CHAPTER 7

Cost-Volume-Profit Analysis
SOLUTIONS TO EXERCISES
EXERCISE 7-24 (20 MINUTES)
1.

2.

3.

fixed expenses

Break-even point (in units) = unit contribution margin

Contribution-margin ratio

$40,000
= 10,000 pizzas
$10 $6

unit contribution margin

unit sales price

$10 $6
= .4
$10

Break-even point (in sales dollars)

fixed expenses

= contribution-margin ratio
=

4.

$40,000
= $100,000
.4

Let X denote the sales volume of pizzas required to earn a target operating income of
$80,000.
$10X $6X $40,000 = $80,000
$4X = $120,000
X = 30,000 pizzas

EXERCISE 7-25 (25 MINUTES)

1.

Break-even point (in units)

fixed costs

= unit contribution margin

$4,000,000

= $3,000 $2,000 = 4,000 components

McGraw-Hill/Irwin
Inc.
Managerial Accounting, 9/e Global Edition

2011 The McGraw-Hill Companies,

7-1

2.

New break-even point (in units)

=
=

($4,000,000) (1.10)
$3,000 $2,000
$4,400,000
= 4,400 components
$1,000

3.

Sales revenue (5,000 $3,000)

.................................................
Variable costs (5,000 $2,000)........................................................
Contribution margin.........................................................................
Fixed costs........................................................................................
Operating income.............................................................................

4.

New break-even point (in units) =

$15,000,000
10,000,000
5,000,000
4,000,000
$ 1,000,000

$4,000,000
$2,500 $2,000

= 8,000 components
5.

Analysis of price change decision:

Price
$3,000
$15,000,000
Sales revenue: (5,000 $3,000).................................
(6,200 $2,500).................................
10,000,000
Variable costs: (5,000 $2,000).................................
(6,200 $2,000).................................
5,000,000
Contribution margin....................................................
4,000,000
Fixed expenses ............................................................
$ 1,000,000
Operating income (loss)..............................................

$2,500
$15,500,000
12,400,000
3,100,000
4,000,000
($900,000)

The price cut should not be made, since projected operating income will decline.

McGraw-Hill/Irwin
Inc.
7-2

2011 The McGraw-Hill Companies,

Solutions Manual

EXERCISE 7-28 (25 MINUTES)

1.

(a) Traditional income statement:

EUROPA PUBLICATIONS, INC.
INCOME STATEMENT
FOR THE YEAR ENDED DECEMBER 31, 20XX
Sales .........................................................................
Less: Cost of goods sold.........................................
Gross margin...............................................................
Less: Operating expenses:
Selling expenses............................................
Administrative expenses...............................
Operating income........................................................

$2,200,000
1,500,000
$ 700,000
$150,000
150,000

300,000
$ 400,000

(b) Contribution income statement:

EUROPA PUBLICATIONS, INC.
INCOME STATEMENT
FOR THE YEAR ENDED DECEMBER 31, 20XX
Sales .........................................................................
Less: Variable expenses:
Variable manufacturing..................................
Variable selling...............................................
Variable administrative..................................
Contribution margin....................................................
Less: Fixed expenses:
Fixed manufacturing......................................
Fixed selling...................................................
Fixed administrative.......................................
Operating income........................................................
2.

$2,200,000
$1,000,000
100,000
30,000
$ 500,000
50,000
120,000

1,130,000
$ 1,070,000

670,000
$ 400,000

contribution margin
operating income
$1,070,000
=
= 2.6
$400,000

Operating leverage factor (at $2,200,000 sales level) =

McGraw-Hill/Irwin
Inc.
Managerial Accounting, 9/e Global Edition

2011 The McGraw-Hill Companies,

7-3

3.

percentage increase operating

Percentage increase in operating income =
i nsalesrev nue lev ragefactor
= 10% 2.6
= 26%

4.

Most operating managers prefer the contribution income statement for answering this
type of question. The contribution format highlights the contribution margin and
separates fixed and variable expenses.

EXERCISE 7-29 (30 MINUTES)

1.
Bicycle Type
High-quality
Medium-quality
2.

Sales
Price
$500
300

Unit
Variable Cost
$300 ($275 + $25)
150 ($135 + $15)

Unit
Contribution Margin
$200
150

Sales mix:
High-quality bicycles........................................................................................
Medium-quality bicycles...................................................................................

3.

Weighted-average unit
contribution margin

25%
75%

= ($200 25%) + ($150 75%)

= $162.50

4.

fixed expenses
weighted-average unit contribution margin
$65,000
=
= 400 bicycles
$162.50

Break -even point (in units) =

McGraw-Hill/Irwin
Inc.
7-4

2011 The McGraw-Hill Companies,

Solutions Manual

Break-Even
Sales Volume
100 (400 .25)
300 (400 .75)

Bicycle Type
High-quality bicycles
Medium-quality bicycles
Total
5.

Sales
Revenue
$ 50,000
90,000
$140,000

Sales Price
$500
300

Target operating income:

$65,000 + $48,750
$162.50
= 700 bicycles

Sales volume required to earn target operating income of $48,750 =

This means that the shop will need to sell the following volume of each type
of bicycle to earn the target operating income:
High-quality...........................................................................
Medium-quality.....................................................................

175 (700 .25)

525 (700 .75)

EXERCISE 7-33 (20 MINUTES)

fixed expenses
contribution margin ratio
$120,000
=
= $600,000
.20

1.

Break - even volume of service revenue =

2.

Target pre - tax income =

target after - tax net income

1 tax rate
$48,000
=
= $80,000
1 .40

target after - tax net income

(1 t )
=
contribution margin ratio
$48,000
$120,000 +
1 .40 = $1,000,000
=
.20
fixed expenses +

3.

Service revenue required to earn

target after-tax income of $48,000

4.

A change in the tax rate will have no effect on the firm's break-even point. At the breakeven point, the firm has no profit and does not have to pay any income taxes.

McGraw-Hill/Irwin
Inc.
Managerial Accounting, 9/e Global Edition

2011 The McGraw-Hill Companies,

7-5

SOLUTIONS TO PROBLEMS
PROBLEM 7-34 (30 MINUTES)
1 Break-even point in units, using the equation approach:
.
$16X ($10 + $2)X $600,000 = 0
$4X = $600,000
X =

$600,000
$4

= 150,000 units
2
.

New projected sales volume = 200,000 110%

= 220,000 units
Operating income = (220,000)($16 $12) $600,000
= (220,000)($4) $600,000
= $880,000 $600,000 = $280,000

3 Target operating income = $200,000 (from original problem data)

.
New disk purchase price = $10 130% = $13
Volume of sales dollars required:
Volume of sales dollars required

fixed expenses + target operating income

contribution - margin ratio
$600,000 + $200,000
$800,000
=
=
$16 $13 $2
.0625
$16
= $12,800,000
=

4 Let P denote the selling price that will yield the same contribution-margin ratio:
.

McGraw-Hill/Irwin
Inc.
7-6

2011 The McGraw-Hill Companies,

Solutions Manual

$16
$10
$2
P
$13
$2
=
$16
P
P
$15
.25 =
P
.25 P =P
$15
$15 =.75 P
P =$15/.75
P =$20

Check: New contribution-margin ratio is:

$20 $15
=.25
$20

5. In the electronic version of the solutions manual, press the CTRL key and click on the
following link: BUILD A SPREADSHEET 07-34.XLS
PROBLEM 7-35 (30 MINUTES)
1.

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

fixed expenses
contribution - margin ratio
$180,000 + $72,000 $252,000
=
=
$20 $8 $2
.5
$20
= $504,000

Break - even point =

2.

Target operating income, using contribution-margin approach:

fixed expenses + target operating income
unit contribution margin
$252,000 + $180,000 $432,000
=
=
$20 $8 $2
$10
= 43,200 units

Sales units to earn operating income of $180,000 =

3.

New unit variable manufacturing cost

= $8 110%
= $8.80

Break-even point in sales dollars:

$252,000
$252,000
=
$20.00 $8.80 $2.00
.46
$20
= $547,826 (rounded)

Break - even point =

4.

Let P denote the selling price that will yield the same contribution-margin ratio:

McGraw-Hill/Irwin
Inc.
Managerial Accounting, 9/e Global Edition

2011 The McGraw-Hill Companies,

7-7

$20.00 $8.00 $2.00

P $8.80 $2.00
=
$20.00
P
P $10.80
.5 =
P
.5P = P $10.80
$10.80 = .5P
P = $10.80/.5
P = $21.60

Check: New contribution-margin ratio is:

$21.60 $8.80 $2.00
=.5
$21.60

PROBLEM 7-36 (30 MINUTES)

1.

Unit contribution margin:

Sales price
Less variable costs:
Sales commissions ($64 x 5%) $ 3.20
System variable costs
16.00
Unit contribution margin..

$64.00
19.20
$44.80

Break-even point = fixed costs unit contribution margin

= $985,600 $44.80
= 22,000 units
2.

Model no. 4399 is more profitable when sales and production average 46,000 units.

Sales revenue (46,000 units x $64.00)...

Less variable costs:
Sales commissions ($2,944,000 x 5%)
System variable costs:
46,000 units x $16.00.
46,000 units x $12.80.
Total variable costs..
Contribution margin...
Less: Annual fixed costs..
Operating income...

McGraw-Hill/Irwin
Inc.
7-8

Model
No. 6754

Model
No. 4399

$2,944,000

$2,944,000

$ 147,200

$ 147,200

736,000
$ 883,200
$2,060,800
985,600
$1,075,200

588,800
$ 736,000
$2,208,000
1,113,600
$1,094,400

2011 The McGraw-Hill Companies,

Solutions Manual

3.

Annual fixed costs will increase by $90,000 ($450,000 5 years) because of straightline depreciation associated with the new equipment, to $1,203,600 ($1,113,600 +
$90,000). The unit contribution margin is $48 ($2,208,000 46,000 units). Thus:
Required sales = (fixed costs + target net profit) unit contribution margin
= ($1,203,600 + $956,400) $48
= 45,000 units

4.

Let X = volume level at which annual total costs are equal

$16.00X + $985,600 = $12.80X + $1,113,600
$3.20X = $128,000
X = 40,000 units
PROBLEM 7-40 (30 MINUTES)
fixed costs
unit contribution margin
$468,000
=
= 90,000 units
$25.00 $19.80

1.

Break - even point (in units) =

2.

Break - even point (in sales dollars) =

3.

Number of sales units required to

earn target operating income

4.

Margin of safety = budgeted sales revenue break-even sales revenue

fixed cost
contribution - margin ratio
$468,000
=
= $2,250,000
$25.00 $19.80
$25.00
fixed costs + target operating income
unit contribution margin
$468,000 + $260,000
=
=140,000 units
$25.00 $19.80
=

= (120,000)($25) $2,250,000 = $750,000

5.

Break-even point if direct-labor costs increase by 8 percent:

New unit contribution margin

= $25.00 $6.00 ($5.00)(1.08) $4.50 $3.00 $1.30

= $4.80
fixed costs

Break-even point = new unit contribution margin

6.

Contribution margin ratio

McGraw-Hill/Irwin
Inc.
Managerial Accounting, 9/e Global Edition

$468,000
= 97,500 units
$4.80

unit contribution margin

sales price
2011 The McGraw-Hill Companies,
7-9

$25.00 $19.80
$25.00
=.208

Old contribution-margin ratio =

Let P denote sales price required to maintain a contribution-margin ratio of .208. Then
P is determined as follows:
P $6.00 ($5.00)(1.08) $4.50 $3.00 $1.30
= .208
P
P $20.20 = .208P
.792P = $20.20
P = $25.51 (rounded)

Check:

New contributionmargin ratio

$25.51 $6.00 ($5.00)(1.08) $4.50 $3.00 $1.30

$25.51
=.208 (rounded)
=

PROBLEM 7-43 (40 MINUTES)

1.

In order to break even, during the first year of operations, 10,220 clients must visit the
law office being considered by Martin Wong and his colleagues, as the following
calculations show.
Fixed expenses:
Advertising...............................................................................
$ 350,000
Rent (600 $480).....................................................................
288,000
Property insurance..................................................................
27,000
Utilities .....................................................................................
37,000
Malpractice insurance.............................................................
160,000
Depreciation ($120,000/4)........................................................
30,000
Wages and fringe benefits:
Regular wages
($25 + $20 + $15 + $10) 16 hours 360 days......... $403,200
Overtime wages
(200 $15 1.5) + (200 $10 1.5)..........................
7,500
Total wages............................................................ $410,700
Fringe benefits at 40%....................................................... 164,280
574,980
Total fixed expenses......................................................................
$1,466,980
Break-even point:
0 = revenue variable cost fixed cost
0 = $30X + ($2,000 .2X .3)* $4X $1,466,980

McGraw-Hill/Irwin
Inc.
7-10

2011 The McGraw-Hill Companies,

Solutions Manual

0 = $30X + $120X $4X $1,466,980

$146X = $1,466,980
X = 10,048 clients (rounded)
*Revenue calculation:
$30X represents the $30 consultation fee per client. ($2,000 .2X .30) represents
the predicted average settlement of $2,000, multiplied by the 20% of the clients
whose judgments are expected to be favorable, multiplied by the 30% of the
judgment that goes to the firm.
2.

Safety margin:
Safety margin = budgeted sales revenue break-even sales revenue
Budgeted (expected) number of clients = 50 360 = 18,000
Break-even number of clients = 10,048 (rounded)
Safety margin = [($30 18,000) + ($2,000 18,000 .20 .30)]
[($30 10,048) + ($2,000 10,048 .20 .30)]
= [$30 + ($2,000 .20 .30)] (18,000 10,048)
= $150 7,852

= $1,192,800
PROBLEM 7-44 (45 MINUTES)
1.

Break-even point in units:

Break -even point =

fixed costs
unit contribution margin

Calculation of contribution margins:

Selling price......................................
Variable costs:
Direct material..............................
Direct labor...................................
McGraw-Hill/Irwin
Inc.
Managerial Accounting, 9/e Global Edition

Computer-Assisted
Manufacturing System
$30.00
$5.00
6.00

Labor-Intensive
Production System
$30.00
$5.60
7.20

2011 The McGraw-Hill Companies,

7-11

Variable overhead........................
Variable selling cost.....................
Contribution margin per unit
(a)

3.00
2.00

16.00
$14.00

4.80
2.00

19.60
$10.40

Computer-assisted manufacturing system:

$2,440,000 + $500,000
$14
$2,940,000
=
$14
= 210,000 units

Break-even point in units =

(b)

Labor-intensive production system:

$1,320,000 +$500,000
$10.40
$1,820,000
=
$10.40
=175,000 units

Break -even point in units =

2.

Celestial Products, Inc. would be indifferent between the two manufacturing

methods at the volume (X) where total costs are equal.
$16X + $2,940,000 = $19.60X + $1,820,000
$3.60X = $1,120,000
X = 311,111 units (rounded)

3.

Operating leverage is the extent to which a firm's operations employ fixed operating
costs. The greater the proportion of fixed costs used to produce a product, the
greater the degree of operating leverage. Thus, the computer-assisted
manufacturing method utilizes a greater degree of operating leverage.
The greater the degree of operating leverage, the greater the change in
operating income (loss) relative to a small fluctuation in sales volume. Thus, there
is a higher degree of variability in operating income if operating leverage is high.

4.

Management should employ the computer-assisted manufacturing method if annual

sales are expected to exceed 311,111 units and the labor-intensive manufacturing
method if annual sales are not expected to exceed 311,111 units.

5.

Celestial Products management should consider many other business factors

other than operating leverage before selecting a manufacturing method. Among
these are:

McGraw-Hill/Irwin
Inc.
7-12

2011 The McGraw-Hill Companies,

Solutions Manual

 Variability or uncertainty with respect to demand quantity and selling price.

The ability to produce and market the new product quickly.
The ability to discontinue production and marketing of the new product while
incurring the least amount of loss.

PROBLEM 7-52 (45 MINUTES)

1.

SUMMARY OF EXPENSES

Manufacturing....................................................................
Selling and administrative................................................
Interest...............................................................................
Costs from budgeted income statement.....................
If the company employs its own sales force:
Additional sales force costs.........................................
Reduced commissions [(.15 .10) $16,000]............
Costs with own sales force...............................................
If the company sells through agents:
Deduct cost of sales force............................................
Increased commissions [(.225 .10) $16,000].........

Expenses per Year

(in thousands)
Variable
Fixed
$ 7,200
$2,340
2,400
1,920
540
$ 9,600
$4,800
2,400
(800)
$ 8,800

$7,200
(2,400)

2,000

total fixed expenses

contribution margin ratio
total variable expenses
Contribution-margin ratio =1
sales revenue

Break -even sales dollars =

(a)

$9,600,000
$16,000,000
=1 .60
=.40

Contribution margin ratio =1

$4,800,000
.40
=$12,000,000

Break-even sales dollars =

McGraw-Hill/Irwin
Inc.
Managerial Accounting, 9/e Global Edition

2011 The McGraw-Hill Companies,

7-13

(b)

2.

$8,800,000
$16,000,000
=1 .55
=.45
$7,200,000
Break-even sales dollars =
.45
=$16,000,000

Contribution margin ratio =1

Required sales dollars =

total fixed costs + target income before income taxes

contribution margin ratio

$10,800
Contribution margin ratio =
1
$16,000
=
1
.675
=
.325

$4,800,000 +
$1,600,0
Required sales dollars to break even =
.325
$6,400,000
=
.325
=
$19,692,308

3.

The volume in sales dollars (X) that would result in equal net income is the volume
of sales dollars where total expenses are equal.
Total expenses with agents paid
increased commission

= total expenses with own sales force

$10,800,000
$8,800,000
X +$4,800,000 =
X +$7,200,000
$16,000,000
$16,000,000
.675 X +$4,800,000 =.55 X +$7,200,000
.125 X =$2,400,000
X =$19,200,000

Therefore, at a sales volume of $19,200,000, the company will earn equal before-tax
income under either alternative. Since before-tax income is the same, so is after-tax
net income.

McGraw-Hill/Irwin
Inc.
7-14

2011 The McGraw-Hill Companies,

Solutions Manual