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CHAPTER 5

COST-VOLUME-PROFIT ANALYSIS
SOLUTIONS
Review Questions
5. Profit before taxes = [(Price Unit variable cost) Sales volume in units]
Fixed costs = Unit contribution margin Sales volume in units Fixed costs.
5.! !e contribution margin statement.
5." !e sales volume at "!ic! #rofit e$uals %ero.
5.# !e sales dollars at "!ic! #rofit e$uals %ero.
5.5 !e unit contribution margin divided b& #rice.
5.$ axes reduce #rofit b& a certain #ercentage be&ond t!e brea'even #oint. (bove
t!e brea'even #oint) t!e slo#e of t!e #rofit line decreases b& taxes #aid.
5.% *e can use t!e +,P relation to estimate #rofit at eac! #rice) $uantit&
combination.
5.& !e amount b& "!ic! sales exceed brea'even sales. -t e$uals (Sales in units
.rea'even volume)/Sales in Units or) e$uivalentl&) (0evenues .rea'even
revenues)/0evenues.
5.' !e #ercentage c!ange in #rofit = t!e #ercentage c!ange in sales volume (or
revenues) (1/2argin of safet&).
5.( 3#erating leverage is a measure of ris' from !aving more fixed costs. -t e$uals
Fixed costs/otal costs.
5. !e relative #ro#ortion in "!ic! a com#an& ex#ects to sell #roducts e.g.) t"o
units of #roduct ( for ever& unit of #roduct ..
5.! !e contribution margin #er average unit.
5." !e contribution margin #er average sales dollar.
5.# -t is easier to "or' "it! revenues directl& and com#aring contribution margin
ratios across #roducts ma'es more sense t!an com#aring unit contribution
margins.
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5.5 (1) 0evenues increase #ro#ortionall& "it! sales volume) (8) variable costs
increase #ro#ortionall& "it! sales volume) (9) selling #rices) unit variable costs)
and fixed costs are 'no"n "it! certaint&) (:) a single;#eriod anal&sis) (<) a 'no"n
and constant #roduct mix) (=) +,P anal&sis does not al"a&s #rovide t!e >best?
solution to a s!ort;term decision) and (@) t!e availabilit& of ca#acit&.
)is*ussion Questions

5.$ Unit contribution margin e$uals unit selling #rice less unit variable cost.
(ssuming t!at unit contribution margin is #ositive) unit selling #rice is a bigger
number t!an unit variable cost) and t!erefore a 1AB increase in unit selling #rice
"ill increase t!e unit contribution margin more t!an a 1AB decrease in unit
variable cost. o illustrate) let t!e unit selling #rice be C<A and t!e unit variable
cost be C9A. !e unit contribution margin "ill be C8A (=C<A ;C9A). ( 1AB
increase in unit selling #rice "ill increase t!e unit contribution margin to C8<
(=C<<;C8A)) but a 1AB reduction in unit variable cost "ill increase t!e unit
contribution margin to onl& C89 (=C<A;C8@).
5.% Profit before taxes = .1< D 0evenues (fact 1)
Profit before taxes = .:AD0evenues C8AA)AAA (fact 8)

Setting t!ese e$uations e$ual to eac! ot!erE
0evenues = C8AA)AAA/.8< = C&((+(((.

5.& -t is generall& advisable to conduct +,P anal&sis on a cas! basis. 4on;cas! items
suc! as de#reciation are not relevant. Fo"ever) it is not uncommon to see +,P
anal&sis being used in conGunction "it! accounting profits;;;"!ic! "ould include
de#reciation as an ex#ense;;;rat!er t!an net cas! flo". Suc! an anal&sis can be
#articularl& erroneous for start;u#s and gro"t! firms because t!e magnitude of
non;cas! items or accruals is li'el& to be large.
5.' 7es. 6et us consider an exam#le. Su##ose t!e unit contribution margin is C< and
t!e fixed costs are C8AA)AAA. !e brea'even $uantit& t!en is :A)AAA units
(=C8AA)AAA/C<). 6et us sa& t!at t!e fixed costs increase b& C1AA)AAA to C9AA)AAA
but t!e unit contribution margin sta&s at C<. !e ne" brea'even $uantit& is =A)AAA
(=C9AA)AAA/C<). !at is "e need an additional volume of 8A)AAA units to
brea'even. *e can also calculate t!is additional volume needed to brea'even b&
dividing t!e c!ange in fixed costs b& t!e unit contribution margin (=C1AA)AAA/C<).
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5.!( 2an& countries use a #rogressive tax structure. !at is) t!e tax rate increases for
!ig!er income brac'ets. Fo"ever) t!e +,P anal&sis is fundamentall& t!e same
exce#t t!at t!e #rofit e$uation is more elaborate. +onsider an exam#le "!ere t!e
tax rate is 9AB u# to C9AA)AAA) but increases to :AB be&ond C9AA)AAA. -n t!is
case) "e !ave to modif& t!e com#utation of #rofit after taxes asH
-f #rofit before taxes is less t!an or e$ual to C9AA)AAA t!en
[5I]Profit after taxes = Profit before taxes (1 30%)
-f #rofit before taxes is greater t!an C9AA)AAA t!en
[5I]Profit after taxes = $300,000 (1 30%) +
(Profit before taxes - $300,000) (1 40%)
!us) for t!e first C9AA)AAA of #rofit) t!e com#an& "ould #a& tax at t!e rate of
9ABJ be&ond C9AA)AAA t!e a##licable tax rate "ould be :AB. Kee# in mind)
!o"ever) t!at !aving multi#le tax brac'ets !as no conse$uence for t!e calculation
of t!e brea'even #oint because) at t!e brea'even #oint) t!e #rofit is %ero and t!ere
are no taxes.
5.! 7es) "e can modif& t!e +,P relation to include ste# costs. *it! ste# costs) fixed
costs do not sta& fixed for a volumes. -t sta&s fixed for a volume range be&ond
"!ic! it increases to t!e next level. +onsider) for exam#le) a com#an& t!at leases
a co#ier for its needs and #a&s a mont!l& rent. !e co#ier !as a certain fixed
ca#acit& to ma'e co#ies over a certain time. ill t!is ca#acit& is reac!ed) t!e rent
does not var& "it! t!e volume of co#ies made. Fo"ever) once t!e com#an&Ls
co#&ing needs exceeds its ca#acit&) anot!er co#ier ma& !ave to be rented and t!e
rent #a&ment increases b& a ste# to include t!e rent of t!e next co#ier.
*!en fixed cost increases in ste#s) t!e +,P anal&sis ma& !ave to be re#eated a
fe" times to converge to t!e ans"er. !in' about com#uting t!e brea'even #oint.
First) assume t!at t!e brea'even #oint "ould fall "it!in t!e first ste#. *it! t!is
assum#tion) "e can calculate t!e brea'even #oint in t!e usual manner described
in t!e text. -f t!is calculation &ields a brea'even #oint t!at is "it!in t!e volume
range over "!ic! t!e fixed cost does not increase to t!e next ste#) "e are done.
3t!er"ise) "e c!ange t!e fixed cost to t!e next ste# value and re#eat our
brea'even calculation. *e re#eat t!is #rocess until "e reac! a #oint "!ere t!e
brea'even volume falls "it!in t!e range of t!e assumed ste# fixed costM
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5.!! Soft"are com#anies t&#icall& !ave a !ig! #ro#ortion of fixed costs in t!eir cost
structure (i.e.) !ig! o#erating leverage) because t!eir #rimar& resource is trained
soft"are #rofessionals. 2ost of t!ese #rofessionals are #aid fixed salaries and
"ages t!at do not var& "it! t!e volume of soft"are #rograms t!e& generate) or
t!e number of soft"are #rograms a com#an& li'e 2icrosoft sells. 0elativel&
s#ea'ing) an automobile com#an& suc! as Ford "ould !ave a greater #ro#ortion
of variable costs in its cost structure) alt!oug! over time t!is #ro#ortion !as
decreased because of increased automation.
5.!" !e #ractice of selling t!e same good at different #rices to different customers is
called discriminator& #ricing. -n general t!e 0obinson;Patman (ct of 1N9=
#ro!ibits discriminator& #ricing in certain situations (suc! as) for exam#le) a
"!olesaler selling t!e same #roduct to t"o retailers at different #rices "it! t!e
#ur#ose of influencing t!eir com#etitive standings). Fo"ever) in ot!er situations)
suc! differential #ricing ma& "ell be necessar& de#ending on t!e nature of t!e
customer or t!e s#ecific mar'et (because of customer;s#ecific or mar'et;s#ecific
costs). *e "ill discuss t!is as#ect later in +!a#ter 1A) "!en "e discuss +ustomer
Profitabilit& (nal&sis.
5.!# 2argin of safet& is a >cus!ion? t!at t!e existing level of o#erations allo"s
managers in dealing "it! o#erating ris'. !e smaller t!is cus!ion) t!e closer is t!e
manager to ma'ing a loss. !us) "!en demand uncertaint& increases
unex#ectedl&) t!is cus!ion >#rotects? managers from incurring losses. -n suc!
situations) it gives t!em some room to offer discounts or #romotions to 'ee# u#
t!e volume in t!e s!ort;term in order to #reserve #rofitabilit&.
5.!5 (s t!e sales volume increases) t!e total variable costs increase but fixed costs sta&
t!e same. 0ecall t!at o#erating leverage is t!e ratio of fixed costs to total costs.
.ecause fixed costs sta& t!e same and t!e total costs increase (because of t!e
increase in variable costs)) t!e o#erating leverage decreases.
5.!$ (s demand conditions fluctuate) s!ort;term #rofits are more sensitive to
conse$uent c!anges in sales volume for firms "it! !ig!er o#erating leverage. !is
is "!& o#erating leverage is vie"ed as measure of ris'. 0eferring to 5x!ibit <.1:)
t!e o#erating leverage of Sierra Plastics increases "it! t!e ne" tec!nolog&.
4otice t!at its #rofits (#rofit before taxes) fluctuate more "it! t!e sales volume
"it! t!e ne" tec!nolog& t!an "it!out t!e tec!nolog&.

5.!% -n general) divisions of large firms often !ave ver& different cost structures and
serve different mar'ets. .ecause t!e +,P anal&sis is essentiall& a tool for s!ort;
term decision ma'ing t!at !el#s managers in deciding t!e level of o#erations) it
ma'es more sense for individual divisional !eads to #erform +,P anal&sis at t!eir
res#ective divisions. (t t!e firm level) t!e effects of t!ese s!ort;term decisions
can t!en be aggregated to determine t!e overall state of t!e firm in t!e s!ort run)
and "!ic! divisions are contributing in "!at measure in t!is res#ect.
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5.!& 7es. -n general t!e unit of one #roduct is not necessaril& com#arable to a unit of
anot!er dissimilar #roduct because t!e& re$uire different amounts of resources;;;
suc! as ra" material) labor) mac!ining time) finis!ing time;;;to #roduce.
!erefore) "e cannot sa& t!at t!e s#orts car is more #rofitable to #roduce because
its unit contribution margin is !ig!er t!an t!e contribution margin of an entr&;
level ve!icle. Fo"ever) "it! t!e contribution margin ratio) "e can ex#ress
relative #rofitabilit& in terms of sales dollars. *e can sa& for instance t!at for
ever& sales dollar) t!e s#orts car contributes t"ent& cents to"ard #rofit (i.e.) +20
of 8AB)) and t!e entr&;level ve!icle contributes ten cents to"ard #rofit (i.e.) +20
of 1AB).
5.!' +,P anal&sis s!ould be considered as a convenient tool to understand t!e
relations bet"een cost) volume and #rofit. -t ma'es man& assum#tions as
discussed in t!e text. 6et us consider a fe" assum#tions assum#tion and identif& a
setting in "!ic! it "ould be violated.
(ssum#tion 1H !e"enues increase proportiona# $it% saes "ou&e' !is
assum#tion essentiall& means t!at #rice #er unit is constant and does not var&
"it! volume. Fo"ever) it is "ell 'no"n t!at as &ou decrease #rice #er unit) &ou
can sell more and vice versa. -n ot!er "ords) #rice #er unit and sales volume are
inversel& related. *!en "e allo" for t!is #ossibilit&) t!is assum#tion is violated.
(ssum#tion 8H (ariabe costs increase proportiona# $it% saes "ou&e. -n ot!er
"ords) unit variable cost sta&s t!e same over t!e relevant range of o#erations so
t!at variable costs increase linearl& "it! volume. !is assum#tion "ill be violated
"!enever t!e sales volume goes be&ond relevant range (e.g.) "!en firms stretc!
existing ca#acit& to meet demand). -n suc! cases) variable costs can increase
more t!an #ro#ortionatel&.
(ssum#tion 9H )eing prices, unit "ariabe costs, an* fixe* costs are +no$n $it%
certaint#. -n t!e real "orld) "e !ave to deal "it! uncertaint& all t!e time. !e
assumed selling #rice) and variable/fixed costs ma& turn out be different from t!e
actual #rice and costs because of c!anges in demand conditions or resource
availabilit&.
(ssum#tion :H )inge-perio* ana#sis' 2ost business relations!i#s extend be&ond
a single #eriod) and most s!ort;term decisions !ave longer;term im#lications.
Please refer to a discussion of suc! im#lications in +!a#ter 8. Suc! im#lications
"ould result in a violation of t!is assum#tion.
(ssum#tion <H Pro*uct-&ix assu&ption' *it! man& #roducts) +,P anal&sis
assumes a 'no"n and constant #roduct mix. Fo"ever) in most instance) t!e
#roduct;mix itself !as to be decided. +!anging t!e #roduct;mix ma& be best t!e
"a& to react to c!anges in demand for t!e different #roducts in t!e mix.
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E,e-*ises
5."(
a. 0ecall t!atH
Profit before taxes = (unit contribution &argin saes "ou&e in units) fixe*
costs.
(dditionall&)
,nit contribution &argin = ,nit seing price ,nit "ariabe cost.
= C9.AA C1.AA = C8.AA #er #ac'age.
!e #roblem also informs us t!at (Ga&Ls fixed costs for t!e mont! = C=AA.
!us) (Ga&Ls #rofit isH
P-o.it /e.o-e t0,es 1 23!.(( nu4/e- o. 50*607es so89: ; 3$((.
b. .rea'ing even im#lies a #rofit of %ero. !us) "e !aveH
CA = (C8.AA -rea+e"en "ou&e) C=AA)
3r) brea'even volume in #ac'ages =
AA . 8 C
=AA C
= "(( 50*607es.
c.
Substituting (Ga&Ls target #rofit of C1):AA into t!e ex#ression for #rofit "e
develo#ed in #art [a]) "e !aveH
C1):AA = C8.AA !e.uire* nu&ber of pac+ages C=AA.
30) !e.uire* saes =
AA . 8 C
:AA 1 C =AA C , +
.

= +((( 50*607es.
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5." a.
( <AB increase c!anges (Ga&Ls variable costs from C1.AA #er #ac'age to C1.AA
(1 O .<A)) or C1.<A #er #ac'age.
+onse$uentl&) t!e revised unit contribution margin = C9.AA C1.<A = C1.<A #er
#ac'age.
Setting target #rofit to %ero in t!e ex#ression for #rofit) "e obtainH
A = C1.<A -rea+e"en "ou&e C=AA.
30) Breakeven volume =
<A . 1 C
=AA C
= #(( 50*607es.
Note/ 0f 1xercise 2'30 %a* been assigne*, #ou &a# notice t%at t%e brea+e"en
"ou&e %as increase* b# 100 pac+ages t%is occurs because 34a# no$ &a+es a
o$er contribution &argin per pac+age $rappe*'
b. *riting;out (Ga&Ls #rofit in detail) "e !aveH
Profit before taxes = (Price ,nit "ariabe cost) nu&ber of pac+ages 5ixe*
costs.
Substituting using t!e given data) "e !aveH
C8):AA = (Price C1.AA) 9)AAA C=AA.
30) Price = C8.AA.
c. -f revenue "ere C:)<AA) (Ga& "ould !ave "ra##ed
AA . 9 C
<AA ) : C
= 1)<AA #ac'ages.
!is sales volume "ould &ield a total contribution margin ofH 1)<AA #ac'ages C8
#er #ac'age = C9)AAA. 4etting out t!e fixed costs of C=AA &ields 5-o.it o. 3!+#((.
(lternativel&) "e can substitute 1)<AA #ac'ages into t!e #rofit e$uation to &ieldH
P-o.it /e.o-e t0,es = (C8.AA 1)<AA) C=AA = 3!+#((.
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5."! CVP Re80tion 0n9 P-o.it P80nnin7+ Cont-i/ution M0-7in R0tio A55-o0*<
2LO+ LO!:.
a. (s discussed in t!e text) "e can re;"rite t!e #rofit asH
Profit before taxes = (6ontribution &argin ratio !e"enue) 5ixe* costs.
For Pina) !er contribution margin ratio is ) (
C1.AA
C.8< ; C1.AA
= A.@<.
(dditionall&) !er fixed costs amount to C=)AAA #er mont!. !us) "e !aveH
P-o.it /e.o-e t0,es 1 2.%5 Revenue: ; 3$+(((.
b. Using t!e #rofit e$uation from #art [a] and setting #rofit e$ual to CA) "e !aveH
CA = (.@< -rea+e"en re"enue) C=)AAA.
=-e06even -evenue 1 3&+(((.
c. Substituting sales of C1A)AAA into PinaLs #rofit calculation &ieldsH
P-o.it /e.o-e t0,es = (A.@< C1A)AAA) C=)AAA = 3+5((.
5.33 CVP and Profit Planning, Hercules (LO, LO!, LO3
a. *e 'no" t!at t!e #rofit e$uation isH
Profit before taxes = (unit contribution &argin saes "ou&e in units) fixe*
costs.
(t brea'even #rofit before taxes = A. For Fercules) unit contribution margin is
revenue variable costs = C1AA ; C9< = C=< #er member #er mont!. Fixed costs
are C:A)N<A #er mont!. Substituting) "e !aveH
A = C=< .rea'even volume ; C:A)N<A
!us) brea'even volume = C:A)N<A/C=< #er member = $"( 4e4/e-s.
b. First) let us gross u# t!e after;tax target to a re$uired #re;tax amount. *e
'no"H
(fter tax #rofit = Pre;tax #rofit (1; tax rate).
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Plugging in t!e numbers) "e !aveH
C11)9@< / A.=< = C1@)<AA = re$uired #re;tax #rofit.
Using t!is estimate in t!e #re;tax #rofit e$uation) "e !aveH
C1@)<AA = C=< re$uired volume ; C:A)N<A
0e$uired volume = C<Q):<A/C=< #er member = &'' 4e4/e-s 2-oun9e9:.
c. *e 'no" from #art [b] t!at Fercules needs to earn C1@)<AA before taxes to
reac! its goal. *e calculate t!e contribution margin ratio as C=</C1AA = A.=<
or =<B. *e 'no"H
Profit before taxes = contribution margin ratio re$uired revenue Fixed costs.
C1@)<AA = A.=< re$uired revenue ; C:A)N<A
0e$uired revenue = 3&'+'(( 2-oun9in7 9own:. 3f course) "e also can calculate
t!is ans"er from t!e ans"er to #art [b]H QNN members C1AA #er member =
CQN)NAA.
d. !e 2argin of safet& = [current sales brea'even sales] / current sales.
Using t!e ans"er from #art [a]) "e !aveH [N<A ; =9A] /N<A = "".$& >
e. 3#erating leverage = Fixed cost / otal cost
= C:A)N<A / [:A)N<A O N<A C9<] = 55.'>
5."# Cont-i/ution M0-7in+ Unit 8eve8 *osts 2LO:.
First) "e need to calculate unit contribution and fixed costs. *e !ave unit
contribution = (#rice variable costs) = (CQAA ; C::A ; C:A) = C98A. (t a volume
of 1<)AAA units) fixed costs are C11A O C<A = C1=A #er unit) or C8):AA)AAA in total.
!en) from t!e #rofit e$uationH
A = unit contribution brea'even volume fixed costs
A = C98A #er unit brea'even volume ; C8):AA)AAA
.rea'even volume = C8):AA)AAA / C98A #er unit = %+5(( units.
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5."5 CVP Re80tion 0n9 so8vin7 .o- un6nowns+ Cont-i/ution M0-7in R0tio
A55-o0*< 2LO+ LO!:.
a. Substituting a target #rofit of C9)=AA into t!e mont!l& #rofit e$uation) "e
!aveH
C9)=AA = (A.@< !e.uire* re"enue) C=)AAA.
30) "e#uired revenue =
) (
A.@<
C9)=AA C=)AAA +
= 3!+&(( 5e-
4ont<.
b. Substituting t!e data into PinaLs #rofit e$uation) "e !aveH
C:)AAA = (A.@< C1<)AAA) 5ixe* costs.
M0,i4u4 e,5en9itu-e on .i,e9 *osts = C11)8<A C:)AAA = 3%+!5(.
c. PinaLs ne" variable cost is CA.8< (1 O A.<) = CA.9@< #er C1.AA of sales.
!us) PinaLs ne" contribution margin ratio isH ) (
C1.AA
C.9@< ; C1.AA
= A.=8<.
Substituting t!is information into t!e #rofit calculation and setting #rofit e$ual to
CA) "e !aveH
CA = (A.=8< -rea+e"en re"enue) C=)AAA.
=-e06even -evenue 1 3'+$((.
Note? -f 5xercise <.98 !as also been assigned) notice t!at PinaLs brea'even
revenue increases b& C1)=AA. From a #edagogical stand#oint) instructors ma&
"is! to #oint out t!at exercises <.9A;<.9: are $uite similar. !e onl& difference is
"!et!er t!e #roblem is cast in terms of sales in units or sales in dollars. !is
framing) t!oug!) ver& muc! affects !o" "e #roceed.
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5."$ CVP Re80tion 0n9 P-o.it P80nnin7+ Unit Cont-i/ution M0-7in A55-o0*<+
T0,es 2LO+ LO!:.
a. *!en taxes are #ro#ortional to #re;tax #rofit) "e can "rite t!e #rofit asH
Profit after taxes = Profit before taxes (1 7ax rate).
= [(,nit contribution &argin 8uantit#) 5ixe* costs]
(1 7ax rate).
For S#ringFres!)
,nit contribution &argin = C1.<A CA.<A = C1.AA.
(nnual Fixed cost = C<A)AAA 18 = C=AA)AAA.
!e tax rate = .8<
+onse$uentl&) S#ringFres!Ls annual after;tax #rofit isH
P-o.it 0.te- t0,es 1 @23.(( Poun9s 80un9e-e9: ; 3$((+(((A B .%5.
9ote/ Please be careful to convert mont!l& fixed costs to an annual amount.
b. S#ringFres!Ls #rofit before taxes = (C1.AA @<A)AAA #ounds) C=AA)AAA =
C1<A)AAA.
T0,es 50i9 = C1<A)AAA .8< = 3"%+5((.
P-o.it 0.te- t0,es = C1<A)AAA .@< = 3!+5((.
c. Since #rofit and taxes = CA at t!e brea'even #oint) "e 'no" t!at t!e #rofit
ex#ression in #art [a] reduces toH
CA = C1.AA -rea+e"en "ou&e C=AA)AAA.
!us) Breakeven volume = $((+((( 5oun9s.
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5."%
Profit after taxes = [(,nit contribution &argin 8uantit#) 5ixe* costs] (1
7ax rate).
C18A)AAA = [(C1.AA !e.uire* "ou&e in poun*s) C=AA)AAA] .@<.
!us) "e#uired volume 1 %$(+((( 5oun9s.
5."& CVP Re80tion in Non-P-o.its+ Cont-i/ution M0-7in R0tio A55-o0*< 2LO+
LO!:.
a. -n t!is case) >#rofit? is t!e amount left over after #a&ing for fixed costs. *e
!aveH
C81)AAA = (R of attendees C<A) ; C1<)AAA
3r) "e need %!( 0tten9ees.
b. 6et us first "rite out t!e #rofit e$uationH
C81)AAA = (R of attendees C<A) O (R of attendees A.<A C8A) ; C1<)AAA
Solving) "e find R of attendees = $((
5ffectivel&) t!e cas! bar raises t!e contribution #er member to C=A) "!ic!
lo"ers t!e re$uired volume.
5."' CVP 0n9 P-o.it P80nnin7+ Cont-i/ution M0-7in R0tio A55-o0*<+ T0,es 2LO+
LO!:.
a. 0ecall t!at using t!e contribution margin ratio) "e can ex#ress #rofit after
taxes asH
Profit after taxes = [(6ontribution &argin ratio -iings) 5ixe* costs] (1
7ax rate).
For (rena) t!e contribution margin ratio is 1 A.9A = A.@A (@AB of billings).
Furt!er) (renaLs mont!l& fixed costs = C1:)AAA and t!e tax rate is 9<B.
+onse$uentl&) (renaLs mont!l& #rofit isH
P-o.it 0.te- t0,es 1 @2.%( =i88in7s: ; 3#+(((A B .$5.
b. (t t!e brea'even #oint) #rofit after taxes = #rofit before taxes = CA (i.e.) no tax
is due because t!ere is no #rofit). +onse$uentl&) "e !ave (since t!e tax rate is
irrelevant at brea'even)H
.ala'ris!nan) 2anagerial (ccounting 1e F30 -4S0U+30 US5 3467
<;18
CA = (A.@A -rea+e"en re"enue) C1:)AAA.
Solving) "e find /-e06even /i88in7s 1 3!(+(((.
c. Using t!e #rofit ex#ression in [a]) "e !aveH
P-o.it /e.o-e t0,es = (A.@A C<A)AAA) C1:)AAA = 3!+(((.
P-o.it 0.te- t0,es = C81)AAA .=< = 3"+$5(.
d. (gain) using t!e #rofit ex#ression in (a)) "e !aveH
C@)8QA = [(A.@A !e.uire* biings) C1:)AAA] .=<.
ReCui-e9 /i88in7s 1 3"$+(((.
5.#( CVP Re80tion+ In.e--in7 Cost St-u*tu-e+ E,tension to )e*ision M06in7 2LO!+
LO":.
a. !e contribution margin ratio =
) (
Price
cost able Unit vari ; Price
.
*it! Sa#Ls information) "e !ave t!e contribution margin ratio
=
) (
C88.AA
cost able Unit vari ; C88.AA
= A.=A.
$nit varia%le cost 1 3&.&( .o- e0*< DEAPF 6it.
(lternativel&) from t!e formula for contribution margin ratio) notice t!at
6ontribution &argin ratio = 1 (,nit "ariabe cost/Price). !e latter term is t!e
>"ariabe cost ratio.? !en)
6ontribution &argin ratio = 1 (ariabe cost ratio.
(##l&ing t!e data from t!e #roblem) "e !aveH
A.=A = 1 (ariabe cost ratio) or (ariabe cost ratio = :AB of sales #rice
!at is) unit variable cost = A.:A C88 = 3&.&( 5e- unit.
.ala'ris!nan) 2anagerial (ccounting 1e F30 -4S0U+30 US5 3467
<;19
b. 6et us use t!e #rofit ex#ressionH
Profit before taxes = (6ontribution &argin ratio !e"enue) 5ixe* costs.
*e 'no" t!at Sa# ex#ects to brea' even at 1@)<AA >S(P? 'its t!us) .rea'even
revenue = 1@)<AA C88.AA = C9Q<)AAA. (dditionall&) "e 'no" t!at #rofit = CA at
t!e brea'even #oint. !us) "e !aveH
CA = (A.=A C9Q<)AAA) 5ixe* costs.
Solving) "e find t!at .i,e9 *osts 1 3!"+(((.
(lternativel&) "e could use t!e unit contribution margin formulation. *e can
calculate t!e brea'even #oint asH
CA = (,nit contribution &argin -rea+e"en "ou&e) 5ixe* costs.
From #art [a]) "e 'no" t!at t!e unit variable cost = CQ.QA. .ecause t!e selling
#rice = C88.AA) "e 'no" t!at t!e unit contribution margin = C88.AA CQ.QA =
C19.8A. !us) "e !aveH
CA = (C19.8A 1@)<AA) 5ixe* costs.
(gain) "e find t!at .i,e9 *osts 1 3!"+(((.
c. !e free s!i##ing and !andling offer reduces Sa#Ls revenue #er >S(P? 'it to
C8A.AA. *it! t!e 'no"ledge ac$uired in #arts [a] and [b] (i.e.) t!e variable
cost #er >S(P? 'it and Sa#Ls mont!l& fixed costs) res#ectivel&)) "e can
calculate Sa#Ls brea'even volume asH
CA = (,nit contribution &argin -rea+e"en "ou&e) 5ixe* costs.
or) CA = [(C8A.AA CQ.QA) -rea+e"en "ou&e] C891)AAA
=-e06even nu4/e- o. 6its 2 Breakeven volume : 1 !(+$!5.
+onse$uentl&) Sa# must sell an additional 8A)=8< 1@)<AA = 9)18< 'its to brea'
even if t!e com#an& decides to offer >free? s!i##ing.
NoteH -nstructors ma& "is! to use t!is #roblem to em#!asi%e t!e im#ortance of
'no"ing bot! t!e unit contribution margin a##roac! and t!e contribution margin
ratio a##roac!. -n #art [a]) it "as necessar& to use t!e contribution margin ratio to
arrive at t!e variable cost #er unit. -n #art [c]) !o"ever) t!e unit contribution margin
a##roac! more readil& accommodates a reduction in t!e sales #rice i.e.) it is
relativel& straig!tfor"ard to calculate t!e unit contribution margin. +alculating t!e
ne" contribution margin ratio is some"!at more involved) alt!oug! it "ill lead to
.ala'ris!nan) 2anagerial (ccounting 1e F30 -4S0U+30 US5 3467
<;1:
an e$uivalent ans"er as t!e unit contribution margin a##roac!. 2oreover) t!e ne"
contribution margin ratio is (8A Q.QA)/8A = A.<= or <=B.

5.# CVP Re80tion 0n9 )e*ision M06in7+ P-i*in7 /0se9 on 0 )e40n9 S*<e9u8e
2LO":.
5m#lo&ing t!e +,P relation) "e can com#ute t!e #rofit at alternative #rices to
determine t!e #rice t!at &ields t!e maximum #rofit. !e follo"ing table contains
t!e detailed com#utations.
P-i*e Revenue V0-i0/8e
Costs
Fi,e9 Costs P-o.it
C98.<A
CN)@<A C1)QAA C9)AAA C:)N<A
C9A.AA
C1A)<AA C8)1AA C9)AAA C<):AA
&!'.5(
&,((( &!,)(( &3,((( &5,*((
C8<.AA
C11)8<A C8)@AA C9)AAA C<)<<A
C88.<A
C11)8<A C9)AAA C9)AAA C<)8<A
=G ins5e*tion+ we .in9 3!%.5( to /e t<e 5-o.it-40,i4iHin7 5-i*e. I-e7 e0-ns
35+$(( in 5-o.it 0t t<is 5-i*e.
NoteH -nstructors ma& "is! to #oint out t!at firms ma& use a demand function
instead of using a demand sc!edule li'e t!e table above. ( demand function gives
t!e revenue for ever& #ossible #rice. (For exam#le) based on t!e data #rovided)
PregLs demand function isH 8uantit# = N<A 8A Price). -n t!is case) "e use
calculus or numerical a##roximation tec!ni$ues (via a s#reads!eet suc! as 5xcelLs
solver function) to determine t!e #rofit;maximi%ing #rice.
5.#! CVP -e80tion 0n9 )e*ision M06in7+ C<oosin7 0 Cost St-u*tu-e+ O5e-0tin7
Leve-07e 2LO"+ LO#:.
a. 3neLs first inclination is to com#are t!e #rofit across t!e various #o#corn
mac!ines. Fo"ever) for t!e same number of customers) revenue is e$ual
across t!e t!ree mac!ines. !us) "e can ran' order #o#corn mac!ines
according to t!eir total costs. -n ot!er "ords) t!e #roblem can be formulated
as a cost minimi%ation #roblem as t!e mac!ine t!at minimi%es cost also
maximi%es #rofit.
*e start b& assessing t!e number of #atrons at "!ic! t!e small #o#corn mac!ine
"ill cost t!e same as t!e medium #o#corn mac!ine. *e !aveH
C=)AAA O (A.<A number of #atrons) = C18)AAA O (A.9< number of #atrons).
.ala'ris!nan) 2anagerial (ccounting 1e F30 -4S0U+30 US5 3467
<;1<
!e number of #atrons at "!ic! t!e cost is t!e same =
1< .
AAA ) = C
= #(+(((.
!us) "!en a t!eater ex#ects less t!an :A)AAA moviegoers a &ear (or
a##roximatel& 11A #er da&)) it is o#timal to rent t!e small #o#corn mac!ine.
+om#aring t!e medium and t!e large #o#corn mac!ines) "e !aveH
C18)AAA O (A.9< number of #atrons) = C1Q)<AA O (A.8< number of #atrons).
!e number of #atrons at "!ic! t!e cost is t!e same =
1A .
<AA ) = C
= $5+(((.
!us) "!en a t!eater ex#ects more t!an =<)AAA moviegoers a &ear (or
a##roximatel& 1@Q #er da&)) it is o#timal to rent t!e large #o#corn mac!ine.
(dditionall&) t!e above anal&sis informs us t!at "!en a t!eater ex#ects bet"een
:A)AAA and =<)AAA moviegoers a &ear) it is o#timal to rent t!e medium #o#corn
mac!ine.
!us) "e !ave t!e follo"ing decision ruleH
Mi9west Cine40 T<e0te-s
Po5*o-n M0*<ine Rent08 Mo9e8
(nnual R of 2oviegoers ( : ) Po#corn 2ac!ine Si%e
: T :A)AAA Small
:A)AAA T : T =<)AAA 2edium
: U =<)AAA 6arge
Note? -nstructors also ma& "is! to gra#!icall& re#resent t!e tradeoff t!is is
#er!a#s best accom#lis!ed b& as'ing students to gra#!) for eac! si%e #o#corn
mac!ine) !o" #o#corn costs (&;axis) varies as a function of t!e number of #atrons
(x;axis). !is allo"s students to see "!ere t!e lines cross !e instructor can
t!en s!ade t!e lo" cost frontier to see !o" t!e #referred mac!ine de#ends on
ex#ected volume.
b. ;perating e"erage = 5ixe* costs<7ota costs
= 5ixe* costs/(5ixe* costs O (ariabe costs).
.ala'ris!nan) 2anagerial (ccounting 1e F30 -4S0U+30 US5 3467
<;1=
For eac! #o#corn mac!ine) "e !aveH
5ixe* 6osts (ariabe 6osts ;perating
=e"erage
Small C=)AAA C98)<AA
(= =<)AAA CA.<A)
.55&
2edium C18)AAA C88)@<A
(= =<)AAA CA.9<)
."#5"
6arge C1Q)<AA C1=)8<A
(= =<)AAA CA.8<)
.5"!"
(s discussed in t!e text) o#erating leverage fre$uentl& is used as a measure of ris'
ceteris paribus) t!e !ig!er t!e o#erating leverage) t!e !ig!er t!e ris'. !us)
"!ile "e see t!at t!e large #o#corn mac!ine is #referred for volumes of =<)AAA
moviegoers and !ig!er) it also carries t!e !ig!est ris') a factor t!at 6eticia ma&
"is! to consider in !er decision.
5.#" CVP Re80tion 0n9 )e*ision M06in7+ M0-7in o. S0.etG+ O5e-0tin7 Leve-07e+
C0s<-=0sis =-e06even An08Gsis 2LO"+ LO#:.
a. :argin of safet# =
)
saes 6urrent
saes -rea+e"en - saes 6urrent
(


*e first need to determine +ottage .a'er&Ls brea'even sales. Using t!e
contribution margin ratio to "rite t!e #rofit e$uation) "e !aveH
Profit before taxes = (6ontribution &argin ratio !e"enue) 5ixe* costs.
.ecause "e do not 'no" +ottage .a'er&Ls fixed costs) "e first !ave to use t!e
model to >bac' out? fixed costs and t!en derive brea'even sales. (ccordingl&)
C@)<AA = (A.: C1<A)AAA) 5ixe* costs
5ixe* costs = C<8)<AA.
4ext) setting target #rofit e$ual to CA "ill allo" us to calculate brea'even
revenueH
CA = (A.: -rea+e"en re"enue) C<8)<AA
-rea+e"en re"enue = C191)8<A.
.ala'ris!nan) 2anagerial (ccounting 1e F30 -4S0U+30 US5 3467
<;1@
Cott07e =06e-GJs M0-7in o. s0.etG =
) (
C1<A)AAA
C191)8<A ; C1<A)AAA
= !.5>.
-n dollars) t!e margin of safet& e$uals C1<A)AAA C191)8<A = 3&+%5(.
b. ;perating e"erage = 5ixe* costs/7ota costs.
*e 'no" t!at t!e contribution margin (in dollars) = 6ontribution &argin ratio
!e"enue. !us) "e !aveH
+ontribution margin = A.: 1<A)AAA = C=A)AAA.
.ecause contribution margin = revenues variable costs) variable costs can be
calculated as CNA)AAA. Piven t!at fixed costs are C<8)<AA) t!e total costs are
C1:8)<AA.
+onse$uentl&) O5e-0tin7 8eve-07e = fixed costs / total costs
= C<8)<AA/C1:8)<AA = (."$& 2-oun9e9:
c. -f 9AB of t!e fixed costs re#resent non;cas! ex#enses) t!e cas! fixed ex#enses
e$ualH A.@A C<8)<AA = C9=)@<A.
*e are no" in a #osition to "rite t!e cas! #rofit asH
6as% profit = (6ontribution &argin ratio !e"enue) 6as% fixe* costs.
o calculate t!e brea'even #oint) "e set cas! #rofit = CA.
CA = (A.:A 6as% brea+e"en re"enue) C9=)@<A.
C0s< /-e06even -evenue 1 3'+&%5.
4otice t!e large difference bet"een t!e revenue re$uired to brea'even on a cas!
basis (CN1)Q@<) and t!e revenue re$uired to brea'even on a non;cas! (accrual)
basis (C191)8<A). 2oreover) t!is #roblem #resents a nice o##ortunit& to tal' "it!
students about "!ic! #rofit model is more germane to t!e firm. *!ile cas! basis
accounting ma& #aint an unusual #icture of t!e organi%ationLs !ealt! (due to t!e
sli##age bet"een cas!;basis accounting and >economic realit&?)) man&
organi%ations (and #eo#le) need to ensure t!at t!e& remain solvent/li$uid in t!e
s!ort;term and t!at cas! ex#enditures do not exceed cas! revenues.
.ala'ris!nan) 2anagerial (ccounting 1e F30 -4S0U+30 US5 3467
<;1Q
5.## Mu8ti-P-o9u*t CVP An08Gsis+ Unit Cont-i/ution M0-7in A55-o0*< 2LO5:.
a. 6et us em#lo& a "eig!ted unit contribution margin a##roac! to solve t!e
#roblem. For 2ountain 2a#les) "e !aveH
8):AA total trees sold QAA) or 1/9 are .utterfl&) and 1)=AA) or 8/9) are 2oonfire.
!us) "e !aveH
>eig%te* unit contribution &argin = 1/9 C1AA O 8/9 C<A.
= C==.=@.
-n turn) 2ountain 2a#lesL #rofit becomesH
Profit before taxes = (C==.=@ total number of trees sold) C@<)AAA.
(t t!e brea'even #oint) "e !aveH CA = (C==.=@ -rea+e"en nu&ber of trees)
C@<)AAA.
Solving) "e find t!at t!e total number of trees sold to brea'even = +!5.
3f t!ese) 1)18< 1/9 = "%5 =utte-.8GJ 1)18< 8/9 = %5( Moon.i-e.
b. Using t!e $eig%te* unit contribution &argin a##roac!) "e !aveH
C<A)AAA = (C==.=@ total number of trees) C@<)AAA.
!e total number of trees = 1)Q@<.
3f t!ese) 1)Q@< 1/9 = $!5 0-e =utte-.8G+ and
1)Q@< 8/9 = 1)8<A are 2oonfire

c. !e c!ange in t!e #roduct mix affects 2ountain 2a#leLs "eig!ted
contribution.
*it! t!e ne" information) "e !aveH
>eig%te* contribution &argin= (.<A C1AA) O (.<A C<A)
= C@<.AA
!e "eig!ted contribution margin is !ig!er t!an in #art [a] because t!e #roduct
mix !as s!ifted to"ard .utterfl&) "!ic! !as t!e !ig!est contribution margin #er
tree.
+onse$uentl&) t!e total number of trees re$uired to brea' even "ill decreaseH
.ala'ris!nan) 2anagerial (ccounting 1e F30 -4S0U+30 US5 3467
<;1N
A = (C@<.AA .rea'even number of trees) C@<)AAA.
.rea'even number of trees = 1)AAA.
3f t!ese) 1)AAA .<A = <AA are .utterfl&) and
1)AAA .<A = <AA are 2oonfire
5.#5 Mu8ti-P-o9u*t CVP An08Gsis+ Cont-i/ution M0-7in R0tio A55-o0*< 2LO5:.
a. -n t!is setting) "e must use t!e "eig!ted contribution margin ratio a##roac!
given t!e absence of unit;level data. (ccordingl&)H
Profit before taxes = (!e"enue4 6ontribution &argin ration4) O
(!e"enueU 6ontribution &argin ratioU) 5ixe* costs)
!e subscri#ts V4L and VUL stand for ne" and used. (dditionall&) "e 'no" t!at
C1)<AA)AAA/C8)AAA)AAA) or @<B of t!e revenue is from ne" cars) and
C<AA)AAA/C8)AAA)AAA) or 8<B of t!e revenue is from used cars.
Furt!er) "e can calculate t!e contribution margin ratio for eac! #roduct using t!e
#roduct;level financial data. *e !aveH
(+ontribution margin ratio)4 =
AAA ) <AA ) 1
AAA ) @<A AAA ) <AA ) 1
= .<A.
(+ontribution margin ratio)U =
AAA ) <AA
AAA ) 8AA AAA ) <AA
= .=A.
!us) t!e "eig!ted contribution margin ratio = (.<A .@<) O (.=A .8<) = .<8<.
*e can no" "rite SelectLs #rofit in terms of t!e "eig!ted contribution margin
ratio and total revenuesH
Profit before taxes = (.<8< 7ota re"enue) CQ:A)AAA.
Setting #rofit e$ual to CA) "e findH
=-e06even tot08 -evenue 1 3+$((+(((.
!is translates into C1)=AA)AAA .@< = 3+!((+((( in new 0uto s08es and
C1)=AA)AAA .8< = 3#((+((( in use9 0uto s08es.
.ala'ris!nan) 2anagerial (ccounting 1e F30 -4S0U+30 US5 3467
<;8A
b. o ans"er t!is $uestion) "e #lug in our desired #rofit in t!e e$uation for #rofit
develo#ed in #art [a]. *e no" !aveH
C1)A<A)AAA = (.<8< 7ota re"enue) CQ:A)AAA.
Solving) "e findH
Tot08 -evenue 1 3"+$((+(((.
!is translates into C9)=AA)AAA .@< = 3!+%((+((( in new 0uto s08es and
C9)=AA)AAA .8< = 3'((+((( in use9 0uto s08es.
5.#$ Mu8ti-P-o9u*t An08Gsis+ wei7<te9 *ont-i/ution 40-7in K wei7<te9
*ont-i/ution 40-7in -0tio 055-o0*<+ He-*u8es 2LO5:.
a. *e 'no" t!at individual and famil& members!i#s !ave a 9H1 ratio (NAA
individual to 9AA families). !us) t!e "eig!ted contribution margin isH
[9 (C1AA;C9<) O 1 (C1<A ;C=A)] / : = C@1.8<.
!en) #lugging into t!e #rofit e$uation) "e !aveH
A = C@1.8< total members!i#s ; C:8)@<A)
otal members!i#s = C:8)@<A/C@1.8< #er average members!i#= =AA.
(t t!is volume) Fercules !as (9/:) =AA = #5( in9ivi9u08 and (1/:) =AA = 5(
.04i8G members!i#s.
b. *e calculate t!e contribution margin for individual and famil& members!i#s
at A.=< (= [(C1AA;C9<)/C1AA] and A.=A (= [(C1<A;C=A)/C1<A] res#ectivel&.
*e 'no" t!at individual and famil& members!i#s !ave a 8H1 ratio in terms of
total revenue (-ndividual revenue is NAA members C1AA #er mont! = CNA)AAA
and famil& revenue is 9AA members!i#s C1<A #er mont! = C:<)AAA.) !us) t!e
"eig!ted contribution margin ratio isH
[(8/9) A.=< O (1/9) A.=A] = A.=999 = =9.99B.
Please note t!at "e "eig!t t!e individual contribution margin ratios b& t!eir
revenue s!ares. -n contrast) "e used t!e s!are of members!i#s to "eig!t
individual contribution margins in #art [a].
Plugging into t!e #rofit e$uation) "e !aveH
A = A.=9999 total revenue ; C:8)@<A
.ala'ris!nan) 2anagerial (ccounting 1e F30 -4S0U+30 US5 3467
<;81
otal members!i#s = C:8)@<A/A.=9999 = 3$%+5((.
NoteH 7ou can verif& t!is ans"er b& using t!e ans"er for #art [a]. otal revenue
reali%ed at t!e ans"er to #art [a] is :<A C1AA O 1<A C1<A = C=@)<AAM
PRO=LEMS
5.#% CVP -e80tion+ P-o.it P80nnin7+ Unit Cont-i/ution M0-7in A55-o0*<+
E,tensions to )e*ision M06in7 2LO+ LO!+ LO":.
a. !e general +,P model isH
Profit before taxes = [(Price ,nit "ariabe cost) 8uantit#] 5ixe* cost.
= (,nit contribution &argin 8uantit#) 5ixe* costs.
Plugging in bot! t!e members!i# fee and t!e fixed and variable cost information
for ParnetLs P&m) "e !aveH
P-o.it 1 @235(( ; 3!((: Nu4/e- o. 4e4/e-sA ; 3+!((+(((.
1 23"(( Nu4/e- o. 4e4/e-s: ; 3+!((+(((.
b. o calculate t!e brea'even #oint in members) "e set #rofit e$ual to CA in t!e
ex#ression for #rofit in [a]H
CA = 9AA .rea'even volume C1)8AA)AAA.
Nu4/e- o. 4e4/e-s -eCui-e9 to /-e06 even 1 #+(((.
c. Fere) "e #lug in t!e number of members from t!e #revious &ear into t!e
#rofit e$uation develo#ed in #art [a]. Woing so &ieldsH
P-o.it /e.o-e t0,es 1 23"(( 5+(((: ; 3+!((+((( 1 3"((+(((.
d. !is strateg& c!anges t!e annual members!i# fee to C<AA .NA = C:<A. -n
turn) t!is c!anges t!e #er;member contribution margin to C:<A C8AA = C8<A.
-f members!i# increases to =)<AA because of t!e discount) t!en ex#ected #rofit
isH
P-o.it /e.o-e T0,es 1 23!5( $+5((: ; 3+!((+((( 1 3#!5+(((.
!is action "ould in*-e0se 5-o.it /G 3!5+((( (i.e.) C:8<)AAA C9AA)AAA)
com#ared to t!e #revious &ear.
.ala'ris!nan) 2anagerial (ccounting 1e F30 -4S0U+30 US5 3467
<;88
!is seems li'e a good o#tion to increase #rofit unless t!ere are significant
>congestion costs.? !e o"ners #robabl& s!ould t!in' t!roug! t!e soundness of
increasing members!i# b& 1)<AA #ersons) or 1)<AA/<)AAA = 9AB. -t is #ossible t!at
t!is "ill translate to increased "aiting time for mac!ines and e$ui#ment) or
difficult& finding a #ar'ing s#ot. !e o"ners ma& "is! to surve& current members
to assess t!eir #references. Suc! a strateg& could bac'fire if #eo#le believe t!at
t!eir >co%&? g&m !as become too cro"ded and) #er!a#s) filled "it! t!e >"rong?
t&#e of #eo#le (e.g.) t!ose "!o are not serious about training). 3n t!e ot!er !and)
current members ma& desire more members as t!is increases t!e #otential for
finding dates) friends!i#s) and so on.
e. *e start "it! our finding from #art [d] t!at #rofit is ex#ected to be C:8<)AAA if
t!e o"ners reduce t!e members!i# fee. *e set t!is amount e$ual to our target
#rofit and solve for t!e advertising ex#ense. (ccordingl&) "e !aveH
C:8<)AAA = (C9AA =)<AA) C1)8AA)AAA 3*"ertising.
*e find t!at t!e 40,i4u4 09ve-tisin7 e,5en9itu-e 1 3"!5+(((.
-n terms of com#aring t!e o#tions) t!e o"ners s!ould assess "!ic! o#tion is li'el&
to be more costl&) in terms of foregone contribution margin or out;of;#oc'et
ex#ense) and "!ic! o#tion is li'el& to lead to t!e greatest increase in members!i#
(if t!is is t!e desired outcome).
f. !e t"o a##roac!es are mat!ematicall& e$uivalent. o see t!is) "e start "it!
t!e unit contribution margin a##roac!H
Profit before taxes = ,nit contribution &argin 8uantit# 5ixe* costs.
o arrive at t!e contribution margin ratio a##roac!) "e first multi#l& ,6: 8 b&
P<P) giving usH
(,6: 8)
P
P
.
-n turn) t!is ex#ression can be re;"ritten asH
P
,6:
(8 P).
!is s!ould loo' familiar it is e$uivalent toH 6:! !e"enue.
+onse$uentl&) t!e t"o a##roac!es "ill #roduce t!e same ans"ers and) t!us) t!e
o"ners of ParnetLs P&m need not "orr& our ans"ers "ill not c!ange.
.ala'ris!nan) 2anagerial (ccounting 1e F30 -4S0U+30 US5 3467
<;89
5.#& CVP Re80tion+ P-o.it P80nnin7+ Cont-i/ution M0-7in R0tio A55-o0*<+
E,tensions to )e*ision M06in7 2LO+ LO!+ LO":.
a. Piven t!e absence of unit;level data) "e need to em#lo& t!e contribution
margin ratio a##roac!. (dditionall&) since "e are as'ed to find t!e brea'even
#oint) and #rofit = CA at t!e brea'even #oint) taxes are not relevant. !us) "e
!aveH
CA = (6ontribution &argin ratio -rea+e"en re"enue) 5ixe* costs.
For Precious Stone Xe"elr&) t!e contribution margin ratio isH

) (
C1)AAA)AAA
=AA)AAA ; C1)AAA)AAA
= :AB.
(dditionall&) Precious Stone Xe"elr&Ls fixed costs = C8=A)AAA. !us) "e !aveH
CA = (A.:A .rea'even revenue) C8=A)AAA.
Solving) "e find /-e06even -evenue 1 3$5(+(((.
b. -ncreasing t!e selling #rice b& 8AB "ill increase revenues b& 8AB (because
$uantit& sta&s t!e same) and) in turn) increase t!e contribution margin ratio.
First) "e !aveH
!e"ise* re"enues = 1.8A 1)AAA)AAA = C1)8AA)AAA.
!e ne" contribution &argin ratio isH
) (
C1)8AA)AAA
=AA)AAA ; C1)8AA)AAA
= <AB.
!us) "e !aveH
CA = (A.<A -rea+e"en re"enue) C8=A)AAA.
Solving) "e find /-e06even -evenue 1 35!(+(((. !us) brea'even revenue
"ould decrease b& C=<A)AAA C<8A)AAA = C19A)AAA.
c. -f variable costs decrease b& 8AB) ne" variable costs "ill beH
,ariable costs = .QA =AA)AAA = C:QA)AAA.
.ala'ris!nan) 2anagerial (ccounting 1e F30 -4S0U+30 US5 3467
<;8:
-n turn) t!e ne" contribution &argin ratio becomesH
)
$1,000,000
4?0,000 - $1,000,000
( = <8B
!us) "e !aveH
CA = (A.<8 -rea+e"en re"enue) C8=A)AAA.
Solving) "e find /-e06even -evenue 1 35((+(((. !us) brea'even revenue
"ould decrease b& C=<A)AAA C<AA)AAA = C1<A)AAA.
d. (s discussed in #art [a]) taxes !ave no effect on t!e brea'even #oint. Since
taxes are a #ercentage of #rofit) an& #ercentage of CA is al"a&s CA. !us) t!e
tax rate is not relevant. (s illustrated in #art [e]) !o"ever) taxes are relevant
"!en t!e firm earns #ositive #rofit.
e. -f all c!anges do ta'e #lace) "e !aveH
0evenues = C1)AAA)AAA 1.8A C1)8AA)AAA
,ariable costs = C=AA)AAA (1 .8A) :QA)AAA
+ontribution margin C@8A)AAA
Fixed costs (sta& t!e same) 8=A)AAA
Profit before taxes C:=A)AAA
axes .9A C:=A)AAA 19Q)AAA
Profit after taxes 3"!!+(((
!us) #rofit is ex#ected to increase b& C81@)AAA) from C1A<)AAA to C988)AAA.
.ot! t!e c!ange in #rice and unit variable cost increase Precious StoneLs
contribution margin and) in turn) #rofit. !e increase in t!e tax rate diminis!es t!e
amount of Profit before taxes t!at Precious Stone retains t!at is) t!e increase in
t!e tax rate reduces t!e slo#e of t!e #rofit after taxes line.
.ala'ris!nan) 2anagerial (ccounting 1e F30 -4S0U+30 US5 3467
<;8<
5.#' CVP Re80tion 0n9 P-o.it P80nnin7+ So8vin7 .o- Un6nowns 2LO+ LO!:.
a. !e general model for t!e cit&Ls sno" removal costs loo's li'e (notice t!at
t!ere is no need for a revenue) or #rofit) com#onent as t!e #roblem deals
strictl& "it! cost)H
7ota costs = 5ixe* costs O ((ariabe cost per sno$fa 9u&ber of sno$fas).
*e are #rovided "it! total costs and sno"fall data for t"o se#arate &earsH
C9AA)AAA = 5ixe* costs O (ariabe cost per sno$fa 8A.
C88Q)AAA = 5ixe* costs O (ariabe cost per sno$fa 18.
*e no" !ave t"o e$uations "it! t"o un'no"ns accordingl&) "e can subtract
t!e second e$uation from t!e first e$uation. Woing so &ieldsH
C@8)AAA = (ariabe cost per sno$fa Q.
30) variable cost #er sno"fall = CN)AAA.
Plugging t!is bac' into eit!er &ear "e find t!at fixed cost = C18A)AAA. !us) t!e
cit&Ls sno" removal costs can be calculated asH
Tot08 Snow Re4ov08 Costs 1 3!(+((( L 23'+((( Nu4/e- o. 40Mo-
snow.088s:.
b. For t!is $uestion) it is sim#l& a matter of #lugging in t!e antici#ated number
of sno"falls into t!e ex#ression for sno" removal costs develo#ed in #art [a].
*e !aveH
E,5e*te9 Snow Re4ov08 Costs 1 C18A)AAA O (CN)AAA 8=) = 3"5#+(((.
!us) t!e cit& s!ould re$uest C<:)AAA more t!an it s#ent t!is &earM !is #roblem)
"!ic! lin's nicel& bac' to +!a#ter 9) is useful for s!o"ing students !o" +,P can
be used for #lanning/budgeting #ur#oses. !is #roblem) t!oug!) deals onl& "it!
t!e +(ost) and t!e ,(olume) #ortions of t!e model.
5.5( =ui89in7 0 CVP Re80tion t<0t In*o-5o-0tes T0,es 0n9 =onus P0G4ents usin7
0 Cont-i/ution M0-7in R0tio A55-o0*< 2LO+ LO!:.
!e first ste# is to "rite Wiamond XubileeLs after;tax #rofit as follo"sH
Profit after taxes = (7ota $agers >innings (ariabe costs -onus 5ixe*
costs)
(1 7ax rate).
.ala'ris!nan) 2anagerial (ccounting 1e F30 -4S0U+30 US5 3467
<;8=
.ecause "e are not #rovided "it! data regarding !o" muc! "as "agered in total)
"e "ill need to "or' "it! t!e contribution margin ratio a##roac!. !e model is
more involved because t!e bonus is a function of #re;tax income. *e begin b&
modeling #re;tax and #re;bonus #rofitH
Pre-tax an* pre-bonus profit = (6ontribution &argin ratio 7ota $agers)
5ixe* costs.
Fere) contribution &argin ratio is t!e contribution margin ratio "it!out t!e
bonusJ it is C1.AA CA.Q8 CA.AQ = CA.1A or 1AB. Furt!er) fixed costs e$ual
C8@)<AA. !us) "e !aveH
Pre-tax an* pre-bonus profit = (.1A 7ota $agers) C8@)<AA.
*e are no" in a #osition to add t!e bonus #a&ment to t!e model as t!e managerLs
bonus e$uals <B of t!e #re;tax and #re;bonus #rofit. (fter subtracting t!e bonus)
"!ic! is <B of t!e #re;tax and #re;bonus #rofit) "e !ave #re;tax (but after bonus)
#rofit asH
Pre-tax profit = [(.1A 7ota $agers) C8@)<AA] (1 .A<).
*e can next add taxes to t!e model. *it! a tax rate of 8<B) "e !aveH
3fter-tax profit = Y[(.1A 7ota $agers) C8@)<AA] (1 .A<)Z (1 .8<).
(t t!is #oint) "e need onl& substitute t!e desired mont!l& after;tax) after;bonus
#rofit of C8Q)<AA. !us)
C8Q)<AA = Y[(.1A 7ota $agers) C8@)<AA] (1 .A<)Z (1 .8<).
So8vin7+ we .in9 t<0t t<e -eCui-e9 4ont<8G 8eve8 o. tot08 w07e-s 27-oss
704/8in7 -evenue: 1 3$%5+(((.
!is #roblem demonstrates !o" t!e >basic? +,P relation can be ex#anded to
incor#orate additional s!ort;term #rofit considerations suc! as bonuses and taxes.
5.5 CVP Re80tion 0n9 P-o.it P80nnin7+ C<oosin7 0 Cost St-u*tu-e 2LO+ LO!+
LO":.
a. o calculate brea'even revenue) "e start "it! t!e #rofit calculation using t!e
contribution;margin ratioH
Profit = (6ontribution &argin ratio !e"enue) 5ixe* costs.
Setting #rofit = CA)
.ala'ris!nan) 2anagerial (ccounting 1e F30 -4S0U+30 US5 3467
<;8@
.rea'even revenue = 5ixe* costs<6ontribution &argin ratio.
Piven t!e information in t!e #roblem for eac! cost structure) "e !aveH
Mont<8G /-e06even -evenue un9e- *u--ent *ost st-u*tu-e?
Fixed costs C9=)AAA #er mont!
+ontribution margin ratio :AB
.rea'even 0evenue C9=)AAA/A.:A = 3'(+(((
Mont<8G /-e06even -evenue un9e- new *ost st-u*tu-e?
Fixed costs C=A)AAA #er mont!
+ontribution margin ratio =AB
.rea'even revenue C=A)AAA/A.=A = 3((+(((
!us) +eceliaLs brea'even revenue "ill increase b& C1A)AAA if s!e ac$uires t!e
ne" mac!ines. 5ven t!oug! !er contribution margin ratio increases ("!ic!)
ceteris paribus) #us!es t!e brea'even #oint do"n) b& ac$uiring t!e ne"
mac!ines) t!e substantial increase in fixed costs drives t!e brea'even #oint u#.
b. (s in #art [a]) t!e #rofit isH
Profit = (6ontribution &argin ratio !e"enue) 5ixe* costs.
*e no" #lug in t!e various #arameters to determine #rofit under eac! cost
structure.
Cu--ent *ost st-u*tu-e?
Profit at CN<)AAA in revenue = (A.:A CN<)AAA) C9=)AAA = 3!+(((.
Profit at C1<A)AAA in revenue = (A.:A C1<A)AAA) C9=)AAA = 3!#+(((.
New *ost st-u*tu-e?
Profit at CN<)AAA in revenue = (A.=A CN<)AAA) C=A)AAA = 23"+(((:.
Profit at C1<A)AAA in revenue = (A.=A C1<A)AAA) C=A)AAA = 3"(+(((.
!us) +ecelia #refers !er current cost structure if mont!l& revenues are ex#ected
to be CN<)AAA) and s!e #refers to ac$uire t!e ne" mac!ines if revenues are
ex#ected to be C1<A)AAA.
c. *e can find t!is #oint of indifference) or crossover #oint) b& e$uating t!e
#rofit e$uation under t!e t"o cost structures and solving for revenue. 6et t!e
re$uired revenue level be C!. !e #rofit at C! isH
.ala'ris!nan) 2anagerial (ccounting 1e F30 -4S0U+30 US5 3467
<;8Q
6urrent cost structure/ (A.:A C!) C9=)AAA.
9e$ cost structure/ (A.=A C!) C=A)AAA.
5$uating t!e t"o #rofit e$uations) "e !aveH
(A.:A C!) C9=)AAA = (A.=A C!) C=A)AAA.
C! = (C=A)AAA C9=)AAA)/(A.=A A.:A) = C18A)AAA.
Nit< 3!(+((( o. -evenue+ Ce*e8i0 406es t<e s04e 5-o.it o. 3!+((( wit<
eit<e- *ost st-u*tu-e. (lso notice t!at for sales greater t!an C18A)AAA) +ecelia
#refers to ac$uire t!e ne" mac!ines "!ereas for sales less t!an C18A)AAA +ecelia
#refers !er current cost structure. !at is) t!e slo#e of t!e #rofit line is !ig!er
under t!e ne" cost structure t!an t!e old cost structure. -nstructors ma& "is! to
gra#! t!e t"o cost structures to illustrate t!is #oint to students.
5.5! CVP Re80tion 0n9 )e*ision M06in7+ P-i*in7 =0se9 on 0 )e40n9 S*<e9u8e
2LO":.
a. !e follo"ing table #rovides t!e #rofit com#utations (and com#arisons) if
fixed costs "ere C1)<AA)AAA #er &ear and variable costs "ere C1 #er co#&.
Int-o9u*to-G P-i*e 3!5O*o5G 35O*o5G 35O*o5G
Users (co#ies sold) @<)AAA 1<A)AAA 9AA)AAA
7ear 1
Price #er co#& C8< C1< C<
,ariable cost #er co#& C1 C1 C1
+ontribution margin #er co#& C8: C1: C:
otal contribution margin C1)QAA)AAA C8)1AA)AAA C1)8AA)AAA
Fixed costs C1)<AA)AAA C1)<AA)AAA C1)<AA)AAA
Profit before taxes 3"((+((( 3$((+((( 32"((+(((:
7ear 8
Price #er co#& C8< C8< C8<
,ariable cost #er co#& C1 C1 C1
+ontribution margin #er co#& C8: C8: C8:
otal contribution margin C1)QAA)AAA C9)=AA)AAA C@)8AA)AAA
Fixed costs C1)<AA)AAA C1)<AA)AAA C1)<AA)AAA
Profit before taxes 3"((+((( 3!+((+((( 35+%((+(((
Ye0- L Ye0- ! P-o.it 3$((+((( 3!+%((+((( 35+#((+(((
!e table clearl& s!o"s t!at -nnova Solutions maximi%es t"o;&ear #rofit b&
setting an introductor& #rice of C< #er co#& (t!is "ould be true for Gust about an&
discount rate).
.ala'ris!nan) 2anagerial (ccounting 1e F30 -4S0U+30 US5 3467
<;8N
b. !e follo"ing table #rovides t!e #rofit com#utations (and com#arisons) if
fixed costs "ere C8AA)AAA #er &ear and variable costs "ere C1< #er co#&.
Int-o9u*to-G P-i*e 3!5O*o5G 35O*o5G 35O*o5G
Users (co#ies sold) @<)AAA 1<A)AAA 9AA)AAA
7ear 1
Price #er co#& C8< C1< C<
,ariable cost #er co#& C1< C1< C1<
+ontribution margin #er co#& C1A CA (C1A)
otal contribution margin C@<A)AAA CA (C9)AAA)AAA)
Fixed costs C8AA)AAA C8AA)AAA C8AA)AAA
Profit before axes 355(+((( 23!((+(((: 23"+!((+(((:
7ear 8
Price #er co#& C8< C8< C8<
,ariable cost #er co#& C1< C1< C1<
+ontribution margin #er co#& C1A C1A C1A
otal contribution margin C@<A)AAA C1)<AA)AAA C9)AAA)AAA
Fixed costs C8AA)AAA C8AA)AAA C8AA)AAA
Profit before axes 355(+((( 3+"((+((( 3!+&((+(((
Ye0- L Ye0- ! P-o.it 3+((+((( 3+((+((( 23#((+(((:
Fere) "e see t!at -nnova SolutionsL o#timal #ricing strateg& c!anges t!e table
s!o"s t!at -nnova Solutions #robabl& is best off b& setting an introductor& #rice
of C8< #er co#& (inter tem#oral considerations also "ould lead -nnova Solutions
to go "it! C8< rat!er t!an C1<).
c. -n an industr& "!ere an >installed base? of customers is im#ortant (as in
soft"are or video games)) firms often sacrifice toda&Ls #rofit to build mar'et
s!are and tomorro"Ls #rofit. !e 'e& idea is t!at t!at t!e firm can increase
#rofitabilit& in future &ears b& ta'ing advantage of consumersL s"itc!ing
(transaction) costs.
!e efficac& of t!is strateg& de#ends on t!e current #eriod tradeoff bet"een
demand and #rice. -f demand increases sufficientl& "it! a #rice dro#) t!en t!e
strateg& of going for a lo" introductor& #rice can generate significantl& more
#rofit in t!e long;run. Fo"ever) as t!e tables s!o") t!e re$uired increase in
demand increases as variable costs increase. For -nnova) >lo";balling?
maximi%ed #rofit "!en t!e variable cost "as lo" but not "!en t!e variable cost
"as !ig!. !us) "e often find suc! a #ricing strateg& being follo"ed onl& b&
t!ose firms "it! lo" variable costs (e$uivalentl&) !ig! contribution margin ratios)
as a #ercentage of #rice. *!ile suc! a strateg& ma& "or' for soft"are or video
games) it is unli'el& to "or' for auto manufacturers.
.ala'ris!nan) 2anagerial (ccounting 1e F30 -4S0U+30 US5 3467
<;9A
.& using 5xcel) it is relativel& straig!tfor"ard for firms to model t!e relations!i#
bet"een #rice and resulting demand. 2oreover) firms often s#end considerable
effort and resources in constructing so#!isticated models t!at ca#ture t!e
economic forces of su##l& and demand.
5.5" CVP Re80tion 0n9 M0-7in o. S0.etG 2LO#:.
a. !is is a non;standard #roblem in t!e sense t!at t!ere is no variable cost. !at
said) "e can vie" t!e commission as .rendaLs contribution margin ratio. *it!
t!is inter#retation) t!e #rofit isH
Profit = (6ontribution &argin ratio 7ransactions in *oars) 5ixe*
costs.
o calculate mont!l& brea'even transactions) "e set #rofit = CA and fixed costs
e$ual to C1Q)AAA. !is &ieldsH
CA = (A.A9 -rea+e"en 7ransactions) C1Q)AAA.

!us) t<e vo8u4e o. 4ont<8G t-0ns0*tions -eCui-e9 to /-e06even 1 3$((+(((.
b. :argin of safet# =
)
saes current
saes brea+e"en - saes current
(
.

= ) (
C1)AAA)AAA
C=AA)AAA ; C1)AAA)AAA
.
= #(>.
!us) .rendaLs transaction volume could decrease b& :AB) or C:AA)AAA before
s!e incurs a loss in a mont!.
c. Using t!e setu# from #art [b]) "e find .rendaLs margin of safet& for a
transaction volume of C1)8AA)AAA to beH
+argin of safet, 1 ) (
C1)8AA)AAA
C=AA)AAA ; C1)8AA)AAA
=
5(>.
.ala'ris!nan) 2anagerial (ccounting 1e F30 -4S0U+30 US5 3467
<;91
Similarl&) for a transaction volume of C1)=AA)AAA) "e findH
+argin of safet, 1 ) (
C1)=AA)AAA
C=AA)AAA ; C1)=AA)AAA
=
$!.5(>.
.ala'ris!nan) 2anagerial (ccounting 1e F30 -4S0U+30 US5 3467
<;98
d. First) "e notice t!at margin of safet& onl& ma'es sense at a given sales
volume. (s sales c!ange) t!e margin of safet& also c!anges. Second) "e notice
t!at t!at margin of safet& increases as transaction volume increases) reflecting
t!e additional sales over t!e brea'even volume of sales (and) !ence) a larger
>cus!ion?). Finall&) "e notice t!at t!e relations!i# bet"een sales and margin
of safet& is non;linear. -n .rendaLs case) 8AB and =AB increases in transaction
volume lead to 8<B and <=.8<B increases in !er margin of safet& [ i.e.) 8<B
= (<A;:A)/:AJ <=.8< = (=8.<A;:A)/:A.
5.5# CVP Re80tion 0n9 )e*ision M06in7+ O5e-0tin7 Leve-07e+ M0-7in o. S0.etG
2LO"+ LO#:.
a. *e !ave enoug! information to construct condensed income statements for
eac! #ro#osalH
P-o5os08 P-o5os08 !
0evenues C8)@<A)AAA C8)@<A)AAA
,ariable +ostsD 1)1AA)AAA 1)N8<)AAA
+ontribution 2arginDD C1)=<A)AAA CQ8<)AAA
Fixed +osts 1)<AA)AAA =@<)AAA
P-o.it /e.o-e T0,es 35(+((( 35(+(((
D = (1 .=A) C8)@<A)AAAJ (1 .9A) C8)@<A)AAA.
DD can also be calculated asH .=A C8)@<A)AAAJ .9A C8)@<A)AAA.
!us) ex#ected #rofit is e$ual under bot! #ro#osals. urning to o#erating
leverage) "e !aveH
;perating e"erage = 5ixe* costs<7ota costs.
!e condensed income statements #rovide us "it! all of t!e information
necessar& to com#ute o#erating leverageH
O-erating leverage 25-o5os08 : 1 C1)<AA)AAA/C8)=AA)AAA = (.5%% 2-oun9e9:.
O-erating leverage 25-o5os08 !: 1 C=@<)AAA/C8)=AA)AAA = (.!$( 2-oun9e9:.
!e margin of safet& = (current sales brea'even sales)/current sales. !us) "e
need to calculate t!e brea'even revenue under eac! #ro#osal. o do so) "e
calculate #rofit using t!e contribution margin ratio. *e !aveH

CA = 6ontribution &argin ratio -rea+e"en re"enue 5ixe* costsJ
-rea+e"en re"enue = 5ixe* costs/6ontribution &argin ratio.
!usH
.ala'ris!nan) 2anagerial (ccounting 1e F30 -4S0U+30 US5 3467
<;99
.rea'even revenue (#ro#osal 1) = C1)<AA)AAA/.= = C8)<AA)AAA.
.rea'even revenue (#ro#osal 8) = C=@<)AAA/.9 = C8)8<A)AAA.
*e are no" in a #osition to calculate t!e margin of safet&H
+argin of safet, 25-o5os08 : 1 (C8)@<A)AAA C8)<AA)AAA)/C8)@<A)AAA = .('('
2-oun9e9:.
M0-7in o. s0.etG 25-o5os08 !: 1 (C8)@<A)AAA C8)8<A)AAA)/C8)@<A)AAA = .&&
2-oun9e9:.
4o" t!at "e !ave #erformed all of t!e re$uisite calculations) "e are in a #osition
to t!in' about "!ic! #ro#osal t!e ban' is li'el& to su##ort. !is is a difficult
$uestion. First) notice t!at ex#ected #rofit is identical under eac! alternative.
!us) "e need to consider t!e #ro#osals on some ot!er dimension t!e u#side
#otential and/or t!e do"nside ris'. -n terms of t!e u#side) eac! additional dollar
of revenue generated under #ro#osal R1 contributes C.=A to #rofit) "!ereas under
#ro#osal 8) eac! additional dollar of revenue generated contributes onl& C.9A to
#rofit. !us) #ro#osal 1 !as !ig!er u#side #otential t!an #ro#osal 8.
.ot! o#erating leverage and margin of safet& #rovide us "it! some measure of
business ris' and) !ence) t!e do"nside. 3#erating leverage is a measure of t!e
extent of fixed costs in t!e business notice t!at t!e first #ro#osal !as muc!
!ig!er o#erating leverage. !is is because t!e first #ro#osal !as significantl&
!ig!er fixed costs t!an t!e second #ro#osal. !e margin of safet& #rovides us t!e
amount b& "!ic! sales revenue could decrease before Wan is in t!e red. 4otice
t!at t!e second #ro#osal !as a !ig!er margin of safet& t!an t!e first #ro#osal
t!us) t!ere is more of a cus!ion in t!e second #ro#osal (as reflected b& t!e lo"er
brea';even #oint). !us) #ro#osal 1 !as more do"nside ris' t!an #ro#osal 8.
*e reall& need to get inside t!e ban'erLs !ead and t!in' about !is/!er obGective)
"!ic! li'el& is @$i 0 get &# &one# bac+AB Piven t!is obGective) a #rudent (and
#robabl& ris';averse) ban'er is li'el& to #us! t!e less ris'& #ro#osal R8. !is
conclusion is not) !o"ever) a fait accom#li and t!is $uestion can generate
interesting discussions about ris' #references and decision;ma'ing under
uncertaint&.
.ala'ris!nan) 2anagerial (ccounting 1e F30 -4S0U+30 US5 3467
<;9:
b. o calculate #rofit) o#erating leverage) and margin of safet&) "e can re#eat our
a##roac! from #art [a]. *e !aveH
P-o5os08 P-o5os08 !
0evenues C:)<AA)AAA C:)<AA)AAA
,ariable +ostsD 1)QAA)AAA 9)1<A)AAA
+ontribution 2arginDD C8)@AA)AAA C1)9<A)AAA
Fixed +osts 1)<AA)AAA =@<)AAA
P-o.it /e.o-e T0,es 3+!((+((( 3$%5+(((
D = (1 .=A) C:)<AA)AAAJ (1 .9A) C:)<AA)AAA.
DD = can also be calculated asH .=A C:)<AA)AAAJ .9A C:)<AA)AAA.
urning to o#erating leverage) "e !aveH
O-erating leverage 25-o5os08 : 1 C1)<AA)AAA/C9)9AA)AAA = .#55 2-oun9e9:.
O-erating leverage 25-o5os08 !: 1 C=@<)AAA/C9)Q8<)AAA = .%$ 2-oun9e9:.
For margin of safet&) "e !aveH
+argin of safet, 25-o5os08 : 1 (C:)<AA)AAA C8)<AA)AAA)/C:)<AA)AAA = .####
2-oun9e9:.
+argin of safet, 25-o5os08 !: 1 (C:)<AA)AAA C8)8<A)AAA)/C:)<AA)AAA = .5(.
4otice t!at as sales increase) #ro#osal 1 becomes more attractive relative to
#ro#osal 8. First) ex#ected #rofit is significantl& !ig!er (C<8<)AAA) under #ro#osal
1 t!an #ro#osal 8. Second) t!e u#side #otential of #ro#osal 1 is !ig!er t!an
#ro#osal 8 as discussed in #art [a]) eac! additional C of revenue contributes
CA.=A to #rofit under #ro#osal 1) but onl& CA.9A under #ro#osal 8. Finall&)
com#ared to #art [a]) t!e differences in o#erating leverage and) #articularl&) t!e
margin of safet& bet"een t!e #ro#osals are smaller #ro#osal 1 is onl& slig!tl&
ris'ier t!an #ro#osal 8. Piven t!e #rofit difference and minimal ris') a #rudent
lender "ould li'el& #us! #ro#osal 1 in t!is setting.
.ala'ris!nan) 2anagerial (ccounting 1e F30 -4S0U+30 US5 3467
<;9<
5.55 Mu8ti-P-o9u*t CVP An08Gsis 2LO5:.
a. !e #rofit isH
Profit before 7axes = [(Price unit "ariabe cost) 8uantit#] 5ixe* costs.
Substituting for +am#us .agelsL s#ecific information) "e !aveH

P-o.it 1 @23.(( ; 3(.#(: nu4/e- o. /07e8s so89A ; 3((+(((.
Piven t!e 8<A)AAA bagels sold in t!e #revious &ear) #rofit "asH
Profit before taxes = CA.=A 8<A)AAA C1AA)AAA.
P-o.it /e.o-e t0,es 1 35(+(((.
b. +am#us .agels "ill no" !ave t"o different #roducts) bagels and bagel
sand"ic!es. (ccordingl&) t!e #rofit isH
Profit = [8uantit#bagels (1.AA .:A)]
O [8uantit#bagel sand"ic!es (Pricebagel sand"ic!es 1.8<)] C18<)AAA.
4otice t!at fixed costs !ave increased b& C8<)AAA and) in order to determine net
income) +am#us .agels needs to 'no" t!e #rice of bagel sand"ic!es as "ell as
t!e $uantit& of bagel sand"ic!es to be sold. 3ne mig!t also argue t!at t!e
$uantit& of bagels t!at "ill no" be sold is ambiguous.
2ore generall&) "!et!er +am#us .agels "ill continue to sell 8<A)AAA bagels
de#ends on "!et!er bagels and bagel sand"ic!es are com#lements or substitutes.
3ne could argue t!e case eit!er "a& on t!e one !and) some customers mig!t
s"itc! from regular bagels to t!e >more refined? bagel sand"ic!. (dditionall&)
some current customers mig!t alread& convert t!e bagels t!e& bu& into bagel
sand"ic!es. 3n t!e ot!er !and) t!e #roducts ma& com#lement eac! ot!er.
Strengt!ening t!e #roduct line b& adding bagel sand"ic!es ma& attract ne"
customers to +am#us .agels "!o) in turn) not onl& bu& bagel sand"ic!es but also
are dra"n to regular bagels.
c. -t is im#ortant to note t!at t!e #roblem setu# is some"!at at&#ical in t!at it is
#roblematic to s#ecif& a $uantit& "it!out 'no"ing a #rice it #robabl& is
useful to discuss t!is issue in class.
!at said) if "e "is! to increase #rofit b& C<A)AAA t!en "e !aveH
.ala'ris!nan) 2anagerial (ccounting 1e F30 -4S0U+30 US5 3467
<;9=
C1AA)AAA = [8<A)AAA (1.AA .:A)] O [8<)AAA (Pricebagel sand"ic!es 1.8<)]
C18<)AAA.
Solving) "e find P-i*e1 3#.!5.
d. !is scenario is more t&#ical as t!e demand for one #roduct affects t!e
demand for t!e ot!er and vice;versa. 4o") in addition to t!e incremental
variable and fixed costs associated "it! introducing bagel sand"ic!es) t!ere is
an o##ortunit& cost associated "it! selling bagel sand"ic!es t!e lost
contribution margin on bagels.
*e can calculate t!is o##ortunit& cost directl& and add it to t!e cost of bagel
sand"ic!es or) #er!a#s more intuitivel&) "e can use t!e model from #art [b])
"!ic! !as t!is o##ortunit& cost >built in.? -n ot!er "ords) notice t!at "e can
directl& #lug t!e ne" $uantities into t!e model) orH
C1AA)AAA = [88<)AAA (1.AA .:A)] O [8<)AAA (Pricebagel sand"ic!es 1.8<)]
C18<)AAA.
Solving) "e find P-i*e 1 3#.&5.
Fere) "e see t!at relations!i#s among #roducts can be ca#tured in our +,P
formulation. (t a more general level) "e could ex#licitl& model t!is relations!i#
(e.g.) 8uantit#bagels = 8<A)AAA 8uantit#bagel sand"ic!es). 2oreover) "!en multi#le
#roducts exist "e need to consider bot! com#lementar& and substitute
relations!i#s. Suc! relations!i#s &ield #ositive or negative externalities and) in
turn) reduce or increase #rofitabilit&. +,P models can !el# sort;out t!ese issues.
5.5$ Mu8ti-P-o9u*t CVP 0n9 Fi,e9 Cost A88o*0tions 2LO5:.
a.
!e follo"ing table #rovides t!e re$uired com#utations.
0etail -nstitutional
raceable fixed costs 1@<)AAA QA)AAA
(llocated fixed cost 1AA)AAA 1AA)AAA
otal 8@<)AAA 1QA)AAA
+ontribution margin ratio ==.=@B :AB
.rea'even revenue 3#!+5(( 3#5(+(((

(t t!is volume) Xan brea's even for t!e entire com#an& as "ell. (fter all) !is total
fixed costs are C1@<)AAA O CQA)AAA O C8AA)AAA = C:<<)AAA. !en) at t!e
com#uted volumes) !e generates a contribution of C:18)<AA A.===@ O C:<A)AAA
A.: = C:<<)AAA. !e firm also brea's even at t!e total level of CQ=8)<AA.
.ala'ris!nan) 2anagerial (ccounting 1e F30 -4S0U+30 US5 3467
<;9@
b. XanLs "eig!ted contribution margin ratio is C:QA)AAA/CNAA)AAA = <9.99B. *it!
t!is estimate) "e can calculate brea'even revenue as
C:<<)AAA / A.<9999 = CQ<9)18<
3r) 3#!$+5$!.5( eac! in retail and institutional sales.
c. !e ans"ers in #arts a and b differ because "e >fix? different items. -n #art (b))
"e fixed t!e sales mix to be <AB from eac! segment. *it! t!is assum#tion) t!e
brea'even sales are CQ<9)18<. Fo"ever) sales mix is not fixed in #art (a). 0at!er)
"e !ave >fixed? t!e allocation to be C1AAK to eac! segment. !us) t!e final
ans"er !as a sales mix t!at is 43 <A;<A across t!e segments. 2oreover) t!e
fixed cost also is not allocated in #ro#ortion to t!e sales mix at brea'evenM -n
general) it ma'es more sense to fix t!e sales mix as in #art (b) in multi;#roduct
+,P anal&sis.
d. -n general) we 5e-.o-4 4u8ti-5-o9u*t CVP .o- t<e enti-e .i-4. !is is
#articularl& a##ro#riate "!en t!e #roducts are similar (e.g.) car dealers!i#)) are
substitutes and s!are considerable fixed cost. Fo"ever) "e also encounter situ0tions
in w<i*< 5-o9u*ts 0-e 9istin*t wit< .ew *o44on .i,e9 *osts. -n t!is case (e.g.)
divisions of Peneral 5lectric or Xo!n Weere)) it ma'es sense to com#ute a division
level brea' even.
5.5% Mu8ti-P-o9u*t CVP An08Gsis 2LO5:.
a. Wetermining t!e #roduct mix is t!e first ste# in com#uting t!e brea'even #oint
in a multi;#roduct setting. -n KimLs case) "e !ave t!e follo"ing #er 1A
customersH
S0n9wi*< Sou5 S0809 )-in6
Price C:.AA C9.AA C9.AA C1.AA
,nit "ariabe cost C1.8< C1.AA CA.@< CA.8<
,nit contribution
&argin
C8.@< C8.AA C8.8< CA.@<
R of orders < @ : =
7ota contribution
&argin
$13'C2 $14'0
0
$D'00 $4'20
7ota Price/ $E0'00 $E1'0
0
$1E'00 $F'00
!us) "e can calculate KimLs "eig!ted contribution margin ratio as C:1.8</C<N =
=N.N1B.
*e are no" in a #osition to "rite do"n KimLs #rofit and com#ute !er brea'even
.ala'ris!nan) 2anagerial (ccounting 1e F30 -4S0U+30 US5 3467
<;9Q
sales. *e !aveH
Profit = (A.=NN1 revenue) C:)N<A.
Setting #rofit = CA) "e findH
.rea'even revenue = C:)N<A/A.=NN1 = 3%+(&(.
=e*0use ( *usto4e-s -e5-esent 35' in -evenue+ Pi4 nee9s to se-ve 3%+(&(O35' 1
!( sets o. *usto4e-s 1 +!(( *usto4e-s 5e- 4ont< to /-e06 even. (t t!is volume)
Kim "ill serve =AA sand"ic!es (18A <)) Q:A bo"ls of sou# (18A @)) :QA salads
(18A :)) and @8A bottles of "ater or cans of soda (18A =).
b. !e >free? drin' offer creates inter;relations among t!e #roducts. Per!a#s t!e easiest "a& to
deal "it! suc! com#lications is to modif& t!e #rofit e$uation to include bot! #aid and free
drin's. *e can t!en re;com#ute t!e contribution margin and selling #rice for a VbundledL
#roduct. !e follo"ing table #rovides t!e detailed com#utationsH
S0n9wi*< Sou5 S0809
P0i9
)-in6
F-ee
)-in6
Price C:.AA C9.AA C9.AA C1.AA CA.AA
,nit "ariabe cost C1.8< C1.AA CA.@< CA.8< CA.8<
,nit contribution
&argin
C8.@< C8.AA C8.8< CA.@< ;CA.8<
R of orders < @ @ 9 9
7ota contribution
&argin
$13'C2 $14'0
0
$12'C2 $E'E2 -$'C2
7ota Price/ $E0'00 $E1'0
0
$E1'00 $3'00 $0'00
!us) t!e #rice for t!e #roduct mix is C=<.AA) and its contribution margin is
C:<.AA.
-n turn) KimLs #rofit and brea'even sales areH
Profit = (C:< 8uantit#) C:)N<A.
Setting #rofit = CA) "e findH
.rea'even number of units = C:)N<A/C:< = 11A.
=e*0use e0*< /un98e -e5-esents ( *usto4e-s+ Pi4 nee9s to se-ve ( ( 1
+(( *usto4e-s 5e- 4ont< to /-e06even. (t t!is volume) Kim "ill serve <<A
sand"ic!es (11A <)) @@A bo"ls of sou# (11A @)) @@A salads (11A @)) and ==A
bottles of "ater or cans of soda (11A =). Pi4 08so wi88 7ene-0te ( 3$5 1
.ala'ris!nan) 2anagerial (ccounting 1e F30 -4S0U+30 US5 3467
<;9N
3%+5( in -evenue 2i.e.+ <e- /-e06even 5oint in s08es 9o880-s is t<e /-e06even
nu4/e- o. /un98es 4u8ti58ie9 /G t<e -evenue 5e- /un98e:.
.ala'ris!nan) 2anagerial (ccounting 1e F30 -4S0U+30 US5 3467
<;:A
!us) Kim needs to serve fe"er customers) because t!e contribution margin for
ever& ten customers !as increased. 4otice t!at KimLs re$uired revenue) !o"ever)
!as c!anged ver& little because !er bundle selling #rice !as increased b& C=
com#ared to #art [a] t!is can be calculated as (9 C9 #er salad) (9 C1 #er
"ater/soda) = C=.
5.5& Mu8ti-P-o9u*t CVP An08Gsis+ Nei7<te9 Cont-i/ution M0-7in R0tio
A55-o0*< 2LO5:.
a. *e start b& setting a #rice for a ne" textboo' t!is "ill allo" us to calculate
t!e #rice of a used textboo' and all of t!e associated variable costs. 6etLs sa&
Pricene" = C1AA.
-f Pricene" = C1AA) t!en ,nit "ariabe costne" = (.@< C1AA) O (.A< C1AA) = CQA.
-n turn) t!e contribution margin ratio on a ne" boo' =
) (
C1AA
CQA ; C1AA
= 8AB.
For Priceused "e !ave .@< C1AA = C@<. !e unit "ariabe costuse* isH (.8< C1AA)
O (.A< C1AA)D = C9A.
D 4ote t!at t!e variable selling costs (in C #er boo') not B) are t!e same bet"een
ne" and used textboo's) or C<.
(ccordingl&) t!e contribution margin ratio on a used boo' =
) (
C@<
C9A ; C@<
= =AB.
-f :AB of Universit& .oo'storeLs revenues come from used boo's and =AB come
from ne" boo's) "e can "rite Universit& .oo'storeLs #rofit model asH
Profit = (.:A 7ota re"enues .=A) O (.=A 7ota re"enues .8A) C9=A)AAA.
!at is) t!e "eig!ted contribution margin ratio = (.:A .=A) O (.=A .8A) = .9=.
Setting #rofit e$ual to CA) "e solve for t!e brea'even revenue asH
CA = (.9= -rea+e"en re"enue) C9=A)AAA.
!us) =-e06even -evenue 1 3+(((+(((.
.ala'ris!nan) 2anagerial (ccounting 1e F30 -4S0U+30 US5 3467
<;:1
*e can #ic' an& number for t!e selling #rice of a ne" boo' because "e em#lo&ed
a contribution margin ratio formulation) "!ere ever&t!ing "as ex#ressed as a B
of selling #rice. !us) brea'even revenue is invariant to t!e selling #rice "e
c!oose (encourage students to tr& itM). 2oreover) Universit& .oo'store needs to
generate C1)AAA)AAA in revenue to brea' even t%e price per boo+ affects on# t%e
nu&ber of textboo+s so* at t%e brea+-e"en point, not t%e re.uire* re"enue.
b. !e im#ortant factor to consider !ere is t!e contribution margin in dollars (C))
not t!e contribution margin ratio (because t!e selling #rices are different).
!e contribution margin on a ne" boo' = C1AA CQA = 3!(.
!e contribution margin on a used boo' = C@< C9A = 3#5.
!us) t!e Universit& .oo'store ma'es C8< more #er boo' on used boo's versus
ne" boo's. !erefore) it strictl& #refers to sell used textboo's rat!er t!an ne"
textboo's. !is ex#lains "!& boo'stores exert significant effort to ac$uire as
man& used boo's as #ossible t!e #rofit is !ig!erM
9ote/ !is relation !olds regardless of t!e number students #ic' for t!e selling
#rice of a ne" boo'. For an& selling #rice) x) Universit& .oo'store receives .8Ax
in contribution margin (x .@<x .A<x)J 3n a used boo') Universit& boo'store
receives .:<x (.@<x .8<x .A<x). 3f course) for an& #ositive selling #rice) .:<x
strictl& exceeds .8Ax.
c. o #rovide for an e$ual contribution margin in C) Universit& .oo'store "ould
set t!e #rice of a used textboo' suc! t!at (based on our assumed numbers)H
C8A = #rice (used) C9A. 30) #rice (used) = 35(.
!us) t!e #rice of a used textboo' "ould be <A/1AA = 5(> of t!e #rice of a ne"
textboo'.
4otice t!at t!e contribution margin ratio on a used textboo' is no" 8A/<A = :AB.
2oreover) "!en considering t!e >bottom line? "e need to consider t!e absolute
contribution margin) not necessaril& t!e contribution margin ratios (unless) of
course) t!e selling #rices are e$ual).
5.5' Mu8ti-P-o9u*t CVP An08Gsis+ How =est to S5en9 A9ve-tisin7 )o880-s 2LO"+
LO5:.
a. ornadoLs #rofit for t!e most recent &ear can be calculated as follo"sH
F F" F5 Tot08
0evenuesD C9)@<A)AAA C9)AAA)AAA C:)AAA)AAA C1A)@<A)AAA
,ariable costsDD C1)Q@<)AAA C1)=<A)AAA C8):AA)AAA C<)N8<)AAA
.ala'ris!nan) 2anagerial (ccounting 1e F30 -4S0U+30 US5 3467
<;:8
+ontribution margin C1)Q@<)AAA C1)9<A)AAA C1)=AA)AAA C:)Q8<)AAA
Fixed costs C9)Q=A)AAA
P-o.it 3'$5+(((
D = $uantit& sold selling #rice #er unit
DD = $uantit& sold variable cost #er unit
b. !ere are at least t"o "a&s to ans"er t!is $uestion. !e longer and more
tedious "a& is to convert t!e increase (decrease) in sales to units for eac! of
t!e t!ree alternatives i.e.) assume t!at ornado focuses its advertising
cam#aign on t!e F1) F9) or F< mar'et. *e can t!en multi#l& t!e sales
$uantities b& t!e a##ro#riate contribution margin to com#ute t!e net increase
in margin under eac! alternative. 4aturall&) "e select t!e o#tion "it! t!e
!ig!est margin.
!e second) and more straig!tfor"ard) a##roac! is to use contribution margin
ratios "!ic! deal "it! dollars directl&. Using t!e given data) "e !aveH
F F" F5
Selling #rice #er unit C1<A C8AA C:AA
,ariable cost #er unit C@< C11A C8:A
6ontribution &argin
ratioG
'20 '42 '40
D = (unit selling #rice unit variable cost)/ unit selling #rice
!at is) an increase of C1 in sales &ields t!e greatest contribution if it is from t!e
F1 mar'et. +onse$uentl&) it ma'es most sense for ornado to focus its cam#aign
on t!e F1 mar'et. !e net effect on #rofit "ill beH
Pain from F1 mar'et C9AA)AAA .<A C=AA)AAA
6oss from F9 mar'et (C8@)AAA) .:< C=A)AAA
6oss from F< mar'et (C8:)AAA) .:A C=A)AAA
-ncrease in fixed costs (C1<A)AAA) given
Net in*-e0se in 5-o.it 3''+(((
!e s'e#tical student ma& "is! to construct tables assuming t!e advertising
cam#aign "ere focused on t!e F9 or F< mar'et to verif& t!at t!e strateg& of
focusing on t!ese mar'ets indeed leads to lo"er #rofit t!an focusing on t!e F1
mar'et.
!is #roblem is useful in !ig!lig!ting t!e difference bet"een unit contribution
margins and contribution margin ratios. !e unit contribution margin calculates
t!e absolute profit) and t!e contribution margin ratio calculates profitabiit#. !us)
"e see t!at alt!oug! t!e F< !as t!e largest contribution margin and) t!us) on a #er
.ala'ris!nan) 2anagerial (ccounting 1e F30 -4S0U+30 US5 3467
<;:9
unit basis contributes t!e most to absolute #rofit) it !as t!e lo"est #rofitabilit& #er
C1 of sales.
c. 2anagement is ma'ing a number of assum#tions. First) t!e& are assuming t!at
t!e advertising cam#aign "ill "or' and lead to a substantial increase sales for
t!e targeted vacuum cleaner. Second) b& assuming t!at t!e increase in revenue
"ill be constant at C=AA)AAA regardless of t!e vacuum cleaner c!osen)
management is assuming t!at t!e >demand 'ic'? in units "ill be smallest for
t!e F< and largest for t!e F1 (t!e F9 "ill be in t!e middle). S#ecificall&)
estimated demand for eac! vacuum cleaner) s!ould it be selected isH
F1H C=AA)AAA/1<A = :)AAA units.
F9H C=AA)AAA/8AA = 9)AAA units.
F<H C=AA)AAA/:AA = 1)<AA units.
!ese #ro#ortions are roug!l& com#arable to t!e current sales mix. 2oreover)
management is assuming t!at t!e mar'et is >t!inner? for t!e F1 and >t!ic'er? for
t!e F< t!is assum#tion ma'es some sense since) ceteris paribus) as #rice
increases "e ex#ect $uantit& demanded (in aggregate) to decrease) #articularl&
"!en t!ere are substitute #roducts available.
Finall&) management is assuming t!at t!e advertising cam#aign "ill cannibali%e
existing sales in ot!er "ords) if t!e advertising cam#aign "ere targeted to"ard
t!e F9 mar'et) some consumers "!o "ould !ave #urc!ased t!e F1 or t!e F<
"ould) instead) #urc!ase t!e F9. (gain) t!e constant loss in revenue assum#tion
sti#ulates t!at fe"er F< customers "ill defect t!an F1 customers) and so on.
2oreover) t!is assum#tion reflects t!at "!ile t!e vacuum cleaners are) to some
extent) substitutes) t!e elasticit& of demand li'el& differs across t!e #roducts.
5.$( 2A9v0n*e9: CVP An08Gsis ; A C-iti*08 Ev08u0tion? Non-8ine0- Cost Fun*tion+
Line0- A55-o,i40tion+ 0n9 )e*ision M06in7 2LO"+ LO$:.
a. !e follo"ing gra#! de#icts t!e relation bet"een t!e number of families) 8)
and Xac'rabbit railsL "ee'l& total costs for A 8 8A.
.ala'ris!nan) 2anagerial (ccounting 1e F30 -4S0U+30 US5 3467
<;::
Students ma& recogni%e t!at t!e s!a#e of t!is cost function is similar to t!e cost
functions t!e& studied in economics (students ma& also remember t!at t!e cubic
cost function closel& a##roximates an& cost function). !e non;linearit& reflects
economies/diseconomies of scale i.e.) average cost decreases u# to a #oint) but
t!en increases. Suc! non;linearities are necessar& to !ave a "ell;defined #rofit
maximi%ation #roblem "it! t!e t&#ical linear setu# if #rice exceeds variable
cost t!en t!e firm "ould #us! #roduction u# to arbitraril& !ig! levels and ma'e
unboundedl& large #rofits.
b. !e linear cost model is develo#ed using t!e end#oints of Xac'rabbit railsL
relevant range) 8 = : and 8 = 1=. !e total cost at eac! of t!ese #oints isH
7ota cost(:) = 1)AAA O (9AA :) [8A (:)
8
] O :
9
= 3+'##.
7ota cost(1=) = 1)AAA O (9AA 1=) [8A (1=)
8
] O 1=
9
= 3#+%%$.
*e are no" in a #osition to find t!e slo#e (unit "ariabe cost) and interce#t (5ixe*
cost)H
Slo#e (unit "ariabe cost) = (C:)@@= C1)N::)/(1=;:) = C89=.
!us) C1)N:: = interce#t O (: 89=)J or interce#t = C1)AAA.
Xac'rabbit rails linear cost function isH .C 1 3+((( L 23!"$ B /uantit, :.
!e follo"ing gra#! de#icts bot! t!e linear and non;linear cost functionsH
.ala'ris!nan) 2anagerial (ccounting 1e F30 -4S0U+30 US5 3467
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!e fit loo's reasonabl& good) and "e can see t!at t!e deviations bet"een t!e
linear and non;linear models are not ver& large (exce#t) #er!a#s) for I = 1N) 8A).
2oreover) t!e follo"ing table delineates t!e total cost under eac! model and t!e
corres#onding difference in total costH
Tot08 Costs
9on-=inear :o*e =inear :o*e
Qu0ntitG
1)AAA O 9AA8 8A8
8
O 8
9
1)AAA O 89=8 )i..e-en*e
A C1)AAA C1)AAA CA
1 C1)8Q1 C1)89= C:<
8 C1)<8Q C1):@8 C<=
9 C1)@:@ C1)@AQ C9N
: C1)N:: C1)N:: CA
< C8)18< C8)1QA ;C<<
= C8)8N= C8):1= ;C18A
@ C8):=9 C8)=<8 ;C1QN
Q C8)=98 C8)QQQ ;C8<=
N C8)QAN C9)18: ;C91<
1A C9)AAA C9)9=A ;C9=A
11 C9)811 C9)<N= ;C9Q<
18 C9)::Q C9)Q98 ;C9Q:
19 C9)@1@ C:)A=Q ;C9<1
1: C:)A8: C:)9A: ;C8QA
1< C:)9@< C:)<:A ;C1=<
1= C:)@@= C:)@@= CA
1@ C<)899 C<)A18 C881
1Q C<)@<8 C<)8:Q C<A:
.ala'ris!nan) 2anagerial (ccounting 1e F30 -4S0U+30 US5 3467
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1N C=)99N C<):Q: CQ<<
8A C@)AAA C<)@8A C1)8QA
AVI? 3"+"$% 3"+"$( 3%
.ala'ris!nan) 2anagerial (ccounting 1e F30 -4S0U+30 US5 3467
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c. !e follo"ing table s!o"s t!e #rofit for A to 8A families under eac! cost
structure (t!e $uantit&) #rice combination t!at "ould be c!osen under eac!
structure and t!e resulting [ex#ected] #rofit is in /o89).
P-o.it
9on-=inear =inear
Qu0ntitG P-i*e 1)AAA O 9AAI 8AI
8
O I
9
1)AAA O 89=I
A 18AA ;C1)AAA ;C1)AAA
1 11<A ;C191 ;CQ=
8 11AA C=@8 C@8Q
9 1A<A C1):A9 C1)::8
: 1AAA C8)A<= C8)A<=
< N<A C8)=8< C8)<@A
= NAA C9)1A: C8)NQ:
@ Q<A C9):Q@ C9)8NQ
Q QAA C9)@=Q C9)<18
N @<A C9)N:1 C9)=8=
( %(( 3#+((( 3"+$#(
11 =<A C9)N9N C9)<<:
18 =AA C9)@<8 C9)9=Q
19 <<A C9):99 C9)AQ8
1: <AA C8)N@= C8)=N=
1< :<A C8)9@< C8)81A
1= :AA C1)=8: C1)=8:
1@ 9<A C@1@ CN9Q
1Q 9AA ;C9<8 C1<8
1N 8<A ;C1)<QN ;C@9:
8A 8AA ;C9)AAA ;C1)@8A
AVI? %(( C1)QAA C1)QA@
4otice t!at Xac'rabbit rails "ould c!oose Price = C@AA and 8uantit# = 1A
families #er "ee'. !is &ields an ex#ected #rofit of C:)AAA under t!e non;linear
cost model and C9)=:A under t!e linear cost model. 3ne mig!t be tem#ted to
conclude t!at t!e cost of using t!e linear model = C:)AAA C9)=:A = C9=A) but
t!is "ould not be a##ro#riate because costs "ill be!ave in t!eir >true? fas!ion
once t!e #ricing decision is made and) t!us) &ield identical #rofit as long as t!e
decision being made is t!e same ("!ic! it is).
*e could) of course) #us! t!e #roblem around some"!at to s!o" t!at linear
a##roximation of non;linear relations leads to errors in decision ma'ing. !e
robustness of t!e linear model) t!oug!) is $uite remar'able. -n t!is #roblem) for
exam#le) one "ould !ave to fit a rat!er #oor linear relation to lead to an error in
#ricing e.g.) use A and 8A families to com#ute t!e linear relation.
.ala'ris!nan) 2anagerial (ccounting 1e F30 -4S0U+30 US5 3467
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!ere are multi#le benefits/reasons for using a linear model. First) organi%ations
often do not 'no" t!eir true cost curve and a linear setu# is li'el& to be as good an
a##roximation as an& ot!er setu#. Second) #ragmatic considerations lead to linear
a##roximation non;linear ex#ressions are overbearing/over"!elming t!ere are
diminis!ing returns to 'ee#ing trac' of detail. 2oreover) linear a##roximation is
one of t!e building bloc's of accounting s&stems. -n t!e #articular #roblem at
!and) Xac'rabbit rails li'el& sacrifices little (if an&t!ing) b& using a linear
a##roximation of its cost curve.
5.$ 2A9v0n*e9: CVP An08Gsis ; A C-iti*08 Ev08u0tion? Non-8ine0- CVP Re80tion+
P-i*in7 2LO"+ LO$:.
a. !e #rofit isH
Profit before taxes = [(Price unit "ariabe cost) 8uantit#] 5ixe* cost.
!e above e$uation assumes t!at t!e $uantit& sold is inde#endent of #rice. !is is
not a good assum#tion "!ere mar'ets are not #erfect and t!e firm can influence
demand via its #ricing strateg&. (s students #robabl& recall from t!eir
microeconomics course) "e can re#resent t!e relation bet"een selling #rice and
demand b& constructing a demand curve.
Substituting t!e relation bet"een $uantit& and #rice into t!e #rofit e$uation) "e
getH
Profit = Y(Price unit "ariabe cost) [98)<AA (1A Price)]Z 5ixe* cost.
Substituting t!e variable cost and fixed cost information gives usH
Profit = Y(Price @<A) [98)<AA (1A Price)]Z 1:)AAA)AAA.
0e;arranging terms) "e !aveH
P-o.it 1 #(+((( Price ; (2 Price :
!
; 3"&+"%5+(((.
b. Solving t!e revised #rofit e$uation for #rice is a bit more com#licated t!an
before. *e can solve for t!is b& using calculus or numericall& (e.g.) using
5xcel).
Using calculus) "e find t!e #rofit maximi%ing $uantit& b& differentiating t!e
#rofit e$uation "it! res#ect to #rice) setting t!e derivative e$ual to %ero) and
solving for #rice. !us) "e !aveH
A = :A)AAA (8A Price)
or) Price 1 3!+((( 5e- unit.
.ala'ris!nan) 2anagerial (ccounting 1e F30 -4S0U+30 US5 3467
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Students trained in calculus can readil& verif& t!at t!e associated second order
condition (obtained b& differentiating t!e first derivative "it! res#ect to P) is
negative) assuring us t!at t!e above e$uation &ields t!e #rofit;maximi%ing #rice.
(i.e.) t!e #rofit function is strictl& concave).
4ote t!at t!e fixed costs of C1:)AAA)AAA #la&s no role in setting t!e #rofit;
maximi%ing #rice. !is is because fixed costs do not c!ange as t!e #rice c!anges.
-n t!e s!ort;term) maximi%ing contribution margin is t!e same as maximi%ing
#rofit.
*e also can solve for t!e #rofit;maximi%ing #rice b& numericall& a##roximation.
+onsider t!e follo"ing table ("it! #rice ranging from C1)AAA to C9)AAA in
increments of C1AA).
P-i*e P-o.it
C1)AAA (CQ)9@<)AAA)
C1)1AA (C=):@<)AAA)
C1)8AA (C:)@@<)AAA)
C1)9AA (C9)8@<)AAA)
C1):AA (C1)N@<)AAA)
C1)<AA (CQ@<)AAA)
C1)=AA C8<)AAA
C1)@AA C@8<)AAA
C1)QAA C1)88<)AAA
C1)NAA C1)<8<)AAA
3!+((( 3+$!5+(((
C8)1AA C1)<8<)AAA
C8)8AA C1)88<)AAA
C8)9AA C@8<)AAA
C8):AA C8<)AAA
C8)<AA (CQ@<)AAA)
C8)=AA (C1)N@<)AAA)
C8)@AA (C9)8@<)AAA)
C8)QAA (C:)@@<)AAA)
C8)NAA (C=):@<)AAA)
C9)AAA (CQ)9@<)AAA)
.& ins#ection) "e see t!at C8)AAA is t!e #rofit;maximi%ing #rice "it!in t!is set of
c!oices. .& construction) t!is also turns out to be t!e #rofit;maximi%ing #rice. *e
could also use t!e >solver? function in 5xcel to find t!e o#timal #rice.
(s a final #oint) instructors ma& "is! to #oint out to students t!e >cost of getting
it "rong? notice t!at if 2r. Par' sets #rice in some >"ill&;nill&? fas!ion) !is
business could lose over CQ)AAA)AAA rat!er t!an earn a #rofit of C1)=8<)AAA. !is
can reall& bring !ome t!e #oint regarding t!e im#ortance of constructing an
accurate #rofit model.
.ala'ris!nan) 2anagerial (ccounting 1e F30 -4S0U+30 US5 3467
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MINI-CASES
5.$! M09e to O-9e- C05s.
a. !e #rofit isH
Profit before taxes= [(Price unit "ariabe cost) 8uantit#] 5ixe* cost.
.ased on t!e information #rovided) "e !ave t!e follo"ingH

Profit = (C8A.AA #rice C: cost of ca# C8 ro&alt& #er ca# C8.<A su##lies #er
ca# [.A8 .@< 8A] ex#ected credit card fees #er ca#) 8uantit# (C8<A for
leaflets and broc!ures O C1AA for #!one lines O C1)N@A for s#ace and e$ui#ment O
C1)A:AD for additional !el#)
D = (@= !ours t!e s!o# is o#en #er "ee' <A !ours "or'ed b& Xessica eac! "ee')
C1A #er !our for tem#orar& !el# : "ee's #er mont!.
!is reduces toH
P-o.it 1 @3.! /uantit, A ; 3"+"$(.

b. !e brea'even #oint can be obtained b& setting #rofit in t!e model from #art
[a] above e$ual to CA. !us) "e !aveH
CA = (C11.8A -rea+e"en "ou&e) C9)9=A.
Solving) "e obtain Breakeven volume 1 "(( *05s.
(t a #lanned #rice of C8A #er ca#) t!is translates to 9AA C8A = 3$+((( in revenue
#er mont!.
!us) in order to brea'even on a mont!l& basis) Xessica needs to sell
a##roximatel& 1A ca#s #er da&.
c. -f Xessica sold 1)AAA ca#s #er mont!) !er ex#ected #rofit "ould beH
Profit = (C11.8A 1)AAA) C9)9=A = 3%+&#( 2not /09Q:
-f Xessica "is!ed to earn C:)A98 #er mont!) s!e "ould need to sellH
C:)A98 = (C11.8 8) C9)9=A) or / 1 $$( *05s) roug!l& 88 ca#s #er da&.
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d. First) notice t!at XessicaLs researc! informs !er t!at at a #rice of C8A) demand
is ex#ected to be 9AA ca#s #er mont! as "e calculated in #art [b]) t!is is
XessicaLs brea'even #oint. !ings donLt loo' good) but #er!a#s Xessica can do
better b& ex#loiting !er mar'et researc! and ne"found 'no"ledge of t!e
demand sc!edule. 6et us ex#and t!e table to com#ute XessicaLs ex#ected #rofit
at alternate #rices.
4ote t!at ex#ected #rofit in t!e table is based on t!e #rofit e$uation "e develo#ed
in #art [a]. S#ecificall&) "e #lug #rice and $uantit& into t!e follo"ing e$uation to
arrive at ex#ected #rofit. -m#ortantl&) as t%e seing price an* .uantit# c%ange, so
too *o t%e cre*it car* co&pan# c%arges, $%ic% e.ua E% of t%e seing price'
Profit = Y[Price : 8 8.<A (.A8 .@< Price)] 8uantit#Z C9)9=A.
30) Profit = [(.NQ<Price Q.<A) 8uantit#] C9)9=A.

P-i*e 5e- *05 )e40n9
E,5e*te9
P-o.it
C8A 9AA CA.AA
C8< 8<A C=@1.8<
C8Q 88A CQ9@.=A
&3( !(( &05(.((
C98 1QA C@Q9.=A
C9: 1=A C=9Q.:A
Xessica maximi%es !er #rofit if s!e sets !er #rice at C9A #er ca# as !er ex#ected
#rofit is !ig!est (CQ<A.AA) at t!is #rice. 0elative to setting t!e #rice at C8A #er ca#)
t!e C9A #rice results in a lo"er volume (8AA ca#s versus 9AA ca#s). Fo"ever) t!e
!ig!er contribution margin #er ca# (C81.A< rat!er t!an C11.8A) offsets t!is.
Note 2*0n /e s6i55e9 wit<out 8oss o. *ontinuitG: ? Students "it! a bac'ground
in economics "ill notice t!at "e can substitute t!e demand sc!edule "it! a
demand function. -n t!is case) t!e relation bet"een demand and #rice is
8uantit# = <AA (1A Price).
*e can modif& t!e ex#ression for #rofit to incor#orate t!is ne" #iece of
information. !us) "e !aveH
Profit= Y[<AA (1A Price)] (.NQ< Price Q.<)Z C9)9=A.
!is sim#lifies toH
Profit = :N8.<A(Price) N.Q<(Price)
8
:)8<A O Q<P 9)9=A.
3r) t!e relation bet"een XessicaLs #rofit and #rice isH
.ala'ris!nan) 2anagerial (ccounting 1e F30 -4S0U+30 US5 3467
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P-o.it 1 5%%.5(2 Price1 ; '.&52P-i*e:
!
; %+$(.
*e can solve for t!e best P using calculus or 5xcelLs solver function. !e exact
ans"er is
P 1 3!'." 0n9 e,5e*te9 5-o.it is 3&5#.$"
e. axes affect #rofit in a relativel& straig!tfor"ard fas!ion. *e can ta'e t!e
#rofit model develo#ed in #art [d] and add t!e tax variable doing so &ieldsH
Profit after taxes = Profit before taxes taxes #aid.
Fere) because taxes are #ro#ortional to income) taxes #aid = (tax rate #re;tax
#rofit). (dding t!is column &ieldsH
P-i*e 5e- *05 )e40n9
E,5e*te9
P-o.it
A.te--t0,
5-o.it
C8A 9AA CA.AA CA.AA
C8< 8<A C=@1.8< C<A9.::
C8Q 88A CQ9@.=A C=8Q.A8
C9A 8AA CQ<A.AA C=9@.<A
C98 1QA C@Q9.=A C<Q@.@A
C9: 1=A C=9Q.:A C:@Q.QA
!e o#timal #rice continues to be 3"( 5e- *05.
4otice t!at t!e o#timal #rice does not c!ange t!is occurs because (in t!is
exam#le)) taxes are a linear function of #re;tax #rofit. !us) Xessica still "is!es to
maximi%e #re;tax #rofit "!ic!) in turn) "ill also maximi%e after;tax #rofit. !is
as#ect of t!e #roblem allo"s instructors to discuss t!e relation bet"een #re;tax
income and tax rates) including extending t!e discussion to non;linear relations
bet"een #re;tax and after;tax income.
axes "ill) of course) reduce t!e amount of XessicaLs #rofit. -n our exam#le)
Xessica "ill no" earn an after;tax mont!l& #rofit ofH
CQ<A .@< = 3$"%.5(.
Note 2C0n s6i5 wit<out 8oss o. *ontinuitG:? -n t!e calculus a##roac!)
incor#orating taxes &ields

Profit after taxes = (<@@.<A(Price) N.Q<(Price)
8
@)=1A) (1 tax rate).
Since t = .8<) "e !aveH
Profit after taxes = (<@@.<A(Price) N.Q<(Price)
8
@)=1A) (.@<).
.ala'ris!nan) 2anagerial (ccounting 1e F30 -4S0U+30 US5 3467
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P-o.it 0.te- t0,es 1 #"".!52 Price : ; %."&%52 Price :
!
; 5%(%.5(.
(gain) "e can solve for t!e best P using calculus or 5xcelLs solver function. !e
exact ans"er is Price 1 3!'." ("!ic! is exactl& "!at "e arrived at earlier).
f. *!ile XessicaLs venture !as intuitive a##eal and our original calculations
seemed to indicate t!at t!e venture mig!t be a >go? (after all) selling 88 !ats a
da& does not seem li'e a lot) t!e numbers sim#l& do not add u#. Piven t!e
totalit& of t!e costs involved and XessicaLs mar'et researc!) it a##ears t!at (at
best) Xessica "ill earn a ver& modest #rofit and "ill be unli'el& to maintain a
reasonable lifest&le "it! t!is business.
*e can see) t!oug!) !o" modest amounts add u# for exam#le) if Xessica "ere to
>manage? 1A 'ios's in various malls around t!e state) s!e could earn a reasonable
sum of mone& t!is is #recisel& "!at franc!isers see' to do.
5.$" Ri*6Js En78is< Hut.
a. +urrentl&) 0ic'Ls is generating C=A)AAA in sales. For alco!ol and food) t!is
translates toH
(lco!ol SalesH C=A)AAA .<< = C99)AAA) or C99)AAA/C: = Q)8<A >alco!ol units.?
Food SalesH C=A)AAA .:< = C8@)AAA) or C8@)AAA/C< = <):AA >food units.?
2ont!l& #rofit can t!en be calculated asH
[Q)8<A (C: C8)] O [<):AA (C< C:)] C1A)N<A = 3(+'5(.
.ecause t!e #ro#ortions are defined in terms of revenue) it ma& be easier to solve
t!e #roblem using a contribution margin ratio a##roac!.
!e contribution margin ratio for food = (< :)/< = .8A) and t!e contribution
margin ration for alco!ol is (: 8)/: = .<A.
!us) t!e #rofit can be calculated asH
P-o.it = (C99)AAA A.<A) O (C8@)AAA A.8A) C1A)N<A = 3(+'5(.
o determine brea'even sales) "e need to calculate a "eig!ted contribution
margin ratio. Since :<B of revenue is from food and <<B is from alco!ol) "e
!aveH
>eig%te* contribution &argin ratio = (A.:< A.8A) O (A.<< A.<A) = A.9=< or
9=.<B.
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!e #rofit is t!enH
Profit = >eig%te* contribution &argin ratio 7ota !e"enue 5ixe* cost.
(t t!e brea'even #oint) "e !aveH
CA = A.9=< -rea+e"en re"enue C1A)N<A.
=-e06even -evenue 1 3"(+(((.
4oteH -t is tem#ting to calculate a "eig!ted unit contribution margin as (A.:<
C1) O (A.<< C8) = C1.<< t!is is not a##ro#riate) t!oug!) because t!e "eig!ts
are t!e ratio of revenue and not t!e ratio of t!e number of units sold.
For $eig%te* unit contribution &argin) "e use unit contribution marginsJ t!e
"eig!ts must also be t!e ratio of units. -f students em#lo& t!is a##roac!) t!e
$eig%te* unit contribution &argin = C1.=A.
For $eig%te* contribution &argin ratio) "e use t!e contribution margin ratio (i.e.)
contribution #er revenue dollar)J t!us) t!e "eig!ts must be t!e ratio of revenue.
Students can go a"r& because t!e& combine t!e revenue "eig!ts "it! unit
contribution margins.
b. Under t!is o#tion) t!e #ro#rietors of 0ic'Ls !ave decided to c!ange t!e
licensing status from a restaurant to a bar. -n terms of calculating #rofit)
revenue sta&s t!e same but 0ic'Ls fixed costs !ave c!anged. (ccordingl&) "e
!aveH
P-o.it = (C=A)AAA A.9=<) C1A)N<A CQ<A C91Q = 3'+%&!.
0ic'Ls mont!l& #rofit !as decreased b& C1)1=Q) "!ic! is t!e exact amount b&
"!ic! fixed costs !ave increased.
For t!e brea'even #oint) t!e "eig!ted contribution margin ratio sta&s t!e sameJ
t!e fixed costs) !o"ever) increase b& C1)1=Q to C18)11QH
!us) =-e06even -evenue = C18)11Q/A.9=< = 3""+!((.
(s "ould be ex#ected) t!e brea'even #oint in revenue !as increased.
c. Under t!e second o#tion) 0ic'Ls #lans on closing earl& so t!at alco!ol sales
e$ual t!e current level of food sales (t!e revenues from bot! #roducts are
e$ual). *it! t!e ne" sales mix) t!e >eig%te* contribution &argin ratio isH
>eig%te* contribution &argin ratio (o#tion 8) = A.< A.8 O A.< A.< = A.9<.
.ala'ris!nan) 2anagerial (ccounting 1e F30 -4S0U+30 US5 3467
<;<<
(dditionall&) total revenues = C8@)AAA O C8@)AAA = C<:)AAA and fixed costs !ave
decreased b& C:<A to C1A)<AA. !us) "e !aveH
P-o.it = C<:)AAA A.9< C1A)<AA = 3&+#((.
!is action !as reduced 0ic'Ls #rofit b& C8)<<A and) at t!is #oint) 0ic'Ls "ould
#refer o#tion 1 over o#tion 8.
*e also !aveH
CA = A.9< -rea+e"en re"enue C1A)<AA.
=-e06even -evenue = C1A)<AA/A.9< = 3"(+(((.
4otice t!at) com#ared to #art [a] 0ic'Ls brea'even #oint in revenue !as sta&ed t!e
same even t!oug! total fixed costs !ave decreased. !is occurs because t!e sales;
mix !as s!ifted to a !ig!er #ro#ortion of food items) "!ic! is t!e lo"er
contribution margin #roduct.
4otice also t!at com#ared to o#tion 1) t!e brea'even revenue is lo"er under
o#tion 8 (alt!oug! #rofit is !ig!er under o#tion 1). !e increase in fixed costs
under o#tion 1 re$uires 0ic'Ls to sell more to brea'even !o"ever) it does not
restrict t!e #ercentage of alco!ol sales) so t!e u#side #otential is !ig!er. -f 0ic'Ls
can maintain t!eir current level of sales) t!e& li'el& "ould #ursue o#tion 1 and bar
status.
d. Under t!is o#tion) 0ic'Ls is #lanning to offer a brunc! to ma'e u# for t!e
revenue s!ortfall from current food sales. From #art [a]) "e 'no" t!at t!e
difference in revenue is C=)AAAJ t!us) =)AAA/: = 1)<AA brunc!es need to be
sold on t!e "ee'ends. !e brunc!es also !ave a negative contribution of ;A.AQ
or a contribution margin ratio of ;A.A8 = (C: C:.AQ)/C:.
!e mix of t!e revenue !as also c!anged. !e ne" "eig!ted contribution margin
ratio isH
>eig%te* contribution &argin ratio = (8@/==) A.8 O (99/==) A.< O (=/==) (;
A.A8) = A.99.
*it! t!is >eig%te* contribution &argin ratio) 0ic'Ls #rofit isH
P-o.it = A.99 C==)AAA C1A)N<A C1A< = 3(+%!5.
4otice t!at t!is turns out to be 0ic'Ls best o#tion #rofit is onl& C88< lo"er t!an
t!e most recent mont!.
.ala'ris!nan) 2anagerial (ccounting 1e F30 -4S0U+30 US5 3467
<;<=
For t!e brea'even #oint) "e !aveH
=-e06even -evenue = Fixed cost/ *eig!ted contribution margin ratio =
C11)A<</A.99 = 3""+5((.
4otice t!at com#ared to o#tion 1) t!e brea'even revenue is !ig!est under o#tion
9) alt!oug! it is still considerabl& belo" t!e current sales level of C=A)AAA (and
antici#ated sales level of C==)AAA). Profit also is CN:9 !ig!er t!an o#tion 1 and
C8)98< !ig!er t!an o#tion 8.
(ll in all) 0ic'Ls "ould be !ard;#ressed not to select o#tion 9.
e. 0ic'Ls !as learned t!e value and im#ortance of #rofit #lanning at t!e #ortfolio
(aggregate or business) level rat!er t!an at t!e individual #roduct level. *!at
in isolation a##ears to be a #oor strateg&) selling a #roduct at a loss) turns out
to be t!e best strateg& for t!e business as a "!ole. -n essence) "!en
com#anies offer multi#le #roducts or services t!e& need to consider t!e
relations!i#s/externalities among t!ese #roducts and services. !e #rofitabilit&
of t!e business as a "!ole is of utmost concern) not t!e #rofitabilit& of
individual #roducts and services.
*e fre$uentl& see suc! be!avior b& restaurants and bars an establis!ment offers
ver& c!ea# food/a##eti%ers (e.g.) !a##& !ours) to stimulate demand for !ig!er
margin alco!ol sales. -n a similar vein) "e also observe restaurants offering >'ids
eat free? nig!ts.
+asinos in 6as ,egas or (tlantic +it& #er!a#s #rovide t!e #rotot&#ical exam#le of
t!is be!avior. +asinos routinel& offer >loss leaders? suc! as lo";#rice meals (e.g.)
buffets for C8 or C9)) free drin's) and !eavil& discounted !otel rooms in order to
attract and retain customers on t!e more !ig!l& #rofitable gambling activities.
+asino o"ners ma'e suc! concessions and offer >com#s? to increase #rofit on
t!eir #rimar& #roduct line.
7et anot!er exam#le is ban's ban's routinel& offer free c!ec'ing in an attem#t
to get customers to 'ee# t!eir savings in t!e ban' and/or #urc!ase !ig!er margin
!ome or auto loans. Finall&) su#ermar'ets fre$uentl& offer loss leaders t!e&
advertise s#ecials on mil') bread) eggs) and t!e li'e. Suc! items are commonl&
#urc!ased goods and attract customers to t!e store. 3nce inside t!e store)
su#ermar'ets !o#e t!at customers do t!e remainder of t!eir s!o##ing t!ere)
bu&ing fruits and vegetables) meats) c!i#s) soda) and so on.
-n all t!e exam#les) t!e fundamental #oint sta&s t!e same it is im#ortant to do
#rofit #lanning and suc! #lanning is a##ro#riatel& done at t!e >#ortfolio? level. -n
s!ort) t!e case ma'es a critical #oint "e need to t!in' about t!e
interde#endencies among t!e #roducts and services being offered.
.ala'ris!nan) 2anagerial (ccounting 1e F30 -4S0U+30 US5 3467
<;<@
5.$# Const-u*tin7 0n9 Inte-5-etin7 CVP I-05<s 2LO+ LO!:.
a. !e >vanilla? cost gra#! "ould !ave units (in t!is case) cu#s of &ogurt) on t!e
x;axis and dollars (total costs) on t!e &;axis. *it! regard to t!e total cost line)
t!e interce#t) C9)AAA) re#resents 7in;7angLs mont!l& fixed costs and t!e slo#e)
C8) re#resents 7in;7angLs variable cost #er cu# of &ogurt. !e follo"ing gra#!
de#icts 7in;7angLs total costs as a function of t!e number of cu#s of &ogurt
soldH
b. *e can readil& add 7in;7angLs revenue line to our #reviousl&;constructed cost
gra#!. !e revenue line "ill start at t!e origin (after all) if "e sell A cu#s "e
!ave CA in revenue) "it! a slo#e of C:) re#resenting t!e #rice #er cu# of
&ogurt. !e #oint "!ere t!e revenue line crosses t!e total cost line is t!e
brea'even #oint. *e can dro# a line do"n to t!e x;axis to read off t!e re$uired
unit sales. *e can dro# a line to t!e &;axis to determine t!e re$uired revenue.
-f t!e revenue line is above t!e total cost line) 7in;7ang "ill earn a #rofit.
+onversel&) if t!e revenue line is belo" t!e total cost line) 7in;7ang "ill incur a
loss. (ll of t!ese relations!i#s are de#icted on t!e follo"ing gra#!H

.ala'ris!nan) 2anagerial (ccounting 1e F30 -4S0U+30 US5 3467
CA
C8)AAA
C:)AAA
C=)AAA
CQ)AAA
C1A)AAA
A
<
A
A
1
)
A
A
A1
)
<
A
A8
)
A
A
A8
)
<
A
A
Cu5s o. Yo7u-t
)
o
8
8
0
-
s

2
3
:
Slo#e = unit variable costs
= C8.AA
-nterce#t = Fixed +osts
= C9)AAA
<;<Q
c. .& subtracting total costs from revenue) "e obtain 7in;7angLs #rofit gra#!.
!is gives us t!e standard #rofit e$uationH
Profit before taxes = (Price unit "ariabe cost) 8uantit# 5ixe* costs.
For 7in;7ang) "e !aveH
Profit before taxes = C8 4umber of cu#s of &ogurt sold C9)AAA.
!is line is de#icted on t!e follo"ing gra#!.
.ala'ris!nan) 2anagerial (ccounting 1e F30 -4S0U+30 US5 3467
CA
C8)AAA
C:)AAA
C=)AAA
CQ)AAA
C1A)AAA
A
<
A
A
1
)
A
A
A1
)
<
A
A8
)
A
A
A8
)
<
A
A
Cu5s o. Yo7u-t
)
o
8
8
0
-
s

2
3
:
.rea'even Point =
1)<AA +u#s of 7ogurt
6oss (rea
Profit (rea
<;<N
!e #oint "!ere t!e #rofit line crosses t!e &;axis re#resents t!e net #rofit "!en
%ero cu#s of &ogurt are sold. !at is) revenues) variable costs) and contribution
margin are all %ero. !us) #rofit at %ero cu#s of &ogurt = fixed costs = C9)AAA.
!e slo#e of t!e #rofit line = t!e unit contribution marginJ in 7in;7angLs case) t!is
is C: ; C8 = C8. !e #oint "!ere t!e #rofit line crosses t!e x;axis re#resents t!e
brea'even #oint) or t!e #oint at "!ic! #rofit = CA. !e #rofit and loss areas can be
identified b& t!e #rofit lineLs #osition relative to t!e x;axis. -f t!e #rofit line is
above t!e x;axis) 7in;7ang earns a #ositive #rofit. +onversel&) if t!e #rofit line is
belo" t!e x;axis) 7in;7ang "ill incur a loss.
d. 7in;7angLs revised #rofit gra#! is #resented belo". 4otice t!e 'in' in t!e
#rofit line because of t!e tax. !e dotted line re#resents t!e original) untaxed
#rofit) and t!e solid line re#resents t!e after tax #rofit. !e t"o lines are t!e
same belo" t!e brea'even #oint because no tax is due if t!e firm ma'es a loss.
!e after;tax #rofit line is belo" t!e #re;tax #rofit line "!en t!e firm ma'es a
#rofit. !e slo#e of t!e after tax line is smaller b& t!e tax #aid.
.ala'ris!nan) 2anagerial (ccounting 1e F30 -4S0U+30 US5 3467
;C:)AAA
;C8)AAA
CA
C8)AAA
C:)AAA
A
<
A
A
1
)
A
A
A1
)
<
A
A8
)
A
A
A8
)
<
A
A
Cu5s o. Yo7u-t
P
-
o
.
i
t

2
3
:
.rea'even #oint =
1)<AA +u#s of 7ogurt
-nterce#t = ; Fixed +osts
= ;C9)AAA
Profit (rea
6oss (rea
Slo#e = unit contribution margin
= C8
<;=A
e. -t is #ossible to construct a >revised? +,P gra#! "it!out using data on units)
as indicated belo". -n t!is case) "e re#resent 7in;7angLs #rofit asH
Profit before taxes = (.<A !e"enue) C9)AAA.
4otice t!at "e are #lotting a net contribution line in #lace of t!e revenue and total
cost lines. !e slo#e (or t!e stee#ness) of t!e contribution line is determined b&
t!e contribution margin ratio) "!ic! in t!is case is .<A. 2oreover) t!e !ig!er t!e
contribution margin ratio) t!e stee#er t!e contribution line.
Note? -nstructors ma& "is! to mention to students t!at t!e contribution line "ill
al"a&s be less t!an t!e :<
\
line because t!e contribution #er sales dollar cannot
exceed oneM
.ala'ris!nan) 2anagerial (ccounting 1e F30 -4S0U+30 US5 3467
<;=1
5.$5 CVP An08Gsis wit< A8te-n0tive Cost St-u*tu-es+ )e40n9 Un*e-t0intG+ 0n9
Ris6 2A9v0n*e9+ LO"+ LO#+ LO$:.
a. *e !ave t!e follo"ing data regarding eac! tec!nolog&H
L0/o--Intensive
Te*<no8o7G
C05it08-Intensive
Te*<no8o7G
Selling #rice #er unit C@< C@<
,ariable cost #er unit C<A C8<
,nit contribution
&argin
C8< C<A
Fixed costs C<AA)AAA C8)<AA)AAA
*e are no" in a #osition to use t!e #rofit e$uation and solve for t!e brea'even
#oint under eac! tec!nolog&. !e #rofit isH
Profit = (,nit contribution &argin 8uantit#) 5ixe* costs.
*e 'no" t!e contribution margin and level of fixed costs for eac! tec!nolog&.
(dditionall&) "e 'no" t!at #rofit = CA at t!e brea'even #oint. !usH
=-e06even vo8u4e 280/o- intensive: = C<AA)AAA/C8< = !(+((( .is<in7 -o9s.
=-e06even vo8u4e 2*05it08 intensive ) = C8)<AA)AAA/C<A = 5(+((( .is<in7 -o9s.
b. *e can use t!e #rofit for eac! tec!nolog& to com#ute #rofit at t!e t"o sales
levelsH
.ala'ris!nan) 2anagerial (ccounting 1e F30 -4S0U+30 US5 3467
;C9)AAA
;C1)<AA
CA
C1)<AA
C9)AAA
A
8
)
A
A
A:
)
A
A
A=
)
A
A
AQ
)
A
A
A1
A
)
A
A
A
Revenue 23:
P
-
o
.
i
t

2
3
:
Profit (rea
0evenue U C=)AAA
.rea'even revenue =
C=)AAA = (1)<AA :)
6oss (rea
0evenue T C=)AAA
<;=8
Profit (6abor;-ntensive) = (C8< )aes in units) C<AA)AAA.
Profit (+a#ital;-ntensive) = (C<A )aes in units) C8)<AA)AAA.
Plugging;in sales of :A)AAA and NA)AAA units to eac! e$uation &ieldsH
Te*<no8o7G
=abor-intensi"e 6apita-intensi"e
Sales = :A)AAA units 1 35((+((( = (C<AA)AAA)
Sales = NA)AAA units = C1)@<A)AAA 1 3!+(((+(((
!us) at sales of :A)AAA units Sall& #refers t!e labor;intensive tec!nolog& and at
sales of NA)AAA units Sall& #refers t!e ca#ital;intensive tec!nolog&. *e can find
t!e indifference #oint b& setting t!e t"o #rofit e$uations e$ual to eac! ot!erH
(C8< )aes in units) C<AA)AAA = (C<A )aes in units) C8)<AA)AAA.
Ne .in9 t<0t s08es in units 0t w<i*< 5-o.it is eCu08 /etween t<e o5tions is?
&(+(((.
c. *e #resent a gra#! of t!e #rofit line for eac! tec!nolog& belo"H
.ala'ris!nan) 2anagerial (ccounting 1e F30 -4S0U+30 US5 3467
<;=9
!e gra#! illustrates t!at t!e unit contribution margin is !ig!er under t!e ca#ital;
intensive tec!nolog&) but so are t!e fixed costs. !e net effect on brea'even sales
is ambiguous in t!is #articular case) brea'even sales increases under t!e ca#ital
intensive tec!nolog& as indicated in #art [a]. 2oreover) "e see t!at for sales T
QA)AAA units Sall& strictl& #refers t!e labor;intensive tec!nolog&) and for sales U
QA)AAA Sall& strictl& #refers t!e ca#ital;intensive tec!nolog&.
d. Using t!e #robabilities given and t!e #rofit RLs calculated in #art [b]) "e can
calculate ex#ected #rofit as follo"sH
E,5e*te9 5-o.it (labor;intensive) =.< C<AA)AAA O .< C1)@<A)AAA =
3+!5+(((.
E,5e*te9 5-o.it (ca#ital;intensive) = .< ;C<AA)AAA O .< C8)AAA)AAA =
3%5(+(((.
!us) ex#ected #rofit is !ig!er under t!e labor;intensive tec!nolog&.
e. !e range of #rofit isH C1)@<A)AAA C<AA)AAA = C1)8<A)AAA under t!e labor;
intensive tec!nolog&. !e corres#onding range for t!e ca#ital;intensive
tec!nolog& isH C8)AAA)AAA (C<AA)AAA) = C8)<AA)AAA.
!e ca#ital;intensive tec!nolog& !as t!e greater range it is t"ice as great as t!e
labor;intensive tec!nolog&. !e #rofit is muc! more variable "it! t!e ca#ital;
intensive tec!nolog& because eac! unit contributes a great deal more to #rofit t!an
under t!e labor;intensive tec!nolog&. 6oo'ing at t!e gra#! from #art [c]) t!is
difference manifests itself via a stee#er slo#e (unit contribution margin) under t!e
ca#ital;intensive tec!nolog&.
-n terms of a c!oice of tec!nolog&) t!e labor;intensive tec!nolog& reall& seems to
be t!e #referred c!oice. (lmost over t!e entire range) t!e labor;intensive
tec!nolog& !as t!e greater #rofit and) additionall&) !as muc! lo"er variabilit& in
#rofit) im#l&ing less ris'.
5.$$ CVP Re80tion 0n9 P-o.it P80nnin7+ T0,es+ Et<i*s 2LO+ LO!+ A9v0n*e9:.
a. 9;71 7; 09)7!,67;!/ 2an& !uman rig!ts organi%ations !ave rig!tfull&
condemned t!e bidi industr& for its extensive ex#loitation of labor and) in
#articular) c!ild labor. .idi "or'ers fre$uentl& are afflicted "it! lung
disorders and s'in infections because of t!e !a%ardous nature of t!eir Gob
"!ere t!e& are constantl& ex#osed to fine tobacco dust. (dditionall&) bidi
"or'ers t&#icall& are de#rived of even minimum !ealt! benefits and
education. Finall&) li'e cigarettes) smo'ing a bidi #oses significant !ealt!
!a%ards to t!e user. -nstructors ma& "is! to use t!is #roblem to raise studentsL
social and !ealt! a"areness.
.ala'ris!nan) 2anagerial (ccounting 1e F30 -4S0U+30 US5 3467
<;=:
o calculate t!e number of #ac's of bidis Panes! must sell) "e start "it! t!e
#rofit e$uationH
Profit before taxes = (Unit contribution margin Iuantit&) Fixed costs.
(dditionall&)
Unit contribution margin = Price unit variable cost.
= 9.AA .@< .8< = 8.AA 0u#ees #er #ac'.
Finall&) fixed costs = 1)A@<)AAA 0u#ees and target #rofit = @<A)AAA 0u#ees.
*it! t!ese #ieces of information) "e !aveH
@<A)AAA = (8.AA re$uired sales volume in units) 1)A@<)AAA.
30) -eCui-e9 s08es vo8u4e in units =
AA . 8
AAA ) Q8< ) 1
= '!+5(( 50*6s.
b. *e need to modif& Panes!Ls +,P model to incor#orate income taxes. *e
start "it! t!e +,P model t!at includes taxesH
Profit after taxes = [(Unit contribution margin Iuantit&) Fixed costs] (1
ax rate).
*it! a :AB tax rate) "e !aveH
@<A)AAA = [(8.AA !e.uire* saes "ou&e in units) 1)A@<)AAA] (1 .
:A).
30) -eCui-e9 s08es vo8u4e in units 1 +$!+5(( 50*6s.
*e see t!at Panes! no" needs to sell 1)1=8)<AA N18)<AA = !5(+((( more #ac's
of bidis to earn a ta'e;!ome #rofit of @<A)AAA 0u#ees #er mont!.
(n alternative met!od is to convert t!e after;tax #rofit to a #re;tax #rofit target.
Using t!e e$uation after;tax #rofit = (1 tax rate) #re;tax #rofit) "e !aveH
@<A)AAA = (1 .:A) Pre-tax profit
Pre;tax #rofit = 1)8<A)AAA 0u#ees.
*e can t!en substitute t!is amount into t!e standard +,P modelH

1)8<A)AAA = (8.AA !e.uire* saes "ou&e in units) 1)A@<)AAA.
.ala'ris!nan) 2anagerial (ccounting 1e F30 -4S0U+30 US5 3467
<;=<
(gain) "e find t!at t!e number of #ac's = +$!+5((.
*e currentl& !aveH
c. Profit after taxes = [(8.AA !e.uire* saes "ou&e in units) 1)A@<)AAA] (1
.:A).
!e value;added tax can be vie"ed as an additional variable cost #er #ac' of bidis
ofH
(9.AA selling #rice .@< materials cost) .8A = A.:< 0u#ees #er #ac'J !us)
Panes!Ls contribution margin is no" 8.AA A.:< = 1.<< 0u#ees. -n turn) if
Panes! still desires an after;tax #rofit of @<A)AAA 0u#ees) "e !aveH
@<A)AAA = [(1.<< !e.uire* saes "ou&e in units) 1)A@<)AAA] (1 .:A).
30) ReCui-e9 s08es vo8u4e in units 1 +5((+((( 50*6s.
(gain) "e see t!at taxes #lace additional demands on Panes!Ls business.
+om#ared to #art [b]) t!e firm needs to sell 1)<AA)AAA 1)1=8)<AA = ""%+5((
more #ac's because of t!e ,(. +om#ared to #art [a]) t!e firm needs to sell
1)<AA)AAA N18)<AA = 5&%+5(( more #ac's because of bot! taxes.
Finall&) notice t!at t!e value;added tax is deducted "!en calculating #re;tax
#rofit.
d. (fter #art [c]) Panes!Ls +,P model is no"H
@<A)AAA = [(1.<< !e.uire* saes "ou&e in units) 1)A@<)AAA] (1 .:A).
!e excise tax furt!er reduces Panes!Ls contribution margin #er #ac' of bidis it
is no" 1.<< .A< = 1.<A 0u#ees. (ccordingl&) t!e ne" model isH
@<A)AAA = [(1.<A !e.uire* saes "ou&e in units) 1)A@<)AAA] (1 .:A).
ReCui-e9 s08es 1 +55(+((( 50*6s o. /i9is (notice again t!at t!e excise tax is
deducted from #re;tax #rofit). *e see t!at t!is tax furt!er increases t!e amount
t!at must be sold to maintain a desired ta'e;!ome #rofit. +ollectivel&) all t!ree
taxes re$uire Panes! to sell 1)<<A)AAA N18)<AA = =9@)<AA more #ac's of bidis
to earn a ta'e;!ome #rofit of @<A)AAA 0u#ees #er mont!.
e. .ot! t!e value;added tax (,() and t!e excise tax are treated as variable
costs. Panes! "ill incur t!ese costs regardless of !is #rofit level (as long as
t!e firm continues to #roduce bidis). !e excise tax varies as a function of t!e
number of #ac's of bidis sold it is a constant A.A< 0u#ees #er #ac') and)
.ala'ris!nan) 2anagerial (ccounting 1e F30 -4S0U+30 US5 3467
<;==
t!erefore) be!aves li'e a variable cost. !e ,( also varies "it! t!e #ac's of
bidis sold) but t!e amount of t!e tax de#ends on t!e ultimate selling #rice and
materials cost. !us) t!is tax is a function of t!ese t"o variables. o reduce
t!e ,() notice t!at Panes! !as an incentive to >inflate? !is materials cost
numbers. Woing so reduces t!e added >value? and t!us reduces t!e ,(
#a&able.
!e income tax varies "it! #re;tax #rofit it varies "it! all cost and revenue
variables t!at affect #rofit. -t is) !o"ever) t&#icall& structured in ste#s no tax on
negative or CA in #rofit) "it! t!e #ercentages increasing as income increases.
!us) "e see t!at taxes alter firmLs +,P model in significant "a&s t!e exact
nature of t!e c!ange de#ends on t!e t&#e and structure of t!e tax.
*it! regard to a sales tax (or tax on revenue)) t!is tax is borne b& consumers. (s
suc!) firms ignore it in t!e +,P model (because sales taxes are ex#licitl&
collected from customers). !is does not) !o"ever) mean t!at sales taxes do not
affect a firmLs #rofit sales taxes mig!t indirectl& affect #rofit b& affecting
consumer demand it is a cost consumers "ill consider in t!eir
#urc!asing/consum#tion decisions. (-nstructors ma& "is! to lin' t!is to t!e
significant sales tax levied on tobacco #roducts states increase t!e costs to
consumers to discourage smo'ing. !ese are often termed >sin taxes.?)
.ala'ris!nan) 2anagerial (ccounting 1e F30 -4S0U+30 US5 3467
<;=@

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