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Chapter 18 Questions

Review Questions

18.6

Suppose the variable costs of a veterinary practice decrease. What types of costs might these

be? How will this change the break-even point? LO 18.5

18.8

Explain what safety margin means? How can managers use this information to manage the

profitability of a business? LO 18.5

18.10 Two companies have identical products, total fixed costs and variable costs per unit, yet one

company is able to set a much lower price for its product and still be as profitable as the other

company. Explain how this can happen. LO 18.5

Exercises

E18.21 Missing data; basic CVP relationships LO 18.1, 18.2

Fill in the missing data for each of the following independent cases. (Ignore income taxes.)

Sales

revenue

Variable

costs

Total

contribution

margin

Fixed

costs

Net

profit

Break-even

sales

revenue

1

$220 000

$ 44 000

?

?

$76 000

?

2

?

$120 000

?

$120 000

?

$160 000

3

$160 000

?

$ 30 000

?

?

$160 000

4

?

$240 000

$480 000

?

$300 000

?

E18.22 Basic CVP analysis: retailer LO 18.1, 18.2, 18.4

University Pizza delivers pizzas to the residential colleges and flats near a major university. The

company’s annual fixed costs are $108 000. The sales price of a pizza is $20, and it costs the company

$12 to make and deliver each pizza. (In the following requirements, ignore income taxes.)

Required:

1. Using the contribution margin approach, calculate the company’s break-even point in units

(pizzas).

2. What is the contribution margin ratio?

3. Calculate the break-even point in sales dollars. Use the contribution margin ratio in your

calculation.

4. How many pizzas must the company sell to earn a target net profit of $60 000? Use the CVP

equation.

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E18.26 CVP analysis with multiple products: retailer LO 18.6

Racing Wheels Bicycle Shop sells racing bicycles. For the purposes of a CVP analysis, the shop owner

has divided sales into two categories, as follows:

Product type

Sales price

Cost

Sales commission

Road bikes

$2 000

$750

$50

Mountain bikes

1500

575

25

Three-quarters of the shop’s sales are mountain bikes. The shop’s annual fixed costs are $390 000. (In

the following requirements, ignore income taxes.)

Required:

1. Calculate the unit contribution margin for each product type.

2. What is the shop’s sales mix?

3. Calculate the weighted average unit contribution margin, assuming a constant sales mix.

4. What is the shop’s break-even sales revenue in dollars? Assume a constant sales mix.

5. How many bicycles of each type must be sold to earn a target net profit of $409 500? Assume a

constant sales mix.

E18.29 (appendix) Cost structure and operating leverage: service firm LO 18.11

A contribution margin statement for Hodgson Lodge is shown below. (Ignore income taxes.)

Revenue

$ 3 000 000

Variable costs

1 800 000

Contribution margin

$ 1 200 000

Fixed costs

900 000

Net profit

$ 300 000

Required:

1. Show the hotel’s cost structure by indicating the percentage of its revenue represented by each item

on the contribution margin statement.

2. Suppose the hotel’s revenue declines by 20 per cent. Use the contribution margin ratio to calculate

the resulting decrease in net profit.

3. What is the hotel’s operating leverage factor when revenue is $3 000 000?

4. Use the operating leverage factor to calculate the increase in net profit resulting from a 25 per cent

increase in sales revenue.

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Problems

P18.32 CVP relationships; indifference point: manufacturer LO 18.5

Brighton Electronics Ltd produces a single product called The Gismo. To produce this product,

Brighton purchases a key component from Supplier A. Supplier A has two versions of this component

and both are suitable for insertion into The Gismo. However, the two alternative components, Model 1

and Model 2, attract different costs for Brighton.

Data relevant to the two components are as follows:

▪ Model 1: variable costs, $16.00 per unit; annual fixed costs, $3 942 400.

▪ Model 2: variable costs, $12.80 per unit; annual fixed costs, $4 454 400.

Brighton’s selling price for The Gismo is $64 per unit, which is subject to a 5 per cent sales commission.

(Ignore income taxes.)

Required:

1. How many units of The Gismo must Brighton sell to break even if Model 1 is selected?

2. Which of the two models would be more profitable if sales and production of The Gismo were 184

000 units per year?

3. Assume Model 2 requires the purchase of additional equipment that is not reflected in the above

data. The equipment will cost $1 800 000 and will be depreciated over a five-year life by the

straight-line method. How many units must the company sell to earn a profit of $3 825 600 if

Model 2 is selected?

4. Ignoring the information presented in requirement 3, at what volume will Brighton’s management

be indifferent as to whether Model 1 or Model 2 is purchased—that is, at what level of production

will the annual total cost of each alternative be equal?

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P18.33 Basic CVP relationships: manufacturer LO 18.1, 18.3, 18.4, 18.5

Vine Pty Ltd produces and sells bottles of wine. Price and cost data are in the following table.

Selling price per bottle

$ 37.50

Variable costs per bottle:

Direct material

$ 12.30

Direct labour

6.00

Manufacturing overhead

9.00

Selling costs

2.40

Total variable costs per bottle

$ 29.70

Annual fixed costs:

Manufacturing overhead

$ 432 000

Selling and administrative

621 000

Total fixed costs

$1 053 000

Forecast annual sales (140 000 units)

$5 250 000

(In the following requirements, ignore income taxes.)

Required:

1. What is Vine’s break-even point in units?

2. What is the company’s break-even point in sales dollars?

3. How many units would Vine have to sell in order to earn a profit of $570 000?

4. What is the firm’s safety margin?

5. Management estimates that direct labour costs will increase by 10 per cent next year. How many

units will the company have to sell next year to reach its break-even point?

6. If Vine’s direct labour costs do increase by 10 per cent, what selling price per unit must it charge to

maintain the same contribution margin ratio?

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