manage the profitability of a business

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1
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.
2
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.
3
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?
4
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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