Cost-Volume-Profit Analysis and Decision-Making

In order to recover from the recent operating losses that the Biggie Widget Company has experienced, management has made some tentative new decisions and believes that the use of CVP analysis will be useful when evaluating these decisions.

Recall that current selling price for widgets is $200 per unit and that total assets reported on the balance sheet were valued at $6,786,651. Total Costs (TC) can be estimated based on product quantity (Q) using the following linear cost function:

TC = 104 Q + 1,300,000

I. Based on this information, determine each to the following
1. Unit contribution margin
2. Contribution margin ratio
3. Breakeven point

II. Determine the quantity of product that must be produced and sold in order to achieve an income equal to:

1. $140,000?

2. 10% of total assets?

III. Complete the following table:
Sales Quantity Revenue Variable Cost Fixed Costs Total Costs Operating income
5,000 units 1,000,000 520,000 1,300,000 1,820,000 2,820,000
10,000 units 2,000,000 1,040,000 1,300,000 2,340,000 4,340,000
15,000 units 3,000,000 1,560,000 1,300,000 2,860,000 5,860,000
20,000 units 4,000,000 2,080,000 1,300,000 3,380,000 7,380,000
30,000 units 6,000,000 3,120,000 1,300,000 4,420,000 10,420,000

IV. List the major assumptions of CVP analysis.

V. Prepare a contribution margin income statement based on April’s EXPECTED production quantity of 15,000 units of product. (This is the Base Case referred to later in this assignment.)

VI. Determine the Operating Leverage Index for this Base Case.

For several months, Biggie Widget Company has exhibited poor profit performance and has incurred net operating losses or low operating profits. Realizing that the company cannot continue to sustain this poor performance, management has proposed the following five changes and is considering whether to implement one or more of these changes in April.

Proposal A: Increase selling price from $200 per unit to $220 per unit (assume unit variable costs do not change).

Proposal B: Decrease the number of sales people from 135 to 90 while increasing their base salary from $3,000 per month to $3,500 per month, thereby decreasing total Sales People's Salaries from $405,000 to $315,000.

Proposal C: Increase advertising by $50,000 per month.

Proposal D: Certify a substitute for Material X called Material X2 which can be purchased for $3.50 per unit instead of $6.90, the current cost of Material X plus related freight. NOTE: The Company’s product requires four units of Material X (and X2).

Proposal E: Increase the rate for Sales People's Commissions from 12% to 16%.

Details related to the estimates of fixed and variable costs (excluding income taxes) based on the analysis of March data are:
Fixed Costs: . Unit Variable Costs: .
Sales People's Salaries $ 405,000 Sales People's Commissions $ 24.00
Advertising 297,200 Material X (4 units @ $6.90) 27.60
Other Fixed 598,800 Other Variable 52.40
Total Fixed Costs $1,300,000 Total Unit Variable Costs $104.00

1. For each proposal above, specify the new profit function that would result from implementing the proposal (the first is completed for you) and determine the new quantity needed to achieve the target profit, which is the same amount of profit as in the BASE CASE above.
New Profit Function Quantity Needed to Achieve Target Profit

2. In general terms, describe how operating income changes as a result of increases and decreases in
A. Selling price.
B. Variable cost per unit.
C. Fixed costs.

A. Selling price, CVP affect the number of unit sold to breakeven point. Selling price per unit if to high BEP would be difficult to meet.

B. Variable cost per unit is -number of unit sold, total variable cost are unit variable cost time number of unit sold. Price X number of units; Variable cost per unit X no. of unit minus total fix cost C. Fixed costs are constant to relevant range. The total contribution margin is, number Unit sold and Contribution margin per unit. If price drop then contribution margin changes.

3. Assume that ALL five of the proposed decisions are implemented and that management wants to attain a target pre-tax profit of $140,000.

A. What is the new profit function? (HINT: Remember that sales commissions are determined as a percent of sales and that the unit selling price is changing.)

B. What is the dollar amount of the contribution margin per unit?

C. What is the breakeven quantity?

D. What is the quantity of finished product that must be produced and sold to attain the target profit equal to:

1. $140,000

2. 10% of total assets,

E. What is the total contribution margin when the target profit is equal to:

1. $140,000

2. 10% of total assets,

F. What is the value of operating leverage when the target profit is equal to:

1. $140,000

2. 10% of total assets,

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  1. Perez Corporation was organized on January 1, 2009. During its first year, the corporation issued 2,000 shares of $50 par value preferred stock and 100,000 shares of $10 par value common stock. At December 31, the company declared the following cash dividends: 2009, $6,000, 2010, $12,000, and 2011, $28,000.

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