Chapter 4

Chapter 4
Cost-Volume-Profit Relationships
Discussion Case 4-1
The point of this case is to illustrate that even when competition is high,
CVP analysis can easily cope with changing assumptions and estimates.
Some possible reasons for disagreeing:

 Even when competition is high, selling prices, unit costs and cost
behavior patterns are unlikely to change by large amounts in the
short-run or to change so quickly that CVP analysis will be of limited
use.
 When completion is high, some values used in CVP analysis such as
selling prices will likely be based on the current price offerings by key
competitors. This will make these estimates quite accurate since
selling prices that customers are willing to pay are easily observable
and given their importance to CVP analysis, will make the resultant
estimates (e.g., break-even points) more reliable.
 Managers can use sensitivity analysis to improve their decision-
making when competition is high. For example, break-even levels,
targeted profit levels, and so on can all be calculated under differing
assumptions about selling prices and unit costs. Indeed this is one of
the strengths of CVP analysis is that it allows for the use of “what if”
assumptions to produce estimates of key metrics such as the break-
even point. This idea is noted in the chapter. So, for example, even if
prices do change quickly in the short-run CVP analysis can easily be
updated to reflect any estimated or actual changes.
Some possible reasons for agreeing:

 If competition causes selling prices, unit costs or cost behavior to
change by large amounts over the short-run then CVP analysis may
have limited value.
 Sales mix may change quickly as the result of competitors’ actions
such as price changes or the introduction of new models. To the
extent these actions are unforeseen, the sales mix assumption used
in multi-product CVP analysis may inaccurate.
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Solutions Manual, Chapter 4 1
Solutions to Questions
4-1 The contribution margin ratio is the ratio 4-6 If a company’s contribution margin per
of the contribution margin to sales. It can be unit increases, then its break-even level of sales
calculated using either the sales and will decrease, assuming no change to fixed
contribution margin amounts per unit or using expenses. An increase in the CM per unit means
the total dollar amounts for these items for a that each dollar of sales revenue is generating
given sales volume. It can be used in a variety more contribution margin to cover fixed
of ways. For example a change in the sales a expenses. As a result, the level of sales required
company expects to generate can be multiplied to break-even will decrease.
by the contribution margin ratio to estimate the
impact on the total contribution margin in 4-7 Two approaches to break-even analysis
dollars. If fixed costs do not change, then the are (a) the graphical method and (b) the
change in total contribution margin will also formula method.
represent the change in operating income. The In the graphical method, total cost and total
CM per ratio can also be used in break-even revenue data are plotted on a graph. The
analysis to determine the total sales revenue intersection of the total cost and the total
that must be generated to earn exactly $0 in revenue lines indicates the break-even point.
operating income. Therefore, knowledge of a The graph shows the break-even point in both
product’s CM ratio is extremely helpful in units and dollars of sales.
forecasting contribution margin and operating Derived from the contribution format profit
income. equation, the formula method, total fixed cost is
divided by the contribution margin per unit to
4-2 The slope of a profit graph is obtain the break-even point in units.
determined by the contribution margin per unit. Alternatively, total fixed cost can be divided by
The higher the contribution margin per unit, the the contribution margin ratio to obtain the
steeper the slope. break-even point in sales dollars.
4-3 Incremental analysis focuses only on the 4-8 A flatter profit line means that profit
changes in revenues, costs and volumes that will changes by a smaller amount for each unit
result from a particular decision. The main change in sales volume. So, a flatter profit line
advantage of the incremental approach is that it means that the contribution margin per unit has
is simpler because it ignores any factors (e.g., decreased. This decrease in the contribution
fixed costs) that do not change under the margin per unit will cause the break-even level
alternatives being considered. As such, the of unit sales to increase as more units will need
approach takes less time to utilize and reduces to be sold to cover fixed costs. If the slope of
the chances for making an error because it only the profit line stays the same but the line moves
uses amounts expected to change. up to intersect the vertical axis closer to $0, this
means that fixed costs have decreased. This is
4-4 All other things equal, Company B, with because the point where the profit line
its higher fixed costs and lower variable costs, intersects the vertical axis represents total fixed
will have a higher contribution margin ratio than costs. So, if the intersection of the profit line
Company A. Therefore, it will tend to realize a with the vertical axis is closer to $0, fixed costs
larger increase in contribution margin and in must be decreasing. If fixed costs are
profits when sales increase. decreasing and the slope of the profit line stays
the same, the break-even point will decrease.
4-5 A margin of safety of 20% means that Importantly, the fact that the slope of the profit
the break-even level of sales dollars is 20% line stays the same, means that the contribution
below the current level of sales dollars. To put ia margin per unit has not changed.
another way, it means that if sales drop by 20%
from the current level the company will be at 4-9 A 5% increase in the income tax rate
the break-even level of total sales. would have no impact on the break-even point
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2 Managerial Accounting, 12th Edition
since at a $0 level of profit, there is no income (2) Multiply the percentage from (1) by the
tax. contribution margin for the product.
4-10 Cost structure represents the relative (3) Sum the individual weighted contribution
proportion of fixed and variable costs in an margins.
organization.
4-13 A higher break-even point would result
4-11 Because Company X is highly automated if the sales mix shifted from the high
it, will likely have higher fixed costs and lower contribution margin product to the low
variable costs, and thus have a higher break- contribution margin product. Such a shift would
even point than Company Y. Hence, Company X cause the weighted average contribution margin
would also have the lower margin of safety. per unit in the company to decrease. With a
lower weighted average contribution margin per
4-12 The weighted average contribution unit, the break-even point would be higher
margin per unit is calculated as follows: because more total unit sales would be required
to cover the same amount of fixed costs.
(1) Calculate the percentage sales mix of each
product, e.g., Product A unit sales ÷ Total unit
sales all products.

Foundational Exercises
1. The contribution margin per unit is calculated as follows:

Total contribution margin (a)............... $8,000
Total units sold (b)............................. 1,000 units
Contribution margin per unit (a) ÷ (b).. $8.00 per unit
The contribution margin per unit ($8) can also be derived by calculating
the selling price per unit of $20 ($20,000 ÷ 1,000 units) and deducting
the variable expense per unit of $12 ($12,000 ÷ 1,000 units).
2. The contribution margin ratio is calculated as follows:

Total contribution margin (a)............... $8,000
Total sales (b)................................... $20,000
Contribution margin ratio (a) ÷ (b)....... 40%
3. The variable expense ratio is calculated as follows:

Total variable expenses (a).................. $12,000
Total sales (b)................................... $20,000
Variable expense ratio (a) ÷ (b)........... 60%
4. The increase in net operating is calculated as follows:

Contribution margin per unit (a)..................... $8.00 per unit
Increase in unit sales (b)............................... 1 unit
Increase in net operating income (a) × (b)..... $8.00
5. If sales decline to 900 units, the net operating would be computed as

follows:
Total Per Unit
Sales (900 units)........... $18,000 $20.00
Variable expenses......... 10,800 12.00
Contribution margin...... 7,200 $ 8.00
Fixed expenses............. 6,000
Net operating income.... $ 1,200
Foundational Exercises (continued)
6. The new net operating income would be computed as follows:

4 Managerial Accounting, 12th Canadian Edition
Total Per Unit
Sales (900 units)........... $19,800 $22.00
Contribution margin...... 9,000 $10.00
Fixed expenses............. 6,000
7. The new net operating income would be computed as follows:

Total Per Unit
Sales (1,250 units)........ $25,000 $20.00
Contribution margin...... 8,750 $ 7.00
Fixed expenses............. 7,500
8. The break-even point in unit sales is as follows:
¿ expenses $ 6,000
= =750 units
CM per unit $8
9. The dollar sales to break-even is as follows:

¿ expenses $ 6,000
= =$ 15,000
CM ratio .4
The dollar sales to break-even ($15,000) can also be computed by

multiplying the selling price per unit ($20) by the unit sales to break-
even (750 units).
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10. The number of units that must be sold to achieve the target profit of
$5,000 is as follows:
¿ expenses+Target profit $ 6,000+$ 5,000

= =1,375
CM per unit $8
11. The margin of safety in dollars is calculated as follows:

Sales.............................................................. $20,000
Break-even sales (at 750 units)........................ 15,000
Margin of safety (in dollars)............................. $ 5,000
The margin of safety as a percentage of sales is calculated as follows:

Margin of safety (in dollars) (a)................. $5,000
Sales (b).................................................. $20,000
Margin of safety percentage (a) ÷ (b)........ 25%
12. The degree of operating leverage is calculated as follows:

Contribution margin (a). ....................... $8,000
Net operating income (b)...................... $2,000
Degree of operating leverage (a) ÷ (b). . 4.0
13. A 5% increase in sales should result in a 20% increase in net

operating income, computed as follows:
Degree of operating leverage (a).............................. 4.0
Percent increase in sales (b)..................................... 5%
Percent increase in net operating income (a) × (b).... 20%
14. The degree of operating leverage is calculated as follows:

Contribution margin (a). ....................... $14,000
Net operating income (b)...................... $2,000
Degree of operating leverage (a) ÷ (b). . 7.0

15. A 5% increase in sales should result in 35% increase in net operating

income, computed as follows:
Degree of operating leverage (a).............................. 7.0

Percent increase in sales (b)..................................... 5%
Percent increase in net operating income (a) × (b).... 35%

Exercise 4-1 (20 minutes)
1. The revised operating income per month is:
Original operating income........ $15,000

Change in contribution margin
(100 units × $15.00 per unit). 1,500
New operating income............. $16,500
2. The revised operating income per month is:

Original operating income................... $15,000
Change in contribution margin
(-200 units × $15.00 per unit).......... (3,000)
New operating income........................ $ 12,000
3. The revised operating income is:

Total
Contribution margin....... 9,000 x $15 $135,000
Fixed expenses…………….(no change) 135,000
Operating income.......... $ 0
Note: This is the company's break-even point.

1. The profit graph is based on the following simple equation:

Profit = Unit CM × Q − Fixed expenses
Profit = ($19 − $15) × Q − $12,000
Profit = $4 × Q − $12,000
To plot the graph, select two different levels of sales such as Q=0 and
Q=4,000. The profit at these two levels of sales are -$12,000 (= $4 × 0
− $12,000) and $4,000 (= $4 × 4,000 − $12,000).
Profit Graph
$5,000
$0
-$5,000
Profit
-$10,000
-$15,000
-$20,000
0 500 1,000 1,500 2,000 2,500 3,000 3,500 4,000
Sales Volume in Units

Exercise 4-2 (continued)
2. Looking at the graph, the break-even point appears to be 3,000 units.
This can be verified as follows:
Profit = Unit CM × Q − Fixed expenses
= $4 × Q − $12,000
= $4 × 3,000 − $12,000
= $12,000 − $12,000 = $0

1. The company’s contribution margin (CM) ratio is:
Total sales (25,000 units)....... $2,500,000
Total variable expenses.......... 1,500,000
= Total contribution margin.... $ 1,000,000
÷ Total sales......................... $2,500,000
= CM ratio............................ 40%
2. The break-even level of sales dollars is:
Fixed expenses $ 800,000

= =$ 2,000,000
CM ratio .40
3. The break-even level of unit sales is:
Sales price per unit = $2,500,000 ÷ 25,000 units = $100

Breakeven unit sales = $2,000,000 (break-even sales dollars) ÷ $100 =
20,000 units
Alternatively:
Contribution margin per unit = $1,000,000 ÷ 25,000 units = $40
Break-even units:
Fixed expenses $ 800,000

= =20,000 units
CM per unit $ 40
4. The change in operating income from an increase in total sales of

$600,000 can be estimated by using the CM ratio as follows:
Change in total sales...................... $600,000
× CM ratio..................................... 40%
= Estimated change in operating
income....................................... $ 240,000

1. The following table shows the effect of the proposed change in monthly
advertising budget:
Sales With
Additional
Current Webinar
Sales Budget Difference
Unit sales 1,000 1,050 50
Sales............................ $1,000,000 $1,050,000 $50,000
Variable expenses......... 800,000 840,000 40,000
Contribution margin...... 200,000 210,000 10,000
Fixed expenses............. 100,000 105,000 5,000
Operating income.......... $ 100,000 $ 105,000 $5,000
Assuming that there are no other important factors to be considered,
the increase in the webinar budget should be approved since it would
lead to an increase in operating income of $5,000.
Alternative Solution 1
Expected total contribution margin:
$200 × 1,050.................................... $210,000
Present total contribution margin:
$200 × 1,000.................................... 200,000
Incremental contribution margin............ 10,000
Change in fixed expenses:
Less incremental advertising expense. . 5,000
Change in operating income.................. $5,000
Alternative Solution 2
Incremental contribution margin:
$200 × 50 units................................ $ 10,000
Less incremental advertising expense.... 5,000
Change in operating income.................. $5,000

2. The $80 increase in variable costs will cause the unit contribution
margin to decrease from $200 to $120 with the following impact on
operating income:
Expected total contribution margin with the
higher-quality components:
1,150* units × $120 per unit........................... $138,000
1,000 units × $200 per unit............................. 200,000
Change in total contribution margin.................... $ (62,000)
*1,000 x 115%
Assuming no change in fixed costs and all other factors remain the
same, the higher-quality components should not be used.

1. Using the formula method:
Break-even point in units sold = Fixed expenses ÷ Unit CM
= $4,200 ÷ $3 per scarf
= 1,400 scarfs
2. Using the formula method:

Break-even point in sales dollars = Fixed expenses ÷ CM ratio
= $4,200 ÷ 0.20
=$21,000
3.
Break-even point in units sold = Fixed expenses ÷ Unit CM
= $4,200 ÷ $2 per scarf
= 2,100 scarfs

1. Unit sales required to earn before-tax target profit of $20,000:
Fixed expenses + Target profit $ 200,000+$ 20,000

=
CM per unit $ 50∗¿=4,400units ¿
*$200 - $150
2. The formula approach yields the dollar sales required to attain a target
profit of $60,000 (before tax) as follows:
Fixed expenses + Target profit $ 200,000+ $ 60,000

=
CM ratio .25∗¿=$ 1,040,000 ¿
*$50  $200
3. Unit sales required to earn target after-tax income of $120,000 given a

tax rate of 25%.
Target after −tax profit
¿ expenses+
1−Tax Rate
¿
Unit Contribution Margin
$ 120,000
$ 200,000+
1−.25
¿
$ 50
$ 200,000+ $ 160,000
¿
$ 50
¿ 7,200 units

1. Break-even hours for residential clients:
Fixed expenses $ 500

= =50 hours
CM per unit $ 10
Break-even hours for commercial clients:
Fixed expenses $ 825

= =55 hours
CM per unit $ 15
2. Revenue at 120 hours per month*................... $4,200

Break-even revenue (at 55 hours)**................ 1,925
Margin of safety (in dollars)............................. $ 2,275
*$35 x 120; **$35 x 55
The margin of safety as a percentage of sales is as follows:

Margin of safety (in dollars)....................... $2,275
÷ Sales.................................................... $4,200
Margin of safety as a percentage of sales... 54.2%

1. The company’s degree of operating leverage would be computed as
follows:
Contribution margin............... $48,000
÷ Operating income............... $10,000
Degree of operating leverage. 4.8
2. A 5% increase in sales should result in a 24% increase in operating

income, computed as follows:
Degree of operating leverage................................... 4.8
× Percent increase in sales...................................... 5%
Estimated percent increase in operating income........ 24%
3. The new income statement reflecting the change in sales would be:
Percent
Amount of Sales
Sales............................ $84,000 100%
Variable expenses......... 33,600 40%
Contribution margin...... 50,400 60%
Fixed expenses............. 38,000
Operating income.......... $ 12,400
Operating income reflecting change in sales............ $12,400
Original operating income...................................... 10,000
Change – income.................................................. $2,400
Percent change in operating income (2,400/12,400)
24%

1. The overall contribution margin ratio can be computed as follows:
Total contribution margin $ 72,000

= =60 %
Total sales $ 120,000
2. The overall break-even point in sales dollars can be computed as
follows:
¿ $ 54,000
Total ¿ expenses = =$ 90,000
Overall CM ratio 60 %
3. The weighted average contribution margin per hour can be computed as
follows:
(1) (2) (3)
(1) X (2)
Weighted
Services CM Sales Average
Per Hour Mix * CM Per Hour
Lawn care $ 8.00 75% $6.00
Garden maintenance $12.00 25% 3.00
Total $9.00
*Lawn care: 6,000 hours ÷ (6,000 + 2,000); Garden maintenance: 2,000
hours ÷ (6,000 + 2,000)
Alternatively, the calculation could be done as follows:

Total contribution margin $ 72,000
= =$ 9 per hour
Total hours 6,000+2,000
4. The total break-even point in hours can be computed as follows:
¿ $ 54,000
Total ¿ expenses = =6,000 hours
Weighted averageCM per hour $ 9 per hour

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

calculated as follows:
Lawn care: 6,000 hours x 75% = 4,500 hours
Garden maintenance: 6,000 hours x 25% = 1,500 hours
6. Overall sales required to generate an after-tax target profit:

¿ expenses+
1−Tax Rate
¿
Overall Contribution Margin Ratio
$ 42,000
$ 54,000+
1−.3
¿
.60
$ 54,000+ $ 60,000
=$ 190,000
.6

1. Variable expenses: $60 × (100% – 40%) = $36.
2. Selling price.......................... $60 100%

Variable expenses.................. 36 60%
Contribution margin............... $24 40%
. a.
In sales dollars: 15,000 units × $60 per unit = $900,000
Alternative solution:
In units: $900,000 ÷ $60 per unit = 15,000 units
b.
In sales dollars: 18,750 units × $60 per unit = $1,125,000

In units: $1,125,000 ÷ $60 per unit = 18,750 units
c. Unit sales require to earn an after-tax profit of $90,000 if tax rate is

25%.
¿ expenses+
1−Tax Rate
¿
$ 90,000
$ 360,000+
1−.25
¿
$ 24
= 20,000 units
d.
In sales dollars: 13,333 units × $60 per unit = $800,000 (rounded)
In units: $800,000 ÷ $60 per unit = 13,333 (rounded)


1. The contribution margin per person would be:
Price per ticket.................................................. $35
Variable expenses:
Dinner............................................................ $18
Program......................................................... 2 20
Contribution margin per person.......................... $15
The fixed expenses of the dinner-dance total $6,000 ($2,800 + $900 +
$1,000 + $1,300); therefore, the break-even point would be computed
as follows:
$ 6,000
=400 attendees
$ 15
2. Variable cost per person ($18 + $2)..................... $20

Fixed cost per person ($6,000 ÷ 300 people)........ 20
Ticket price per person to break even................... $40
Check:
Operating income if 300 people attend at $40 per ticket:
Contribution margin: 300 x ($40 - $20) = $6,000
Fixed expenses: 6,000
Operating income: $ 0

3. Cost-volume-profit graph:
$20,000
Total Sales
$18,000
Break-even point: 400 people,
$16,000
or $14,000 in sales
$14,000
$12,000
Total Expenses
$10,000
Dollars
$8,000
$6,000
Fixed Expenses
$4,000
$2,000
$0
0 100 200 300 400 500 600
Number of Persons

Per
Total Unit
1. Sales (60,000 units × 1.3 = 78,000 units).... $780,000 $10.00
Variable expenses....................................... 468,000 6.00
Contribution margin.................................... 312,000 $4.00
Fixed expenses........................................... 100,000
Operating income....................................... $ 212,000
2. Sales (60,000 units × 1.20 = 72,000 units). . $648,000 $9.00

Fixed expenses........................................... 100,000
3. Sales (60,000 units × 0.9 = 54,000 units).... $594,000 $11.00

Fixed expenses ($100,000 + $20,000)......... 120,000
4. Sales (60,000 units × 0.85 = 51,000 units). . $586,500 $11.50

Fixed expenses........................................... 100,000

a. Case #1 Case #2
Number of units sold.. . 15,000 * 4,000
Sales.......................... $180,000 * $12 $100,000 * $25
Variable expenses....... 120,000 * 8 60,000 15
Contribution margin..... 60,000 $4 40,000 $10 *
Fixed expenses........... 50,000 * 32,000 *
Net operating income. . $ 10,000 $ 8,000 *
Case #3 Case #4
Number of units sold.. . 10,000 * 6,000 *
Sales.......................... $200,000 $20 $300,000 * $50
Variable expenses..... 70,000 * 7 210,000 35
Contribution margin..... 130,000 $13 * 90,000 $15
Fixed expenses........... 118,000 100,000 *
Net operating income (loss).. $ 12,000 * $ (10,000)*
b. Case #1 Case #2
Sales.......................... $500,000 * 100% $400,000 * 100%
Variable expenses........ 400,000 80% 260,000 * 65%
Contribution margin..... 100,000 20% * 140,000 35%
Fixed expenses............ 93,000 100,000 *
Net operating income. . $ 7,000 * $ 40,000
Case #3 Case #4
Sales.......................... $250,000 100% $600,000 * 100%
Variable expenses....... 100,000 40% 420,000 * 70%
Contribution margin.... 150,000 60% * 180,000 30%
Fixed expenses........... 130,000 * 185,000
Net operating income (loss). $ 20,000 * $ (5,000) *
*Given

1. Variable expenses: $30 × (100% – 50%) = $15.
2. Break-even point in units and sales dollars:
In units: $450,000  ($30 - $15) = 30,000 units

In sales dollars: $450,000  .50 = $900,000
3. Sales in units and dollars to achieve a target operating income of

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

In dollars: ($450,000 + $150,000)  .5 = $1,200,000
4. New break-even point in units:

($450,000 + $54,000)  ($30 - $12) = 28,000 units
5. Sales in dollars to achieve a target after-tax profit of $100,000 with a tax

rate of 20%.
($450,000 + ($100,000  1-.2)  .5 = $1,150,000

1.
Per
Total Unit
Sales (15,000 games)......... $300,000 $20
Variable expenses............... 90,000 6
Contribution margin............ 210,000 $14
Fixed expenses................... 182,000
Net operating income.......... $ 28,000
The degree of operating leverage is:
2. a. Sales of 18,000 games represent a 20% increase over last year’s

sales. Because the degree of operating leverage is 7.5, net operating
income should increase by 7.5 times as much, or by 150% (7.5 ×
20%).
b. The expected total dollar amount of net operating income for next
year would be:
Last year’s net operating income...................... $28,000
Expected increase in net operating income next
year (150% × $28,000)................................ 42,000
Total expected net operating income................ $70,000

1. Break-even point in units and sales dollars:
In units: $108,000  ($50 - $32) = 6,000 units

In sales dollars: $108,000  .36* = $300,000
*($50 - $32)  $50
2. An increase in the variable expenses as a percentage of the selling price

would result in a higher break-even point. The reason is that if variable
expenses increase as a percentage of sales, then the contribution
margin will decrease as a percentage of sales. A lower CM ratio would
mean that more tackle boxes would have to be sold to generate enough
contribution margin to cover the fixed costs.
3.
Increase in unit sales…………………. (a) 2,000
New selling price................ $45*
Variable cost per unit.......... 32
New contribution margin (b) $13
Incremental operating income: (a) x (b) $ 26,000
(a) 8,000 x .25
*
$50 – ($50 x .1)
Loss of operating income due to sales price reduction of $5 on

the base unit sales of 8,000 X $5 = $40,000
Therefore:
Incremental operating income above $26,000

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

1. Basic Deluxe Total Company

Amount % Amount % Amount %
Sales............... $600,000 100 $400,000 100 $1,000,000 100
Variable
expenses....... 240,000 40 260,000 65 500,000 50
Contribution
margin.......... $360,000 60 $140,000 35 500,000 50 *
Fixed expenses 400,000
Operating
income.......... $ 100,000
*$500,000 ÷ $1,000,000 = 50%.
2. The break-even point in sales dollars for the company as a whole would
be:
¿ expenses $ 400,000
= =$ 800,000
CM ratio 50 %
3. The break-even point in units for the company as a whole would be:
(1) (2) (3)

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

Breakeven units =
¿ $ 400,000
Total ¿ expenses = =41,754 units
Weighted averageCM per unit $ 9.58 per unit
Individual product unit sales at break-even: Basic: 32,025 (41,754

x .767); Deluxe: 9,729 (41,754 x .233)
4. The additional contribution margin from additional sales of $50,000 can

be computed as follows:
$50,000 × 50% CM ratio = $25,000
This answer assumes no change in selling prices, variable costs per unit,
fixed expenses, or sales mix.
5. The additional contribution margin from additional sales of 5,000 units

can be computed as follows:
5,000 units × $9.58 per unit* = $47,900
*weighted average contribution margin from part 3 above.
This answer assumes no change in selling prices, variable costs per unit,
fixed expenses, or sales mix.

Problem 4-18 (60 minutes)
1. The CM ratio is 60%:
Selling price...................... $20 100%
Variable expenses.............. 8 40%
Contribution margin........... $12 60%
2. Break-even point in sales dollars: $180,000  .60 = $300,000
3. $75,000 increased sales × 60% CM ratio = $45,000 increased

contribution margin.
Since fixed costs will not change, operating income should also increase
by $45,000.
4. a. Operating leverage = Contribution margin  operating income

$240,000  $60,000 = 4
b. 4 × 20% = 80% increase in operating income. In dollars, this

increase would be 80% × $60,000 = $48,000.

Problem 4-18 (continued)
5. Last Year: Proposed:
20,000 units 25,000 units*
Total Per Unit Total Per Unit
Sales............................ $400,000 $20.00 $450,000 $18.00**
Variable expenses......... 160,000 8.00 200,000 8.00
Contribution margin...... 240,000 $12.00 250,000 $10.00
Fixed expenses............. 180,000 210,000
Operating income.......... $ 60,000 $40,000
* 20,000 units × 1.25 = 25,000 units
** $20 per unit × (1 – 0.10) = $18 per unit
No, the changes should not be made since operating income would
decrease by $20,000.
6. Expected total contribution margin:

25,000 units × $11 per unit*............................. $275,000
20,000 units × $12 per unit............................... 240,000
Incremental contribution margin, and the amount
by which advertising can be increased with
operating income remaining unchanged............. $ 35,000
*$20 – ($8 + $1) = $11

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

Variable expenses (15,000 units × $40 per unit).... 600,000
Contribution margin............................................ 450,000
Fixed expenses................................................... 540,000
Operating loss..................................................... $ (90,000)
2.
18,000 units × $70 per unit = $1,260,000 to break even
3. See the next page.
4. At a selling price of $58 per unit, the contribution margin is $18 per unit.
Therefore:
This break-even point is different from the break-even point in part (2)
because of the change in selling price. With the change in selling price,
the unit contribution margin drops from $30 to $18, resulting in an
increase in the break-even point.

3.
Unit Unit Unit Total
Selling Variable Contribution Volume Contribution Fixed Operating
Price Expense Margin (Units) Margin Expenses income (loss)
$70 $40 $30 15,000 $450,000 $540,000 $ (90,000)
$68 $40 $28 20,000 $560,000 $540,000 $ 20,000
$66 $40 $26 25,000 $650,000 $540,000 $110,000
$64 $40 $24 30,000 $720,000 $540,000 $180,000
$62 $40 $22 35,000 $770,000 $540,000 $230,000
$60 $40 $20 40,000 $800,000 $540,000 $260,000
$58 $40 $18 45,000 $810,000 $540,000 $270,000
$56 $40 $16 50,000 $800,000 $540,000 $260,000
The maximum profit is $270,000. This level of profit can be earned by selling 45,000 units at a price
of $58 each.

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

2. Break-even sales:
¿ $ 223,600
Total ¿ expenses = =$ 545,366 ( rounded )
Contribution marginratio .41
3. The break-even point in units for the company as a whole would be:
(1) (2) (3)
(1) X (2)
Weighted Average
CM Sales CM
Products Per Unit Mix* Per Unit
Sinks $168 25% $42
Mirrors $ 40 50% 20
Vanities $144 25% 36
Total $98
*Sinks: 525 units ÷ 2,100 (525 + 1,050 + 525)
Mirrors: 1,050 units ÷ 2,100 (525 + 1,050 + 525)
Vanities: 525 units ÷ 2,100 (525 + 1,050 + 525)
Breakeven units =
¿ $ 223,600
Total ¿ expenses = =2,282units ( rounded )
Weighted averageCM per unit $ 98
4. Memo to the president:

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

1. a. Selling price..................... $25 100%
Variable expenses............ 15 60%
Contribution margin.......... $10 40%
Break-even units:
b. The degree of operating leverage is:
2. The new CM ratio will be:

Selling price.................... $25 100%
Variable expenses............ 18 72%
Contribution margin......... $ 7 28%
The new break-even point will be:

3. Units sales to attain target profit:
Thus, sales will have to increase by 12,857 balls (42,857 balls, less
30,000 balls currently being sold) to earn the same amount of net
operating income as last year. The computations above and in part (2)
show the dramatic effect that increases in variable costs can have on an
organization. The effects on Northwood Company are summarized
below:
Present Expected
Break-even point (in balls)................................. 21,000 30,000
Sales (in balls) needed to earn a $90,000 profit... 30,000 42,857
Note that if variable costs do increase next year, then the company will
just break even if it sells the same number of balls (30,000) as it did last
year.
4. The contribution margin ratio last year was 40%. If we let P equal the
new selling price, then:
P = $18 + 0.40P
0.60P = $18
P = $18 ÷ 0.60
P = $30
To verify:
Selling price.................... $30 100%
Variable expenses........... 18 60%
Contribution margin........ $12 40%
Therefore, to maintain a 40% CM ratio, a $3 increase in variable costs
would require a $5 increase in the selling price.

5. The new CM ratio would be:

Selling price........................ $25 100%
Variable expenses................ 9* 36%
Contribution margin............. $16 64%
*$15 – ($15 × 40%) = $9
The new break-even point would be:
Although this new break-even is greater than the company’s present

break-even of 21,000 balls [see Part (1) above], it is less than the break-
even point will be if the company does not automate and variable labor
costs rise next year [see Part (2) above].
6a. Unit sales to attain target profit:
Thus, the company will have to sell 1,875 more balls (31,875 –
30,000 = 1,875) than now being sold to earn a profit of $90,000 per
year. However, this is still less than the 42,857 balls that would have
to be sold to earn a $90,000 profit if the plant is not automated and
variable labor costs rise next year [see Part (3) above].

b. The contribution income statement would be:

Sales (30,000 balls × $25 per ball)..................... $750,000
Variable expenses (30,000 balls × $9 per ball).... 270,000
Contribution margin.......................................... 480,000
Fixed expenses................................................. 420,000
Net operating income........................................ $ 60,000
c. This problem illustrates the difficulty faced by some companies. When

variable labor costs increase, it is often difficult to pass these cost
increases along to customers in the form of higher prices. Thus,
companies are forced to automate resulting in higher operating
leverage, often a higher break-even point, and greater risk for the
company.
There is no clear answer as to whether one should have been in favor
of constructing the new plant.

1. Unit sales to break-even:
2. The contribution margin is $216,000 because the contribution margin is

equal to the fixed expenses at the break-even point.
3.
Total Unit
Sales (17,000 units × $30 per unit)....... $510,000 $30
Variable expenses
(17,000 units × $12 per unit)............. 204,000 12
Contribution margin.............................. 306,000 $18
Fixed expenses.................................... 216,000
Net operating income........................... $ 90,000
4. Unit sales required to earn an after-tax profit of $90,000

¿ expenses+
¿
1−Tax Rate Problem 4-22 (continued)
$ 90,000
$ 216,000+
1−.3 ¿ 19,143 units ( rounded )
¿
$ 18
5. Margin of safety in dollar terms:
Margin of safety in percentage terms:
6. The CM ratio is 60%.
Expected total contribution margin: ($500,000 × 60%). . $300,000

Present total contribution margin: ($450,000 × 60%)..... 270,000
Increased contribution margin...................................... $ 30,000
$50,000 incremental sales × 60% CM ratio = $30,000
Given that the company’s fixed expenses will not change, monthly net
operating income will also increase by $30,000.

1. Break-even points:
Fixed expenses $300,000

Break even unit sales= = =12,500 pairs
CM per unit $60 - $36
Break even unit sales dollars =
= = $750,000 *$24  $60
CM ratio .40*
2. See the graph on the following page.
3. Operating income (loss) if 12,000 pairs are sold:

(12,000 x $24) - $300,000 = ($12,000)
Note: since unit sales are below the break-even point of 12,500
calculated in Part 1 above, we know an operating loss will be
incurred.
4. The new break-even point will be:

Break even unit sales= = =15,000 pairs
CM per unit $60 - $40
5. Operating income (loss) if 15,000 pairs are sold:
At 12,500 unit sales (break-even point) operating income is $0.
Incremental contribution margin and contribution margin for the
additional 2,500 units is:
2,500 x ($60 - $36 - $4) = $50,000
6. The new break-even point in sales dollars will be:

Fixed expenses $300,000+ $60,000
= = $654,545 *($60 - $27)  $60
CM ratio .55*

2. Cost-volume-profit graph:
$1,200,000
$1,100,000
Total Sales
$1,000,000
Break-even point: 12,500 pairs,
$900,000
or $750,000 in sales
$800,000
Total Expenses
$700,000
$600,000
Dollars
$500,000
$400,000
Fixed Expenses
$300,000
$200,000
$100,000
$0
0 2,500 5,000 7,500 10,000 12,500 15,000 17,500 20,000
Number of Pairs

1. The contribution margin per sweatshirt would be:
Selling price............................................. $13.50
Variable expenses:
Purchase cost of the sweatshirts............. $8.00
Commission to the student salespersons.. 1.50 9.50
Contribution margin.................................. $ 4.00
Since there are no fixed costs, the number of unit sales needed to yield
the desired $1,200 in profits can be obtained by dividing the target
$1,200 profit by the unit contribution margin:
2. Since an order has been placed, there is now a “fixed” cost associated
with the purchase price of the sweatshirts (i.e., the sweatshirts can’t be
returned). For example, an order of 75 sweatshirts requires a “fixed”
cost (investment) of $600 (=75 sweatshirts × $8.00 per sweatshirt).
The variable cost drops to only $1.50 per sweatshirt, and the new
contribution margin per sweatshirt becomes:
Selling price......................................... $13.50
Variable expenses (commissions only).... 1.50
Contribution margin.............................. $12.00
Since the “fixed” cost of $600 must be recovered before Mr. Hooper
shows any profit, the break-even computation would be:
If a quantity other than 75 sweatshirts were ordered, the answer would

change accordingly.

1. a. Warm Cozy Total

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

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

Break-even units = = =375 units
Weighted average CM per unit $6*
*[(600 ÷ 800) x ($8 - $2)] + [(200 ÷ 800) x ($12 - $6)]

Or
$4,800  800
Margin of safety = Actual sales – break-even sales

Units: 800 – 375 = 425
Percentage: 425 ÷ 800 = 53.1%

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

¿ expenses+
1−Tax Rate
¿
Weighted average contribution margin per unit
$ 4,725
$ 2,250+
1−.3
¿
$6
$ 2,250+ $ 6,750
=1,500units
$6

2. a. Warm Cozy Toasty Total

$ % $ % $ % $ %
Sales.............................. $4,800 100 $2,400 100 $4,000 100 $11,200 100
Variable expenses........... 1,200 25 1,200 50 3,200 80 5,600 50
Contribution margin......... $3,600 75 $1,200 50 $ 800 20 $ 5,600 50
Fixed expenses............... 2,250
Operating income............ $ 3,350

b. Break-even sales = Fixed expenses ÷ CM ratio
= $2,250 ÷ 0.50
= $4,500
Margin of safety:
Dollars: $11,200 - $4,500 = $6,700
Percentage: $6,700 ÷ $11,200 = 59.8%
3. The reason for the increase in the break-even point can be traced to the
decrease in the company’s average contribution margin ratio when the
third product is added. Note from the income statements above that this
ratio drops from 67% to 50% with the addition of the third product.
Toasty has a CM ratio of only 20% ($800 ÷ $4,000), which causes the
overall average contribution margin ratio to fall, since both of the other
products have a higher ratio.
This problem shows the somewhat tenuous nature of break-even
analysis when more than one product is involved. The manager must be
very careful of his or her assumptions regarding sales mix when making
decisions such as adding or deleting products.
It should be pointed out to the president that even though the break-
even point is higher with the addition of the third product, the
company’s margin of safety is also greater. Notice that the margin of
safety increases from $3,825 to $6,700 or from 53.1% to 59.8%. Thus,
sales from the new product will shift the company much further above
its break-even point, even though the break-even point itself is higher.

1. Operating income:
November Basic Advanced Elite Total

Unit sales............................................
2,000 2,000 4,000 8,000
Contribution margin per unit................. $40.00 $108.00 $198.00
Total contribution margin .....................
$80,000 $216,000 $792,000 $1,088,000
Total fixed expenses............................. 408,000
Operating income................................. $680,000
December Basic Advanced Elite Total

Unit sales............................................
6,000 2,000 2,000 10,000
Contribution margin per unit................. $40.00 $108.00 $198.00
Total contribution margin .....................
$240,000 $216,000 $396,000 $852,000
Total fixed expenses............................. 418,000
Operating income................................. $434,000
2. Operating income in December is lower despite the higher unit sales

because the sales mix has changed. In November, 50% of the total unit
sales came from the Elite model, which has the highest contribution
margin per unit. However, in December the Elite model represents only
20% of total unit sales while the Basic model, the least profitable, made
up 60% of total unit sales. This is likely the result of the advertising
campaign which appears to have shifted some sales from the Elite
model to the Basic model. Although the advertising campaign does
appear to have increased total unit sales it was not a success because it
changed the sales mix such that a higher proportion of total unit sales
came from the least profitable product.
3. The break-even in unit sales can be computed as follows:
=
Weighted average CM per unit $ 136∗¿=3,000units ¿
*$1,088,000  8,000 units

4. December’s break-even point has gone up. The reason is that the
division’s sales mix has changed whereby there was a higher proportion
of the least profitable model being sold as part of the overall mix.
5. If the mix stays the same in January as it was in December, then the
weighted average CM per unit will also be the same in the two months.
It can be calculated most easily as follows:
$852,000  10,000 = $85.20
Therefore, the total contribution margin in January will be:

12,000 x $85.20 = $1,022,400

1. The income statements would be:
Present
Amount Per Unit %
Sales.............................. $800,000 $20 100%
Variable expenses............ 560,000 14 70%
Contribution margin......... 240,000 $6 30%
Fixed expenses............... 192,000
Proposed
Amount Per Unit %
Sales.............................. $800,000 $20 100%
Variable expenses*.......... 320,000 8 40%
Contribution margin......... 480,000 $12 60%
Fixed expenses**............ 432,000
*$14 – $6 = $8
**$192,000 + $240,000
2. a. Degree of operating leverage:

Present:
Proposed:

b. Dollar sales to break even:
Present:
Proposed:
c. Margin of safety:
Present:
Proposed:

3. Frieden will be indifferent between performing or not performing the

major upgrade at the volume (X) where total costs are equal.
Solve for X as the number of units where:

Total costs with upgrade = Total costs without upgrade
$8X + $432,000 = $14X + $192,000
$6X = $240,000
X = 40,000 units
Or: Change in Fixed costs  Change in Contribution Margin

$240,000  $6 = 40,000 units
Interestingly, the indifference point equals the current level of sales.

So, unless sales are expected to increase, it may not be in Frieden’s
best interest to proceed with the upgrade since it will have no impact
on operating income as shown in the answer above to requirement 1.
4. If the expected increase in monthly contribution margin exceeds the

increase in monthly fixed expenses, Frieden should proceed with the
new advertising campaign.
Expected contribution margin increase:

(40,000 x 10%) x $6 per unit = $24,000
Increase in fixed costs per month 20,000
Benefit of proceeding with the campaign: $ 4,000
Frieden should go ahead with the new advertising campaign since it

will increase operating income by $4,000 per month if unit sales
increase 10% per month as expected.

1. The numbered components are as follows:
(1) Dollars of revenue and costs.
(2) Volume of output, expressed in units,% of capacity, sales,
or some other measure of activity.
(3) Total expense line.
(4) Variable expense area.
(5) Fixed expense area.
(6) Break-even point.
(7) Loss area.
(8) Profit area.
(9) Revenue line.

2. a. Line 3 Total expense line: Remain unchanged.
Line 9:Revenue line Have a steeper slope.
Break-even point: Decrease.
b. Line 3: Have a flatter slope.
Line 9: Remain unchanged.
Break-even point: Decrease.
c. Line 3: Shift upward.
Break-even point: Increase.
d. Line 3: Remain unchanged.
Break-even point: Remain unchanged.
Shift downward and have a
e. Line 3: steeper slope.
Break-even point: Probably change, but the
direction is uncertain.
f. Line 3: Have a steeper slope.
Line 9: Have a steeper slope.
Break-even point: Remain unchanged in terms of
units; increase in terms of total
dollars of sales.
g. Line 3: Shift upward.
Break-even point: Increase.
Line 3: Shift upward and have a flatter
h. slope.
Break-even point: Probably change, but the
direction is uncertain.

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

The additional sales of units required to cover these fixed costs would
be:
Therefore, a total of 21,000 units (16,000 + 5,000) must be sold in

order for the company to break even. This number of units would equal
total sales of:
21,000 units × $3.00 per unit = $63,000 in total sales
2.
Thus, the company must sell 7,500 units above the break-even point to
earn a profit of $12,000 each month. These units, added to the 21,000
units required to break even, equal total sales of 28,500 units each
month to reach the target profit.
3. If a bonus of $0.10 per unit is paid for each unit sold in excess of the
break-even point, then the contribution margin on these units would
drop from $1.60 to $1.50 per unit.
The desired monthly profit would be:
25% × ($35,000 + $1,000) = $9,000
Thus,
Therefore, the company must sell 6,000 units above the break-even
point to earn a profit of $9,000 each month. These units, added to the
21,000 units required to break even, would equal total sales of 27,000
units each month.

1. The income statements would be:
Present Proposed
Per Per
Amount Unit % Amount Unit %
Sales........................ $450,000 $30 100 $450,000 $30 100
Variable expenses..... 315,000 21 70 180,000 12 * 40
Contribution margin. . 135,000 $9 30 270,000 $18 60
Fixed expenses......... 90,000 225,000
Operating
income.................. $ 45,000 $ 45,000
*$21 – $9 = $12
2. a. Present Proposed
Degree of operating
leverage.................... $135,000  45,000 = 3 $270,000  45,000 = 6
b.
Break-even point in $90,000  .30 = $225,000  .60 =
dollars....................... $300,000 $375,000
c.
Margin of safety =
Total sales –
Break-even sales:
$450,000 – $300,000. $150,000
$450,000 – $375,000. $75,000
Margin of safety
percentage =
Margin of safety ÷
Total sales:
$150,000 ÷ $450,000. 33 1/3%
$75,000 ÷ $450,000. . 16 2/3%

3. The major factor would be the sensitivity of the company’s operations to
changes in the operating environment. In years of strong economic
activity, the company will be better off with the new equipment. The
new equipment will increase the CM ratio and, as a consequence, profits
would rise more rapidly in years with strong sales. However, the company
will be worse off with the new equipment in years in which sales drop.
The greater fixed costs of the new equipment will result in losses being
incurred more quickly and they will be deeper. Thus, management must
decide whether the potential greater profits in good years is worth the
risk of deeper losses in bad years.
4. No information is given in the problem concerning the new variable

expenses or the new contribution margin ratio. Both of these items must
be determined before the new break-even point can be computed. The
computations are:
New variable expenses:
Sales = Variable expenses + Fixed expenses + Profits
$585,000* = Variable expenses + $180,000 + $54,000**
$351,000 = Variable expenses
* New level of sales: $450,000 × 1.3 = $585,000
** New level of operating income: $45,000 × 1.2 = $54,000
New CM ratio:
Sales..................................... $585,000 100%
Variable expenses.................. 351,000 60%
Contribution margin............... $ 234,000 40%
With the above data, the new break-even point in sales dollars can be
computed as:
$180,000  .40 = $450,000

The greatest risk is that the marketing manager’s estimates of increases
in sales and operating income will not materialize and that sales will
remain at their present level. Note that the present level of sales is
$450,000, which is the break-even level of sales under the new
marketing method.
5. The level of sales would needed under the new marketing strategy to
generate $45,000 in operating income can be calculated as follows:
($180,000 + $45,000)  .40 = $562,500
Thus, sales would have to increase by more than 25% ($562,500 is

25% higher than $450,000) in order to make the company better off
with the new marketing strategy than with the current situation. This
appears to be extremely risky.

1. The CM ratio is 50%:
Selling price...................... $40 100%
Variable expenses.............. 20 50%
Contribution margin........... $20 50%
2. Break-even point in sales dollars: $120,000  .50 = $240,000
3. $50,000 decreased sales × 50% CM ratio = $25,000 decreased

contribution margin. Since fixed costs will not change, operating income
should also decrease by $25,000.
4. Operating leverage = Contribution margin  operating income

$200,000  $80,000 = 2.5
5. 2.5 × 20% = 50% decrease in operating income.
6. Last Year: Proposed:

10,000 units 14,000 units*
Total Per Unit Total Per Unit
Sales............................ $400,000 $40.00 $504,000 $36.00**
Variable expenses......... 200,000 20.00 280,000 20.00
Contribution margin...... 200,000 $20.00 224,000 $16.00
Fixed expenses............. 120,000 140,000
Operating income.......... $ 80,000 $84,000
* 10,000 units × 1.4 = 14,000 units

** $40 per unit × (1 – 0.10) = $36 per unit
Yes, the changes should be made since operating income increases and
the margin of safety increases.

1. Break-even points:
Existing Equipment Modified Equipment
$330,000 ÷ ($36 - $28) $750,000 ÷ ($40 - $25)
= 41,250 units = 50,000 units
2. A 25% profit-to-sales ratio requires a profit of $40 × 0.25 = $10 per
unit
Therefore, the equation is: ($40 - $25)X =$750,000 +$10X
($40 - $25)X - $10X= $750,000
$5X= $750,000
X = 150,000 units
. The number of units that must be sold to achieve after-tax profit of
3
$63,000 with a tax rate of 30% the equation is:
Target units =
After −tax target profit
Fixed expenses +
1−.3
Contribution margin per unit
$ 63,000
$750,000 +
1−.3
=
$15
$750,000 +$90,000
= $15 =¿
= 56,000 units
4. Equal profits would occur at the volume level where:
($36 - $28)X - $330,000 = ($40 - $25)X - $750,000
$8X - $330,000 = $15X - $750,000
$7X = $420,000
X = 60,000 units

1. The CM ratio is 30%.
Total Per Unit Percent of Sales
Sales (19,500 units)......... $585,000 $30.00 100%
Variable expenses............ 409,500 21.00 70%
Contribution margin......... $175,500 $ 9.00 30%
Break-even point in units and dollar sales:
2. Incremental contribution margin:

$80,000 increased sales × 0.30 CM ratio............ $24,000
Less increased advertising cost............................ 16,000
Increase in monthly operating income.................. $ 8,000
Since the company is now showing a loss of $4,500 per month, if the
changes are adopted, the loss will turn into a profit of $3,500 each
month ($8,000 less $4,500 = $3,500).
3. Sales (39,000 units @ $27.00 per unit*)......... $1,053,000

Variable expenses
(39,000 units @ $21.00 per unit)................. 819,000
Contribution margin...................................... 234,000
Fixed expenses ($180,000 + $60,000)............ 240,000
Operating loss.............................................. $ (6,000)
*$30.00 – ($30.00 × 0.10) = $27.00

4. Unit sales required to achieve target profit:
*$30.00 – $21.75** = $8.25; **$21.00 + $0.75
5. a. The new CM ratio would be:

Per Unit Percent of Sales
Sales............................ $30.00 100%
Variable expenses......... 18.00 60%
Contribution margin...... $12.00 40%
The new break-even point would be:

Problem 4-33
(continued)
b. Comparative income statements follow:
Not Automated Automated
Per Per
Total Unit % Total Unit %
Sales (26,000
units).............. $780,000 $30.00 100 $780,000 $30.00 100
Variable
expenses......... 546,000 21.00 70 468,000 18.00 60
Contribution
margin............ 234,000 $ 9.00 30 312,000 $12.00 40
Fixed expenses... 180,000 252,000
Net operating
income............ $ 54,000 $ 60,000
3. Indifference point:
Let Q = Point of indifference in units sold

$9.00Q - $180,000 = $12.00Q - $252,000
$3.00Q = $72,000
Q = $72,000 ÷ $3.00
Q = 24,000 units

If more than 24,000 units are sold in a month, the proposed plan will
yield the greater profits; if less than 24,000 units are sold in a month,
the present plan will yield the greater profits (or the least loss).
Whether or not the company should automate its operations depends

on how much risk the company is willing to take and on prospects for
future sales. The proposed changes would increase the company’s
fixed costs and its break-even point. However, the changes would
also increase the company’s CM ratio (from 0.30 to 0.40). The higher
CM ratio means that once the break-even point is reached, profits will
increase more rapidly than at present. If 26,000 units are sold next
month, for example, the higher CM ratio will generate $6,000 more in
profits than if no changes are made.

The greatest risk of automating is that future sales may drop back
down to present levels (only 19,500 units per month), and as a
result, losses will be even larger than at present due to the
company’s greater fixed costs. (Note the problem states that sales
are erratic from month to month.) In sum, the proposed changes will
help the company if sales continue to trend upward in future months;
the changes will hurt the company if sales drop back down to or near
present levels.

CASE 4-34 (75 minutes) Before proceeding with the solution, it is helpful first to restructure the data
into contribution format for each of the three alternatives. (The data in the statements below are in
thousands.)
20%
15% Commission Commission Own Sales Force
Sales.......................................... $16,000 100% $16,000 100% $16,000.00 100.0%
Variable expenses:
Manufacturing........................... 7,200 7,200 7,200.00
Commissions (15%, 20% 7.5%). 2,400 3,200 1,200.00
Total variable expenses................ 9,600 60% 10,400 65% 8,400.00 52.5%
Contribution margin..................... 6,400 40% 5,600 35% 7,600.00 47.5%
Fixed expenses:
Manufacturing overhead............ 2,340 2,340 2,340.00
Marketing................................. 120 120 2,520.00 *
Administrative........................... 1,800 1,800 1,725.00 **
Interest.................................... 540 540 540.00
Total fixed expenses..................... 4,800 4,800 7,125.00
Income before income taxes......... 1,600 800 475.00
Income taxes (30%).................... 480 240 142.50
Net income.................................. $ 1,120 $ 560 $ 332.50
*$120,000 + $2,400,000 = $2,520,000

**$1,800,000 – $75,000 = $1,725,000

CASE 4-34 (continued)
1. When the income before taxes is zero, income taxes will also be zero
and net income will be zero. Therefore, the break-even calculations can
be based on the income before taxes.
a. Break-even point in dollar sales if the commission remains 15%:
b. Break-even point in dollar sales if the commission increases to 20%:
c. Break-even point in dollar sales if the company employs its own sales
force:
2. In order to generate a $1,120,000 net income, the company must

generate $1,600,000 in income before taxes. Therefore,
3. To determine the volume of sales at which net income would be equal

under either the 20% commission plan or the company sales force plan,
we find the volume of sales where costs before income taxes under the
two plans are equal. See the next page for the solution.

CASE 4-34 (continued)
X = Total sales revenue

0.65X + $4,800,000 = 0.525X + $7,125,000
0.125X = $2,325,000
X = $2,325,000 ÷ 0.125
X = $18,600,000
Thus, at a sales level of $18,600,000 either plan would yield the same
income before taxes and net income. Below this sales level, the
commission plan would yield the largest net income; above this sales
level, the sales force plan would yield the largest net income.
4. a., b., and c.

15% 20% Own
Commission Commission Sales Force
Contribution margin (Part 1) (a)..... $6,400,000 $5,600,000 $7,600,000
Income before taxes (Part 1) (b).... $1,600,000 $800,000 $475,000
Degree of operating leverage:
(a) ÷ (b).................................... 4 7 16
5. We would continue to use the sales agents for at least one more year,
and possibly for two more years. The reasons are as follows:
First, use of the sales agents would have a less dramatic effect on
net income.
Second, use of the sales agents for at least one more year would
give the company more time to hire competent people and get the
sales group organized.
Third, the sales force plan doesn’t become more desirable than the
use of sales agents until the company reaches sales of $18,600,000 a
year. This level probably won’t be reached for at least one more year,
and possibly two years.
Fourth, the sales force plan will be highly leveraged since it will
increase fixed costs (and decrease variable costs). One or two years
from now, when sales have reached the $18,600,000 level, the
company can benefit greatly from this leverage. For the moment,
profits will be greater and risks will be less by staying with the
agents, even at the higher 20% commission rate.

CASE 4-35 (60 minutes)
1. The overall break-even sales can be determined using the CM ratio.
Frog Minnow Worm Total
Sales.......................... $200,000 $280,000 $240,000 $720,000
Variable expenses....... 120,000 160,000 150,000 430,000
Contribution margin.... $ 80,000 $120,000 $ 90,000 290,000
Fixed expenses........... 282,000
Net operating income. . $ 8,000
Contribution margin ratio:
Contributionmargin $ 290,000
= =40 % ( rounded )
Sales $ 720,000
Overall break-even level of sales:
= =$ 705,000
Contributionmargin ratio .40
2.
a. The break-even points for each product can be computed using the
contribution margin approach as follows:
Frog Minnow Worm
Unit selling price................ $2.00 $1.40 $0.80
Variable cost per unit.......... 1.20 0.80 0.50
Unit contribution margin (a) $0.80 $0.60 $0.30
Product fixed expenses (b).. $18,000 $96,000 $60,000
Unit sales to break even
(b) ÷ (a)........................ 22,500 160,000 200,000

Case 4-35 (continued)
b. If the company were to sell exactly the break-even quantities
computed above, the company would lose $108,000—the amount of
the common fixed cost. This occurs because the common fixed costs
have been ignored in the calculations of the break-evens.
The fact that the company loses $108,000 if it operates at the level of
sales indicated by the break-evens for the individual products can be
verified as follows:
Unit sales................. 22,500 160,000 200,000
Sales....................... $45,000 $224,000 $160,000 $ 429,000
Variable expenses..... 27,000 128,000 100,000 255,000
Contribution margin. . $18,000 $ 96,000 $ 60,000 174,000
Fixed expenses......... 282,000
Net operating loss..... $(108,000)
c. The overall break-even sales units can be determined by calculating the

weighted-average contribution margin per unit as shown below:

Unit Sales................... 100,000 200,000 300,000 600,000
Unit sales mix*........... 16.67% 33.3% 50% 100%
Unit Contribution margin $0.80 $0.60 $0.30
Weighted average CM per unit** $0.13 $0.20 $0.15 $0.48
*Unit sales for each product ÷ total unit sales
** Unit sales mix for each product x unit contribution margin
Overall break-even units:
= =587,500 units Units of each product that
Weighted average CM per unit $ 0.48
must be sold at overall break-even level:
Frog: 587,500 x .167 = 98,112 (rounded)

Minnow: 587,500 x .333 = 195,638 (rounded)
Worm: 587,500 x .50 = 293,750

Case 4-35 (continued)
Using the weighted average contribution margin per unit approach yields a
much higher level of sales required for the Frog lure product compared to
results in part 2a. This is driven by the relatively low amount of fixed costs
directly related to the Frog lures ($18,000) used in calculating the break-
even on an individual product basis. However, as shown above, a company
must cover all of its fixed costs to break-even, not just those costs directly
related to individual products. Incorporating all fixed costs, direct and
common, yields the appropriate level of unit sales that must be achieved to
ensure the company breaks even. In the case of the Frog lure product,
when all fixed costs are considered, 98,112 units must be sold compared to
only 22,500 units when only the direct fixed costs are included in the
analysis.

Connecting Concepts: Section 1 (40 minutes)
1. The first step is to determine the cost-behaviour pattern for the

Marketing Department costs as follows:
Follow-up
Month Activities Total Costs
High activity level (November) 625 $211,250
Low activity level (May)....... 305 $118,450
Change............................... 320 $92,800
Variable cost = Change in cost ÷ Change in activity
= $92,800 ÷ 320 follow-up activities
= $290 per follow-up activity
Total cost (November)............................................... $211,250
Variable cost element
($290 per activity × 625 activities)........................... 181,250
Monthly fixed cost element......................................... $30,000
The cost formula for total annual marketing costs is:
Y = $360,0001 + $290x
1
$30,000 x 12
The next step is to estimate the total number of follow-up activities

required to acquire 40 new customers assuming a conversion ratio of
0.35%:
= 40 ÷ 0.0035
= 11,429 follow-up activities (rounded)
The estimated cost of conducting 11,429 follow-up activities is as

follows:
Total costs = $360,000 + $290x
= $360,000 + $290(11,429)
= $3,674,410

Connecting Concepts: Section 1 (continued)
2. Jackson is likely to approve of the estimated spending for the Marketing

Department since it is less than the $4 million ARR for one-year from
the new customers:
40 x $100,000 = $4,000,000
3. The revised cost estimate for the Marketing Department given the
proposed changes is calculated as follows:
Number of follow-up activities given the improved conversion ratio:
= 40 ÷ 0.004
= 10,000 follow-up activities
The estimated cost of conducting 10,000 follow-up activities is as

follows:
Total costs = $360,000 + $400,000* + $350x
= $760,000 + $350(10,000)
= $4,260,000
*bonus of $10,000 x 40=$400,000
Jackson is unlikely to approve these increases since they will result in

estimated total costs that exceed the one-year ARR for the 40 new
customers of $4 million.
4. Since Jackson believes that the Marketing Department should spend no

more than $4 million on its activities (i.e., 40 x $100,000 per new
customer) that will be her indifference point since it effectively
represents a break-even level of spending. So, the new conversion rate
can be calculated as follows:
$4,000,000 = $760,000 + $350(x)

Where x = the number of follow-up activities
x = 9,257 (rounded)
The new conversion rate = 0.0043* (rounded)
*40/9,257=.0043
So, only a small improvement in the conversion rate is needed.


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Some possible reasons for disagreeing:

Some possible reasons for agreeing:

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1. The contribution margin per unit is calculated as follows:

2. The contribution margin ratio is calculated as follows:

3. The variable expense ratio is calculated as follows:

4. The increase in net operating is calculated as follows:

5. If sales decline to 900 units, the net operating would be computed as

6. The new net operating income would be computed as follows:

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7. The new net operating income would be computed as follows:

8. The break-even point in unit sales is as follows:

9. The dollar sales to break-even is as follows:

The dollar sales to break-even ($15,000) can also be computed by

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¿ expenses+Target profit $ 6,000+$ 5,000

11. The margin of safety in dollars is calculated as follows:

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

12. The degree of operating leverage is calculated as follows:

13. A 5% increase in sales should result in a 20% increase in net

14. The degree of operating leverage is calculated as follows:

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15. A 5% increase in sales should result in 35% increase in net operating

Degree of operating leverage (a).............................. 7.0

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Original operating income........ $15,000

2. The revised operating income per month is:

3. The revised operating income is:

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1. The profit graph is based on the following simple equation:

Sales Volume in Units

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

Fixed expenses $ 800,000

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

Fixed expenses $ 800,000

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

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2. Using the formula method:

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

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

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

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1. Break-even hours for residential clients:

Fixed expenses $ 500

Break-even hours for commercial clients:

Fixed expenses $ 825

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

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

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

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

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Total contribution margin $ 72,000

Alternatively, the calculation could be done as follows:

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

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