist on a lower price for the product it purchases.

Q7-11
12. Fixed costs do not vary in response to changes in volume. Thus, the more intensively facilities
are utilized, the lower the fixed cost per unit of output. This usually results in an overall lower
unit cost.
13. Operating income is the primary focus of cost-volume-profit analysis because income taxes and
nonoperating gains and losses do not possess the characteristics of fixed or variable costs.
14. The regional airline will probably have a higher break-even point than a furniture manufacturer
because most of an airline’s costs are fixed . It is important to note that even though both
companies report identical revenue and net income figures, their break-even points will likely
differ significantly because of differences in their cost structures.
15. Basic assumptions underlying cost-volume-profit analysis include: (1) a constant selling price
per unit, (2) a stable sales mix if more than one product is produced, (3) unchanging fixed costs
within a relevant range of output, (4) stability of variable costs expressed as a percentage of sales
revenue, and (5) units produced equal units sold.

Q12-15
SOLUTIONS TO BRIEF EXERCISES
B. Ex. 20.1 a. Total variable costs increase approximately in proportion to an increase in the
volume of activity.
b. Variable costs per unit remain relatively constant at all levels of activity; this is
the reason that total variable costs vary in proportion to changes in the volume
of activity.
c. Total fixed costs remain relatively constant despite increases in the volume of
activity.
d. Because total fixed costs tend to remain constant as the volume of activity
increases, fixed costs per unit decline with increases in the volume of activity.
e. Semivariable costs include both fixed and variable cost elements. Because of the
variable cost element, total semivariable costs tend to rise as the volume of
activity increases. Due to the fixed element of the semivariable cost, however,
this increase is less than proportionate to the increase in the volume of activity.
f. On a per-unit basis, the fixed elements of a semivariable cost decline as the

volume of activity increases, but the variable elements tend to remain constant.
Thus, semivariable costs per unit decline as the volume of activity rises, but not
as rapidly as if the entire cost were fixed.
B. Ex. 20.2 a. Variable. The cost of goods sold normally rises and falls in almost direct
proportion to changes in net sales. Although fixed manufacturing overhead is a
component of cost of goods sold, it is applied on a per unit basis and, therefore,
acts like a variable cost.
b. As described in this exercise, the salaries to salespeople are semivariable with
respect to net sales. The monthly minimum amount represents a fixed cost that
does not vary with fluctuations in net sales. However, the commissions on sales
transactions represent a variable element of sales salaries that does fluctuate in
approximate proportion to fluctuations in net sales.

BE20.1,2
B. Ex. 20.2 c. Income taxes are not a fixed, variable, or semivariable cost with respect to
(continued) net sales. Income taxes may be viewed as a variable cost, but the relevant
activity base is taxable income, not net sales. (Different tax brackets
complicate the analysis of income taxes expense, even given taxable income as
the activity base. Therefore, cost-volume-profit analysis usually focuses upon
operating income—that is, income before income tax expense and other items
that resist classification as costs that are fixed, variable, or semivariable with
respect to net sales.)
d. Fixed. Property tax expense is known for each period and is not affected by
fluctuations in sales volume.
e. Fixed. Depreciation expense on a sales showroom is independent of the level

of net sales. Fluctuations in net sales have no effect upon the amount of
depreciation applicable during the period to the sales showroom.
(Depreciation can become a variable cost only when it is treated as a product
cost, or when depreciation is computed using the units-of-output method.
Neither of these situations applies to the depreciation on a sales showroom,
which is a period cost.)
f. Fixed. Use of an accelerated method causes depreciation expense to change
from one period to the next, but the expense for each period still remains
“fixed” with respect to fluctuations in net sales. The key idea is that
fluctuations in net sales have no effect upon the amount of depreciation
expense applicable to the period.
B. Ex. 20.3 a. (1) Estimated cost of responding to 125 emergency calls in one
month:
Fixed element of monthly emergency response cost
cost ……………………………………………….. $ 19,500
Variable cost of responding to 125 calls
(125 calls × $110 per call) ……………………… 13,750
Estimated total cost of responding to emergency
calls ……………………………………………….. $ 33,250
(2) Average cost per call (125 calls per month):

Estimated total cost of responding to 125
emergency calls per month [part a (1) ] ……… $ 33,250
Number of calls …………………………………… 125
Average cost per call ($33,250 ÷ 125 calls) ……. $ 266

BE20.3
B. Ex. 20.3 b. The overall cost of responding to emergency calls is semivariable—that is,
(continued) it includes both fixed and variable elements. Therefore, when the volume
of emergency calls is unusually low, the average cost of responding to
each call will rise, because the fixed cost elements must be spread over
fewer calls.
B. Ex. 20.4 a. Contribution margin ratio  70% (100%, minus variable costs of 30%)
Fixed Costs + Target Profit

b. Break-Even Sales Volume 
Contribution Margin Ratio
$5,950 + $0

0.70
 $8,500
c. Fixed element of room service costs ………………………… $ 5,950
Variable element of room service costs ($15,000 × 30 %) … 4,500
Estimated total room service costs in a month
generating $15,000 room service revenue ……………… $ 10,450
B. Ex. 20.5 a. If contribution margin ratio is 40%, variable costs must be 60% of sales
Unit sales price = $24 variable costs ÷ 0.60 = $40
Unit Contribution Margin  Unit Sales Price  Variable Cost per Unit
 $40 (above) - $24 = $16
Fixed Costs + Target Operating Income

b. Sales Volume (in units) 
Unit Contribution Margin
$660,000 + $300,000
=
$16
= 60,000 units

c. Sales Volume (in dollars) =
$660,000 + $300,000
=
0.40
= $2,400,000
[or 60,000 units (part b ) x ($40 unit sales price (part a ) = $2,400,000]

BE20.4,5
B. Ex. 20.6 a. If variable costs are 70% of sales revenue, the contribution
margin ratio must be (1 - 0.70) = 30%
Fixed Costs
b. Break-Even Sales Volume =
CM ratio
Fixed Costs
$15,000 = ; Fixed Costs = $4,500
0.30

c. Sales Volume =
$4,500 + $9,000
=
0.30
= $ 45,000
B. Ex. 20.7 a. Break-even sales volume ($80 × 25,000 units) ………… $ 2,000,000
Contribution margin ratio ………………………………. 45%
Fixed costs ($2,000,000 × 0.45) ……………………………. $ 900,000
b. Break-even sales volume ($80 × 25,000 units) …………… $ 2,000,000

Less: Fixed costs (part a ) ………………………………… 900,000
Variable cost of 25,000 units ……………………………… $ 1,100,000
Variable cost per unit ($1,100,000 ÷ 25,000 units) ……… $ 44
Alternatively, if the contribution margin ratio is 45%, variable costs must amount
to 55% of the unit sales price. Thus, $80 sales price × 55% = $44.
c. Total costs = fixed costs + (variable cost per unit × number of units)
= $900,000 + ($44 × number of units)
B. Ex. 20.8 a. $4,000 ($1,800 additional monthly fixed cost, divided by 45%
contribution margin)
b. $6,222 [($1,800 additional cost + $1,000 target
operating income) ÷ 45%]

BE20.6,7,8
B. Ex. 20.9 The following activity bases could be suggested to each of your clients:
Client Possible Activity Bases

Freeman’s Retail Floral Shop Sales dollars
Susquehanna Trails Bus Passenger miles driven
Wilson Pump Manufacturers Number of pumps produced
Sales dollars
Machine hours
Direct labor hours
McCauley & Pratt, Attorneys at Law Billable client hours
Number of cases
B. Ex. 20.10 a. Contribution Percentage of Average

Margin Ratio × Total Sales = Contribution
Flashlights 40% 15% 6%
Batteries 20% 85% 17%
Average contribution margin ratio 23%
Break-Even
Fixed Costs/Average Contribution Margin Ratio =
Sales Revenue
$3,680,000 ÷ 23% = $16,000,000
b. Fixed Costs + Target Operating Income

= Target Revenue
Average Contribution Margin Ratio
($3,680,000 + $1,380,000) ÷ 23% = $22,000,000

BE20.9,10
SOLUTIONS TO EXERCISES
Ex. 20.1 a. Break-even point
b. Fixed costs
c. Relevant range
d. Contribution margin
e. Unit contribution margin
f. Economies of scale
g. Semivariable costs
h. None (This is not a meaningful measurement; variable costs have already been
deducted in arriving at operating income.)
Ex. 20.2 a. (1) Machine Manufacturing

Hours Overhead
High point 5,500 $ 311,500
Low point 2,800 184,600
Changes 2,700 $ 126,900
Thus, the estimated variable element of Bursa Mfg. Co.’s manufacturing overhead
is $47 per machine hour. [$126,900 change in cost divided by 2,700 unit change in
the activity base (machine hours)].
(2) Total manufacturing overhead

at 5,500 machine-hour level ………………………. $ 311,500
Variable element of manufacturing overhead at 5,500
machine-hour level (5,500 machine hours ×
$47 per machine hour) ………..………………… 258,500
Fixed element of manufacturing overhead …...…. $ 53,000
b. Estimated manufacturing overhead at activity level
of 5,300 machine hours:
Fixed element [part a (2) ] ………………………….. $ 53,000
Variable cost element ($47 per machine hour
× 5,300 machine hours) …...…………………… 249,100
Total estimated manufacturing overhead ……. $ 302,100
c. Estimated manufacturing overhead: February March

February:
$53,000 + ($47 per MH × 3,200 MH) ….... $ 203,400
March:
$53,000 + ($47 per MH × 4,900 MH) ..... $ 283,300
Actual manufacturing overhead ….....…… 224,000 263,800
Amount over (under) estimated …..…..… $ (20,600) $ 19,500

E20.1,2
Ex. 20.3 a. Unit contribution margin, $70  $43 = $27
b. Sales required to break even, $405,000 ÷ $27 = 15,000 units
c. ($405,000 + $270,000) ÷ $27 = 25,000 units
Ex. 20.4 a. Product 1 Product 2

Contribution margin ratio 60% 30%
Relative sales mix ……… × 40% × 60%
24% + 18% = 42%
Fixed Costs
Break-Even in Sales =
Break-Even in Sales = $63,000 ÷ 42% = $150,000
b. Product 1 Product 2
Contribution margin ratio 60% 30.0%
Relative sales mix ……… × 25% × 75.0%
15% + 22.5% = 37.5%

Break-Even in Sales =
Break-Even in Sales = ($63,000 + $12,000) ÷ 37.5% = $200,000
Ex. 20.5 a. Contribution

Variable Margin Ratio Fixed Operating Units
Sales Costs per Unit Costs Income Sold
(1) $200,000 $120,000 $20 $55,000 $25,000 4,000
(2) 180,000 105,000 15 45,000 30,000 5,000
(3) 600,000 360,000 30 150,000 90,000 8,000
Contribution
b. Variable Margin Ratio Fixed Operating
Sales Costs Ratio (%) Costs Income
(1) $900,000 $720,000 20% $85,000 $95,000
(2) 600,000 360,000 40% 165,000 75,000
(3) 500,000 350,000 30% 90,000 60,000

E20.3,4,5
Ex. 20.6 It is never ethical to lie to one’s employees. This type of behavior will only serve to
promote an atmosphere of distrust throughout the company. Rather than
attempting to motivate the sales force by lying about sales quotas, the company
should consider rewarding regional sales managers using commissions and
bonuses.
Ex. 20.7 Unit Sales Price - Variable Cost per Unit

a. Contribution Margin Ratio =
Unit Sales Price
$28  $7
= = 75%
$28
Fixed Costs + $0
b. Break-Even Sales Volume =
$240,000
= = $320,000
0.75

c. Sales Volume =
$240,000 + $450,000
=
0.75
= $920,000
d. Sales volume (40,000 units x $28) $ 1,120,000

Less: Break-even sales volume (per part b ) 320,000
Margin of safety at 40,000 units $ 800,000
e. Operating Income = Margin of Safety × Contribution Margin Ratio
= $800,000 × 0.75 = $600,000

E20.6,7
Ex. 20.8
a.
Projected operating Income without either investment:

($1,200,000 × 0.25) - $80,000 $ 220,000
Ordering
Ad Campaign System
Projected sales revenue $1,260,000 (1) $ 1,200,000
× CM ratio 0.25 0.30
Total contribution margin $ 315,000 $ 360,000
minus fixed costs (100,000) (100,000)
Operating income $ 215,000 $ 260,000
Thus projected operating income will decrease by $5,000 if the ad campaign is chosen
($215,000 - $220,000), and increase by $40,000 ($260,000 - $220,000) if the ordering system
is chosen.
(1) ($1,200,000 x 1.05)
b. For the ad campaign to result in an equal increase in operating income, the total
contribution margin produced must equal that of the ordering system ($360,000).
Sales Revenue x 25% = $360,000
Sales Revenue = $1,440,000
$1,440,000 - $1,200,000
Percentage Increase = = 20%
$1,200,000

E20.8
Ex. 20.9
a. Contribution margin per unit:

Unit sale price $ 1.75
Less: Variable cost per unit ($50,000 ÷ $40,000 units) 1.25
Contribution margin per unit $ 0.50
b. Margin of safety at sales of 45,000 units:

Sales revenue ($1.75 × $45,000 units) $ 78,750
Less: Sales revenue at break-even point
($1.75 × $40,000 units) 70,000
Margin of safety $ 8,750
c. Estimated operating loss at sales level of 38,000 units:

Sales revenue ($1.75 × 38,000 units) $ 66,500
Less: Variable costs ($1.25 × 38,000 units) $ 47,500
Fixed costs (given) 20,000 67,500
Operating Income (loss) $ (1,000)
d. (1) Unit cost at production level of 40,000 units:

Variable cost per unit $ 1.25
Fixed cost per unit ($20,000 ÷ 40,000 units) 0.50
Total unit cost $ 1.75
(2) Unit cost at production level of 50,000 units:

Variable cost per unit $ 1.25
Fixed cost per unit ($20,000 ÷ 50,000 units) 0.40
Total unit cost $ 1.65
Total cost per unit declines at higher production levels because the fixed manufacturing costs are
allocated over a greater number of units.

E20.9
Ex. 20.10 a. Contribution Margin Unit Sales Price - Variable Costs
=
Ratio Sales Price
$24 - $18
= = 25%
$24
Fixed Costs
Break-Even Sales Volume =
$240,000
= = $960,000
0.25
b. Sale volume at 75,000 units (75,000 × $24) …………………. $ 1,800,000

Less: Break-even sales volume (part a ) ……………………… 960,000
Margin of safety sales volume ………………………………… $ 840,000
Ex. 20.11 a. Selling price per unit …………………………………………… $ 16

Variable manufacturing costs per unit…………………………. (8)
Variable selling and administrative costs per unit …………… (4)
Contribution margin per unit…………………………………… $ 4
Fixed manufacturing costs …………………………………….. $ 150,000

Fixed selling and administrative costs ……………………….. 350,000
Total fixed costs ……………………………………………….. $ 500,000
Total fixed costs ………………………………………………… $ 500,000

Divided by contribution margin per unit ……………………… ÷ $4
Monthly break-even in units …………………………………… 125,000
b. Contribution margin ratio (CM ÷ SP) ………………………….. 25%
Total fixed costs ………………………………………………… $ 500,000

Target monthly income ………………………………………… 100,000
$ 600,000
Divided by contribution margin ratio …………………………. ÷ 25%
Sales revenue required ………………………………………… $ 2,400,000
c. Total fixed costs ………………………………………………… $ 500,000

Contribution margin ratio ……………………………………… ÷ 25%
Monthly break-even sales revenue …………………………… $ 2,000,000
Current monthly sales level …………………………………… $ 3,800,000

Monthly break-even sales revenue …………………………… (2,000,000)
Margin of safety ………………………………………………… $ 1,800,000

E20.10,11
Ex. 20.11 d. Anticipated increase in sales revenue ………………………. $ 200,000
(continued) Contribution margin ratio …………………………………… x 25%
Estimated increase in operating income ……………………. $ 50,000
Ex. 20.12 20,000 units x $7 per unit = $140,000 total fixed costs
Fixed Costs ÷ Contribution Margin = Break-Even in Units
$140,000 ÷ (SP - $26) = 10,000 units
10,000 SP - $260,000 = $140,000
10,000 SP = $400,000
SP = Selling Price = $40 per unit
Ex. 20.13 a. The lowest bid price required to maintain the current
level of operating income equals total variable cost
per unit:
Direct materials ……………………………………………….. $ 9

Direct labor ……………………………………………………. 8
Variable manufacturing overhead ………………………….. 7
Lowest bid price to maintain current income level ………… $ 24
b. Contribution Margin Ratio (CM%) = Contribution Margin (CM) ÷ Selling Price

(SP)
36% = (SP - $9 - $8 - $7 - .04 SP) ÷ SP
0.36 SP = 0.96 SP - $24
$24 = 0.60 SP
SP = Bid Price = $40

E20.12,13
Ex. 20.14 a. Vests Skis Ropes
Unit selling prices $120 $300 $50
Unit variable costs (60) (210) (10)
Unit contribution margins $60 $90 $40

Divided by unit selling prices 120 300 50
Unit contribution margin ratios 50% 30% 80%
Average
CM% x Mix % = CM
Vests 50% 20% 10%
Skis 30% 70% 21%
Ropes 80% 10% 8%
Fixed Costs ÷ Average Contribution Ratio (CM%) = Break-Even Sales Revenue
$741,000 ÷ 39% = $1,900,000
b. (Fixed Costs + Operating Income)/CM% = Sales Revenue Required
($741,000 + $234,000) ÷ 39% = $2,500,000
c. To maximize operating income, the marketing manager should pursue a strategy

that shifts the sales mix away from the products with the lowest contribution
margin ratios (vests and skis) to the product with the highest contribution margin
ratio (ropes).
Ex. 20.15 a. ($980,000 - $752,500) ÷ (19,200 DLH - $12,700 DLH) = $35 per DLH
b. $980,000 = Monthly Fixed Costs  ($35 × 19,200 DLH)
Monthly Fixed Costs = $980,000 - $672,000 = $308,000
c. Total 3-Month Cost = ($308,000 × 3 months)  ($35 × 50,000 DLH)
Total 3-Month Cost = $924,000  $1,750,000 = $2,674,000

E20.14.15
SOLUTIONS TO PROBLEMS SET A
25 Minutes, Easy PROBLEM 20.1A

THERMAL TENT, INC.
a. Required contribution margin per unit

Budgeted operating Income $ 260,000
Fixed costs 540,000
Total required contribution margin $ 800,000
Number of units to be produced and sold 50,000
Required contribution margin per unit
($800,000 ÷ 50,000 units) $ 16
Required sales price per unit:

Required contribution margin per unit $ 16
Variable costs and expenses per unit 84
Total required unit sales price $ 100
Fixed Costs
b. Break-Even Sales Volume (in units) =
Contribution Margin per Unit
$540,000
=
$16
= 33,750 units
c. Margin of safety at 50,000 units:

Sales volume at 50,000 units ($100 × 50,000 units) $ 5,000,000
Less: Break-even sales volume ($100 × $33,750 units) 3,375,000
Margin of safety $ 1,625,000
Operating Income at 50,000 units:

Contribution margin ration ($100 - $84) ÷ $100 .16
Operating Income ($1,625,000 × .16) $ 260,000

P20.1A
PROBLEM 20.1A
THERMAL TENT, INC. (concluded)
d. No. With a unit sales price of $94, the break-even sales volume in units is 54,000 units:
Unit contribution margin = $94 - $84 variable costs = $10
$540,000
Break-even sales volume (in units) =
$10
= 54,000 units
Unless Thermal Tent has the ability to manufacture 54,000 units (or lower fixed and/or
variable costs), setting the unit sales price at $94 will not enable Thermal Tent to break even.

P20.1A (p.2)
25 Minutes, Medium PROBLEM 20.2A
BLASTER CORP.
a. Sales price per unit:

Budgeted costs $ 2,250,000
Add: Budgeted operating income 900,000
Budgeted sales revenue $ 3,150,000
Sales price per unit ($3,150,000 ÷ 30,000 units) $ 105
b. (1) Total fixed costs:

Manufacturing overhead ($720,000 × 75%) $ 540,000
Selling and adminstrative expenses ($600,000 × 80%) 480,000
Total fixed costs $ 1,020,000
(2) Variable costs and expenses per unit:

Direct materials $ 21
Direct labor 10
Manufacturing overhead ($24 × 25%) 6
Selling and administrative expense ($20 × 20%) 4
Total variable costs per unit $ 41
(3) Unit contribution margin:

Sales price per unit $ 121
Less: Variable costs per unit [from (2) ] 41
Unit contribution margin $ 80
(4) Number of units required to break even:

Fixed costs [from (1) ] $ 1,020,000
Contribution margin per unit [from (3) ] $ 80
Number of units required to break even ($1,020,000 ÷ $80) 12,750

P20.2A
STOP-N-SHOP
a.

P20.3A
PROBLEM 20.3A
STOP-N-SHOP (continued)
Operating data:
Revenue per parking-space hour 50 cents
Variable costs per parking-space hour 5 cents
Fixed costs per year:
Supervisor’s salary $ 24,000
Wages ($300 × 52 × 5) 78,000
Rent on lot ($7,250 × 12) 87,000
Fixed maintenance and other expenses ($3,000 × 12) 36,000
Total fixed costs $ 225,000
Capacity = 800 spaces × 2,500 hours per year = 2,000,000 parking-space hours per year
Revenue at full capacity = 2,000,000 × $0.50 = $1,000,000 per year

P20.3A (p.2)
PROBLEM 20.3A
STOP-N-SHOP (concluded)
b. Contribution margin ratio:

Parking charge per hour $ 0.50
Less: Variable costs per unit 0.05
Contribution margin ratio ($0.45 ÷ $0.50) 90%
Break-even sales volume:

Fixed costs:
Rent on lot ($7,250 × 12) $ 87,000
Supervisor's salary 24,000
Wages ($300 × 52 × 5) 78,000
Fixed maintenance and other costs ($3,000 × 12) 36,000
Total annual fixed costs $ 225,000
Contribution margin ratio (above) 90%
Break-even sales volume ($225,000 ÷ 0.90) $ 250,000
c. (1) New contribution margin ratio per parking-space hour:

Parking charge per hour $ 0.50
Less: Variable costs ($0.05 + $0.15) 0.20
New contribution margin ratio ($0.30 ÷ $0.50) 60%
New level of fixed costs:

Rent on lot ($7,250 × 12) $ 87,000
Supervisor’s salary 24,000
Vacation pay ($300 × 2 × 5) 3,000
Fixed maintenance and other costs ($3,000 × 12) 36,000
Total fixed costs under new arrangement $ 150,000
(2) Required sales revenue to produce desired operating

income:
Total fixed costs under new arrangement (above) $ 150,000
Add: Target profit 300,000
Total contribution margin required $ 450,000
New contribution margin ratio (above) 60%
Sales volume ($450,000 ÷ 0.60) $ 750,000

P20.3 (p.3)
RAINBOW PAINTS
a. Contribution margin ratio:

Unit sales price $ 10
Less: Variable costs per unit 6
Contribution margin per gallon $ 4
Contribution margin ratio ($4 ÷ 10, the unit sales price) 40%
Break-even sales volume in dollars:

Fixed costs ($3,160 + $3,640 + $1,200) $ 8,000
Break-even sales volume in dollars ($8,000 ÷ 0.4) $ 20,000
Break-even sales volume in gallons:

Break-even sales volume in dollars (above) $ 20,000
Unit sales price 10
Break-even sales volume in gal. ($20,000 ÷ $10 per gal.) 2,000
b. On the following page.
c. Projected operating income at various levels:

2,200 Gallons 2,600 Gallons
Contribution margin per gallon ($10 - $6) $ 4 $ 4
Total contribution margin at indicated volume $ 8,800 $ 10,400
Less: Fixed costs 8,000 8,000
Projected monthly operating income $ 800 $ 2,400

P20.4A
PROBLEM 20.4A
RAINBOW PAINTS (concluded)
b.

P20.4A (p.2)
40 Minutes, Strong PROBLEM 20.5A
SIMON TEGUH
a. Unit contribution margin:

Sales price per unit $ 0.75
Less: Variable costs per unit:
Merchandise $ 0.25
Rental commission 0.05 0.30
Unit contribution margin $ 0.45
Break-even volume in units:

Monthly fixed costs:
Depreciation ($36,000 × 0.20 × 1/12) $ 600
Wages 1,500
Other 600
Total monthly fixed costs $ 2,700
Contribution margin per unit (above) $ 0.45
Break-even volume in units ($2,700 ÷ $0.45) 6,000
Break-even volume in dollars:

Break-even volume in units (above) 6,000
Unit sales price $ 0.75
Break-even volume in dollars (6,000 units × $0.75) $ 4,500
b. See following page.
c. Sales volume to produce operating income equal to 30%

return on investment:
Total monthly fixed costs (part a ) $ 2,700
Desired operating income ($45,000 × 30% × 1/12) 1,125
Total desired contribution margin $ 3,825
Contribution margin per unit (part a ) $ 0.45
Sales volume in units ($3,825 ÷ $0.45 per unit) 8,500
Sales volume in dollars (8,500 units × $0.75 per unit) $ 6,375
d. New monthly fixed costs [$2,700 + (20 × $30)] $ 3,300

New contribution margin per unit:
Less: Variable costs per unit (only merchandise cost) 0.25 $ 0.50
New break-even volume in units ($3,300 ÷ $0.50 per unit) 6,600

P20.5A
PROBLEM 20.5A
SIMON TEGUH (concluded)
b.

P20.5A (p.2)
PRECISION SYSTEMS
a. Variable costs per unit before 15% increase in the cost of

direct labor $ 60
Increase in cost of direct labor, 15% of $20 3
Variable costs and expenses per unit
after 15% increase in the cost of direct labor $ 63
Because the contribution margin ratio of 40% is required,

the variable costs of $63 per unit must equal 60%
of sales price after the wage increase.
New sales price, $63 ÷ 0.60 $ 105

Sales price before increase 100
Required increase in sales price per unit $ 5
b. Unit contribution margin:

Less: Variable costs per unit
following 15% increase in direct labor cost (part a ) 63
Sales volume required to maintain current operating income:

Sales Volume 
$390,000 + $350,000
 = $20,000 units
$37
c. Current After
Capacity Expansion
(20,000 Units) (25,000 Units)
Total contribution margin ($37 per unit) $ 740,000 $ 925,000

Less: Fixed costs 390,000 530,000*
Operating income at full capacity $ 350,000 $ 395,000
*$390,000 + additional depreciation per year on new

machinery, $140,000 (20% of $700,000).

P20.6A
PERCULA FARMS
a. Raising clownfish will result in the highest
operating income.
Clownfish Angelfish
Number of salable fish 100,000 50,000

× sale price $ 4 $ 10
Total revenue $ 400,000 $ 500,000
Variable costs:
Eggs $ 5,500 $ 9,500
Feedings 78,750 150,000
Water changes 35,000 100,000
Heating and lighting 14,000 20,000
Total variable costs $ 133,250 $ 279,500
Fixed costs: 80,000 80,000
b. The most important factors in determining operating income are survival rates, and the
costs of feeding and water changes.
c. and d.
Operating income with new filter material:
Clownfish Angelfish

Total revenue $ 480,000 $ 600,000
Variable costs:
Eggs $ 5,500 $ 9,500
Feedings 84,000 160,000
Fixed costs: 88,000 88,000
Percula will earn the highest operating income by purchasing the new filter material and
raising angelfish.

P20.7A
PROBLEM 20.7A
PERCULA FARMS (concluded)
c. and d.
Operating income with new heating and lighting
equipment: Clownfish Angelfish
Total revenue $ 420,000 $ 550,000
Variable costs:
Eggs $ 5,500 $ 9,500
Feedings 78,750 150,000
Fixed costs: 88,000 88,000

P20.7A (p.2)
LIFEFIT PRODUCTS
a. Contribution margins of product lines:

Shoes ($15 contribution margin ÷ $50 sales price) 30%
Shorts ($4 contribution margin ÷ $5 sales price) 80%
b. (1) Average contribution margin ratio:

From shoes (30% contribution margin × 80% of sales mix) 24%
From shorts (80% contribution margin × 20% of sales mix) 16%
(2) Monthly operating income:

Total sales $ 1,000,000
Average contribution margin ratio × 40%
Total contribution margin ($1,000,000 × 40%) $ 400,000
Less: Fixed costs and expenses 378,000
Operating income $ 22,000
(3) Monthly break-even sales volume (in dollars):

Fixed costs and expenses $ 378,000
Average contribution margin ratio ÷ 40%
Break-even sales volume ($378,000 ÷ 40%) $ 945,000
c. Assuming new sales mix (shoes, 70%; shorts, 30%)

(1) Average contribution margin ratio:
From shoes (30% contribution margin × 70% of sales) 21%
From shorts (80% contribution margin × 30% of sales) 24%



P20.8A
PROBLEM 20.8A
LIFELIFT PRODUCTS (concluded)
d. In the new sales mix, increased sales of shorts have replaced some sales of shoes. Shorts have
a much higher contribution margin than shoes. Thus, at a given sales volume, selling shorts
instead of shoes provides more contribution margin, contributes more toward operating
income, and lowers the sales volume required to break even.

P20.8A (p.2)
SOLUTIONS TO PROBLEMS SET B
25 Minutes, Medium PROBLEM 20.1B

SATKA, INC.
a. Required contribution margin per unit

Budgeted operating Income $ 400,000
Fixed costs 800,000
Total required contribution margin $ 1,200,000
Number of units to be produced and sold 30,000
Required contribution margin per unit
($1,200,000 ÷ 30,000 units) $ 40
Required sales price per unit:

Required contribution margin per unit $ 40
Variable costs and expenses per unit 100
Total required unit sales price $ 140
Fixed Costs
b. Break-Even Sales Volume (in units) =
Contribution Margin per Unit
$800,000
=
$40
= 20,000 units
c. Margin of safety at 30,000 units:

Sales volume at 30,000 units ($140 x 30,000) $ 4,200,000
Less: Break-even sales volume ($140 x $20,000) 2,800,000

P20.1B
PROBLEM 20.1B
SATKA, INC. (concluded)
d. Yes. With a unit sales price of $132, the break-even sales volume in units is 25,000 units:
Unit contribution margin = $132 - $100 variable costs = $32
$800,000
Break-even sales volume (in units) =
$32
= 25,000 units
Given current demand of 30,000 units, the company can still generate an operating income of
$160,000 with a selling price of $132 (5,000 units above break-even × $32 contribution margin
per unit = $160,000).

P20.1B (p.2)
SNUG-AS-A-BUG
a. Sales price per unit:

Budgeted costs $ 4,800,000
Add: Budgeted operating income 560,000
Budgeted sales revenue 5,360,000
Sales price per unit ($5,360,000 ÷ 80,000 units) $ 67
b. (1) Total fixed costs:

Manufacturing overhead ($2,400,000 × 90%) $ 2,160,000
Selling and adminstrative expenses ($800,000 × 60%) 480,000
Total fixed costs $ 2,640,000
(2) Variable costs and epenses per unit:

Direct materials $ 18
Direct labor 2
Manufacturing overhead ($30 × 10%) 3
Selling and administrative expense ($10 × 40%) 4
Total variable costs per unit $ 27
(3) Unit contribution margin:

Less: Variable costs per unit [from (2) ] 27
(4) Number of units required to break even:

Fixed costs [from (1) ] $ 2,640,000
Contribution margin per unit [from (3) ] 44
Number of units required to break even ($2,640,000 ÷ $44) 60,000

P20.2B
MOOR-N-MORE
a.
MOOR-N-MORE
Cost-Volume-Profit Graph
Annual Basis

P20.3B
PROBLEM 20.3B
MOOR-N-MORE (continued)
Operating data:
Revenue per mooring-space hour $ 5
Variable costs per mooring-space hour 10 cents
Fixed costs per year:
General manager's salary $ 32,940
Wages ($250 × 52 × 3) 39,000
Rent ($5,000 × 12) 60,000
Fixed city taxes ($1,500 × 12) 18,000
Total fixed costs $ 149,940
Capacity = 80 spaces × 3,000 hours per year = 240,000 moor-space hours per year
Revenue at full capacity = 240,000 × $5 = $1,200,000 per year

P20.3B (p.2)
PROBLEM 20.3B
MOOR-N-MORE (concluded)
b. Contribution margin ratio:

Mooring charge per hour $ 5.00
Less: Variable costs per unit 0.10
Contribution margin ratio ($4.90 ÷ $5.00) 98%
Break-even sales volume:

Fixed costs:
Rent ($5,000 × 12) $ 60,000
General Manager's salary 32,940
Wages ($250 × 52 × 3) 39,000
Fixed city taxes ($1,500 × 12) 18,000
Total annual fixed costs $ 149,940
c. (1) New contribution margin ratio per parking-space hour:

Mooring charge per hour $ 5.00
Less: Variable costs ($0.10 + $0.20) 0.30
New contribution margin ratio ($4.70 ÷ $5.00) 94%
New level of fixed costs:

Rent ($5,000 × 12) $ 60,000
General Manager's salary 32,940
Vacation pay ($250 × 2 × 3) 1,500
Fixed city taxes ($1,500 × 12) 18,000
Total fixed costs under new arrangement $ 112,440
(2) Required sales revenue to produce desired

operating income:
Total fixed costs under new arrangement (above) $ 112,440
Add: Target profit 112,560
Total contribution margin required $ 225,000
New contribution margin ratio (above) 94%
Sales volume ($225,000 ÷ 94%) $ 239,362

P20.3B (p.3)
GREEN THUMB
a. Contribution margin ratio:

Less: Variable costs per unit 12
Contribution margin per bag $ 8
Contribution margin ratio ($8 ÷ $20) 40%
Break-even sales volume in dollars:

Fixed costs ($5,000 + $2,400 + $1,600) $ 9,000
Break-even sales volume in dollars ($9,000 ÷ 40%) $ 22,500
Break-even sales volume in bags:

Break-even sales volume in dollars (above) $ 22,500
Break-even sales volume in bags ($22,500 ÷ $20) 1,125
b. On the following page.
c. Projected operating income at various levels:

1,500 bags 1,800 bags
Contribution margin per bag ($20 - $12) $ 8 $ 8
Total contribution margin at indicated volume $ 12,000 $ 14,400
Less: Fixed costs 9,000 9,000
Projected monthly operating income $ 3,000 $ 5,400

P20.4B
PROBLEM 20.4B
GREEN THUMB (concluded)
b.
GREEN THUMB
Cost-Volume-Profit Graph
Monthly Basis

P20.4B (p.2)
40 Minutes, Strong PROBLEM 20.5B
ED WINSLOW
a. Unit contribution margin:

Less: Variable costs per unit:
Merchandise $ 1.10
Rental commission 0.10 1.20
Break-even volume in units:

Monthly fixed costs:
Depreciation ($60,000 × 0.20 × 1/12) $ 1,000
Wages 1,800
Other 200
Total monthly fixed costs $ 3,000
Contribution margin per unit (above) 2
Break-even volume in units ($3,000 ÷ $2) 1,500
Break-even volume in dollars:

Break-even volume in units (above) 1,500
Break-even volume in dollars (1,500 units × $3.20) $ 4,800
b. See following page.
c. Sales volume to produce operating income equal to 12%

return on investment:
Total monthly fixed costs (part a ) $ 3,000
Desired operating income ($70,000 × 12% × 1/12) 700
Total desired contribution margin $ 3,700
Contribution margin per unit (part a ) $ 2
Sales volume in units ($3,700 ÷ $2) 1,850
Sales volume in dollars (1,850 × $3.20) $ 5,920
d. New monthly fixed costs [$3,000 + ($45 × 50)] $ 5,250

New contribution margin per unit:
Less: Variable costs per unit (only merchandise cost) 1.10 $ 2.10
New break-even volume in units ($5,250 ÷ $2.10) 2,500

P20.5B
PROBLEM 20.5B
ED WINSLOW (concluded)
b.
ED WINSLOW
Cost-Volume-Profit Chart
Monthly Basis

P20.5B (p.2)
ELECTRO SYSTEMS
a. Variable costs per unit before 20% increase in the cost

of direct labor $ 6.00
Increase in cost of direct labor, 20% of $1.00 0.20
Variable costs and expenses per unit
after 20% increase in the cost of direct labor $ 6.20
Because the contribution margin ratio of 60% is

required, the variable costs of $6.20 per unit must
equal 40% of sales price after the wage increase.
New sales price, $6.20 ÷ 40% $ 15.50

Sales price before increase 15.00
Required increase in sales price per unit $ 0.50
b. Unit contribution margin:

Less: Variable costs per unit
following 20% increase in direct labor cost (part a ) 6.20
Sales volume required to maintain current operating income:
Fixed Costs + Target Operating

Sales Volume 
$1,000,000 + $800,000
 = $204,545 (rounded)
$8.80
c. Current After
Capacity Expansion
210,000 Units 220,500 Units
Total contribution margin ($8.80 per unit) $ 1,848,000 $ 1,940,400

Less: Fixed costs 1,000,000 1,100,000
Operating income at full capacity $ 848,000 $ 840,400
Fixed costs after the expansion:

$1,000,000 + $100,000 depreciation
expense ($500,000 ÷ 5 years).

P20.6B
DORSAL RANCH
a. Raising cod will result in the highest
operating income.
Cod Salmon

Total revenue $ 1,500,000 $ 1,800,000
Variable costs:
Eggs $ 14,000 $ 18,000
Feedings 336,000 700,000
Water treatments 24,000 60,000
Total contribution margin $ 1,114,000 $ 1,007,000
Fixed costs: 900,000 900,000
b. The most important factors in determining operating income are survival rates, and
the costs of feeding and water changes.
c. and d.
Operating income with new filter material:
Cod Salmon

Total revenue $ 2,000,000 $ 2,520,000
Variable costs:
Eggs $ 14,000 $ 18,000
Feedings 403,200 840,000
Fixed costs: 920,000 920,000
Dorsal will earn the highest operating income by purchasing the new filter material
and raising salmon.

P20.7B
PROBLEM 20.7B
DORSAL RANCH (concluded)
c. and d.
Operating income with new heating
and lighting equipment: Cod Salmon
Total revenue $ 1,600,000 $ 1,980,000
Variable costs:
Eggs $ 14,000 $ 18,000
Feedings 336,000 700,000
Fixed costs: 920,000 920,000

P20.7B (p.2)
HOMETEAM SPORTS
a. Contribution margins of product lines:

Hats ($6 ÷ $20) 30%
Shirts ($21 ÷ $28) 75%
b. (1) Average contribution margin ratio:

Hats (30% × 40% mix) 12%
Shirts (75% × 60% mix) 45%


Break-even sales volume ($684,000 ÷ 57%) $ 1,200,000
c. Assuming new sales mix (shirts, 40%; hats, 60%)

(1) Average contribution margin ratio:
Hats (30% × 60%) 18%
Shirts (75% × 40%) 30%

$ 36,000

Break-even sales volume ($684,000 ÷ 48%) $ 1,425,000

P20.8B
PROBLEM 20.8B
HOMETEAM SPORTS (concluded)
d. In the new sales mix, increased sales of hats have replaced some sales of shirts. Shirts have a
much higher contribution margin than hats. Thus, at a given sales volume, selling hats
instead of shirts provides less contribution margin, contributes less toward operating
income, and increases the sales volume required to break even.

P20.8B (p.2)
SOLUTIONS TO CRITICAL THINKING CASES
20 Minutes, Medium CASE 20.1
MULTIPLE PERSPECTIVES—
ATTEND OUR SEMINAR
The following are possible reasons you could give each of the individuals to motivate them to
come to your seminar:
The factory worker who serves as her company’s labor union representative in charge of contract
negotiations
Knowledge of budgeting and budget processes is a source of empowerment in most

organizations. When it comes to negotiating a labor contract, lack of budgetary knowledge can
put one at a distinct disadvantage. The factory’s labor union representative will be directly
involved in determining one of the company’s largest variable costs—its direct labor. An
understanding of cost-volume-profit relationships will enable her to better evaluate the impact
of her wage requests on the company’s performance and to better scrutinize what management
says they can or cannot do.
The purchasing agent in charge of ordering raw materials for a large manufacturing company
The purchasing agent is also directly involved with one of the company’s largest variable
costs—raw materials inventory. Having a general knowledge of cost-volume-profit
relationships will help him to better understand the impact of his actions on company
performance. For example, what is the impact on operating income of receiving large quantity
discounts from a major supplier? What is the effect of receiving purchase discounts for prompt
payment to all vendors? What is the effect on operating income of selecting one supplier over
another? What is the net effect of paying a premium for high-quality raw materials given a
resulting reduction in waste and scrap?
The vice president of sales for a large automobile company
The vice president of sales plays a critical role in determining her company’s operating
performance. A knowledge of cost-volume-profit relationships will help her to evaluate
important questions related to the decisions she must make. For example, given that a target
income for the company has been imposed, what sales quotas must she establish for her
dealers? Or, conversely, by imposing an established sales quota on the company’s dealers, what
changes in operating income can be expected? Given an expected level of sales, how will fixed
and variable production costs be affected?

Case 20.1
CASE 20.1
MULTIPLE PERSPECTIVES—
ATTEND OUR SEMINAR (concluded)
The director of research and development for a pharmaceutical company
Each year, the director of research and development must request budgetary funding for the
development of new products. Investment in research and development represents a significant
fixed cost for most pharmaceutical companies. A general understanding of cost-volume-profit
relationships will help the director to defend his budget request. By how much will new
products increase total sales? What are the variable and fixed costs associated with bringing a
new product to market? What is the effect of those costs on operating income?

Case 20.1 (p.2)
40 Minutes, Strong CASE 20.2
DON’T MESS WITH THE PURPLE COW
a. Sales (in gallons) required to earn $10,000 per month:
Sales (in gallons) required to break even 1,500
Sales (in gallons) beyond break-even point required to earn $10,000
per month, $10,000 ÷ $7.80 ($8.00 - $0.20 bonus) 1,282
Sales (in gallons) required to earn $10,000 per month 2,782
b. Projected monthly results for typical drive-in store: (1) (2)

Reduce Increase
Selling Advertising
Price Expense
Average selling price per gallon $ 12.80 $ 14.80
Less: Variable cost per gallon 6.80 6.80
Contribution margin per gallon $ 6.00 $ 8.00
Estimated sales (gallons):

If selling price is reduced, 3,000 × 120% × 3,600
If selling price is not reduced, 3,000 × 110% × 3,300
Total contribution margin earned $ 21,600 $ 26,400
Less: Total fixed costs per month (12,000) (12,000)
Additional fixed cost—advertising (3,000)
Projected monthly operating income $ 9,600 $ 11,400
Monthly break-even point (in gallons):

Total fixed costs per month $ 12,000 $ 15,000
Contribution margin per gallon $ 6 $ 8
Monthly break-even point (total fixed costs ÷

contribution margin per gallon) 2,000 gallons 1,875 gallons
c. Memo to Management:
RE: Alternative marketing proposals: price reductions or additional advertising
The Purple Cow should adopt neither of the two proposed marketing strategies. Of these
strategies, the increased advertising would be preferable to the reductions in sales prices, as
indicated by the computations of projected operating income (part b ). However, neither
approach is projected to achieve a higher operating income than is currently being achieved
with the strategy of paying managers a bonus of 20 cents per gallon for sales in excess of the
break-even point. The current profitability of a typical Purple Cow drive-in facility is
summarized next.

Case 20.2
CASE 20.2
DON’T MESS WITH THE PURPLE COW (concluded)
Sales volume in excess of break-even point (in gallons)
(3,000 gallons, less 1,500-gallon break-even point) 1,500
Contribution margin per unit of sales over the break-even point

($14.80 sales price, less $6.80 variable costs,
less $0.20 per gallon manager’s bonus) $ 7.80
Operating income under current conditions

(1,500 gallons × $7.80 per gallon) $ 11,700
This amount exceeds by $300 the projected monthly operating income from the better of the
two proposed new marketing strategies.

Case 20.2 (p.2)
10 Minutes, Easy CASE 20.3
SEC FORM 8-K
ETHICS, FRAUD AND CORPORATE GOVERNANCE
a. Section 409 of the Sarbanes-Oxley Act (SOX) requires public companies disclose certain
material events within four business days after they occur. Such events include
management’s commitment to dispose of long-lived assets and/or terminating employees
under a pension plan. SOX also requires that a firm file a Form 8-K if certain long-lived
assets have become materially impaired.
b. The charge to income that was disclosed in the Form 8-K by the CFO probably related to
the impairment of the assets at the Jacksonville Plant and/or the costs associated with
closing the plant.
c. Given the company has been struggling in recent years to break-even, large charges related
to asset impairments and/or plant closures would probably result in the reporting of a net
loss for the year.
d. Floyd Christenson’s argument is one of a desperate man. His suggestion that a Form 8-K
not be filed is unjustified ethically and legally.

Case 20.3
35 Minutes, Medium CASE 20.4
FORD MOTOR COMPANY
INTERNET
a. Utility trucks (e.g., primarily sport utility vehicles) have contributed most to the company's
sales mix in the most recent year reported (approximately 28%).
b. For many years, including the most recent year reported, sports utility vehicles have been
the largest segment of the U.S. automobile industry's total sales mix, often accounting for
more than 25% of total vehicle sales.
c. Historically, Ford's sales mix has remained relatively constant with full-size pickup trucks
and sports utility vehicles comprising more than 50% of its total sales. In recent years, the
contribution of large and medium cars to its sales mix has declined and both small and
medium car sales have increased.
d. Historically, the U.S. automobile industry's sales mix has remained relatively constant with
full-size pickup trucks and sports utility vehicles comprising nearly 40% of total sales. In
recent years, the contribution of large size cars to the industry's sales mix has declined, and
both small and medium car sales have increased. With energy prices at record highs, it is
likely that the industry will experience a rapid growth in its small car segment, and a
possible declines in full-size pickup trucks and sports utility vehicles. Combined small and
medium car sales now account for nearly 40% of total industry sales.
e. Products with the highest contribution margins contribute most to the bottom line. Thus,
by shifting its sales mix to include more products with high contribution margins, a
company can improve its overall profitability. In the automobile industry, full-size pickup
trucks and sports utility vehicles have always had higher contrubution margins than
vehicles in the small car segment. As demand for smaller cars increases, the industry must
find ways to manufacture these vehicles more cost effectively to avoid downturns in
profitability.

Case 20.4

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CHAPTER 20

© The McGraw-Hill Companies, Inc., 2012

CRITICAL THINKING CASES

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20.2 A,B Blaster Corporation/Snug-As-A-Bug 25 Medium

20.3 A,B Stop-n-Shop/Moor-n-More 30 Medium

20.4 A,B Rainbow Paints/Green Thumb 30 Medium

20.5 A,B Simon Teguh/Ed Winslow 40 Strong

20.6 A,B Precision Systems/Electro Systems 30 Strong

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20.8 A,B Lifefit Products/HomeTeam Sports 35 Strong

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20.1 Multiple Perspectives—Attend Our Seminar 20 Medium

20.2 Don’t Mess with the Purple Cow 40 Strong

20.3 Filing Form 8-K 10 Easy

20.4 Ford Motor Company 15 Easy

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1. It is important for management to understand cost-volume-profit relationships in order to do a

3. a. Total variable costs increase in approximate proportion to an increase in activity.

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f. On a per-unit basis, the fixed elements of a semivariable cost decline as the

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e. Fixed. Depreciation expense on a sales showroom is independent of the level

(2) Average cost per call (125 calls per month):

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Fixed Costs + Target Profit

Unit sales price = $24 variable costs ÷ 0.60 = $40

 $40 (above) - $24 = $16

Fixed Costs + Target Operating Income

Fixed Costs + Target Operating Income

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Fixed Costs + Target Operating Income

b. Break-even sales volume ($80 × 25,000 units) …………… $ 2,000,000

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Client Possible Activity Bases

B. Ex. 20.10 a. Contribution Percentage of Average

$3,680,000 ÷ 23% = $16,000,000

b. Fixed Costs + Target Operating Income

($3,680,000 + $1,380,000) ÷ 23% = $22,000,000

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Ex. 20.2 a. (1) Machine Manufacturing

(2) Total manufacturing overhead

c. Estimated manufacturing overhead: February March

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Ex. 20.4 a. Product 1 Product 2

Break-Even in Sales = $63,000 ÷ 42% = $150,000

Fixed Costs + Target Operating Income

Break-Even in Sales = ($63,000 + $12,000) ÷ 37.5% = $200,000

Ex. 20.5 a. Contribution

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Ex. 20.7 Unit Sales Price - Variable Cost per Unit

Fixed Costs + Target Operating Income

d. Sales volume (40,000 units x $28) $ 1,120,000

e. Operating Income = Margin of Safety × Contribution Margin Ratio

= $800,000 × 0.75 = $600,000

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Projected operating Income without either investment:

(1) ($1,200,000 x 1.05)

Sales Revenue x 25% = $360,000

Sales Revenue = $1,440,000

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a. Contribution margin per unit: