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### Chapter 3BB

Course: BUAD 2050, Spring 2012
School: Toledo
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03 Chapter CHAPTER Outline Cost-Volume-Profit (CVP) Analysis What is CVP analysis? Breakeven Point What? How? Contribution margin Equation Graph Applications Target profit Margin of Safety Changes and sensitivity Analysis Cost-Volume-Profit Analysis (CVP) What is cost-volume-profit analysis? It is the study of the effects of output volume on revenue (sales), expenses (costs), and net income (net...

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03 Chapter CHAPTER Outline Cost-Volume-Profit (CVP) Analysis What is CVP analysis? Breakeven Point What? How? Contribution margin Equation Graph Applications Target profit Margin of Safety Changes and sensitivity Analysis Cost-Volume-Profit Analysis (CVP) What is cost-volume-profit analysis? It is the study of the effects of output volume on revenue (sales), expenses (costs), and net income (net profit). Cost-Volume-Profit Analysis (CVP) Contribution Income Statement Sales Less: variable expenses Contribution margin Less: fixed expenses Net income The Break-Even Point The break-even point is the volume of activity where the organizations revenues and expenses are equal. Sales Less: variable expenses Contribution margin Less: fixed expenses Net income NI = 0 \$250,000 150,000 100,000 100,000 \$ - 2 Relations? The Break-Even Point The break-even point is the volume of activity where the organizations revenues and expenses are equal. Sales Less: variable expenses Contribution margin Less: fixed expenses Net income \$250,000 150,000 100,000 100,000 \$ - NI = 0 The Break-Even Point The break-even point is the volume of activity where the organizations revenues and expenses are equal. Sales Less: variable expenses Contribution margin Less: fixed expenses Net income \$250,000 150,000 100,000 100,000 \$ - NI = 0 Break-Even Point Techniques The break-even point is the point where total revenue equals total costs (both variable and fixed). Unit CM Contribution margin CM Ratio Equation Contribution Margin Method Break-even Fixed costs = volume in units Contribution margin per unit BEP (dollars) = BEP (units) x Selling Price Contribution Margin Method Break-even in dollars = Fixed costs Contribution margin ratio BEP (units) = BEP (dollars) / Selling Price Contribution Margin Method Break-even Fixed costs = volume in units Contribution margin per unit Break-even in dollars = Fixed costs Contribution margin ratio BEP (units) = BEP (dollars) / Selling Price BEP (dollars) = BEP (units) x Selling Price Example Bright Day is considering the introduction of a new product called Multi Minerals. The companys first concern is whether it can sell at least enough units to cover its fixed costs! Here is some per unit information about Multi Minerals: Sales revenue per unit Variable cost per unit Contribution margin per unit \$ 20 12 100% 60% Bright Day expects to incur \$24,000 in fixed marketing costs in connection with Multi Minerals. Lets calculate the break-even point in units and dollars. Example Break-even in Units Break-even in Dollars Fixed costs CM per unit Fixed costs CM ratio = units Lets Proof it!!! =\$ Example Here is the proof Units \$ Total Sales revenue 3,000 \$ 20 Variable cost 3,000 Contribution margin 3,000 \$ 12 8 Fixed Cost Net Income 0 BEP NI = 0? Check Yourself Matrix, Inc. manufactures one model of lawnmower the sells for \$175 each. Variable expenses to produce the lawnmower are \$100 per unit. Total fixed costs are \$225,000 per month. Use the contribution method to determine how many lawnmowers Matrix must sell next month: 1. 3,000. 2. 3,500. 3. 4,000. 4. 4,500. Check Yourself Matrix, Inc. manufactures one model of lawnmower the sells for \$175 each. Variable expenses to produce the lawnmower are \$100 per unit. Total fixed costs are \$225,000 per month. Use the contribution method to determine how much in sales revenue must lawnmowers Matrix make the next month: 1. \$525,000. 2. \$600,500. 3. \$754,000. 4. \$487,500. The Equation Method The equation method begins by expressing the income statement At the break-even point, profit = zero At the break-even point: Sales Revenue = Total Cost Sales Revenue = Variable cost + Fixed cost We can look at the above equation like this: Selling price per unit Number of units sold = Variable cost per unit Number of units sold + Fixed cost Check Yourself Matrix, Inc. manufactures one model of lawnmower the sells for \$175 each. Variable expenses to produce the lawnmower are \$100 per unit. Total fixed costs are \$225,000 per month. Use the equation method to determine how many lawnmowers Matrix must sell next month: 1. 3,000. 2. 3,500. 3. 4,000. 4. 4,500. Cost-Volume-Profit Graph We have developed income statements for zero sales, break-even sales, and ten thousand units. Units sold Revenue @ \$36 Variable Expenses @ \$24 Contribution Margin @\$12 Fixed Expenses Net Income Income \$ (60,000) \$ (60,000) at Various Levels 5,000 10,000 \$ 180,000 \$ 360,000 (120,000) (240,000) 60,000 120,000 (60,000) (60,000) \$ \$ 60,000 Information to prepare a break-even Excel graph. Units sold Revenue Total Cost Fixed Cost 60,000 60,000 5,000 180,000 180,000 60,000 10,000 360,000 300,000 60,000 Cost-Volume-Profit Graph Draw and label the axes. Horizontal axis activity (in units) Vertical axis - dollars Draw the sales line. A diagonal line that begins at the origin Draw the fixed cost line. A horizontal line Draw the total cost line. A diagonal line that begins at the fixed cost line and vertical axis Cost-Volume-Profit Graph Break-even Graph Dollars 400,000 300,000 Revenue BEP Total Cost \$180,000 200,000 Fixed Cost 5,000 units 100,000 - 5,000 10,000 Units Sold Loss Area Profit Area Applications of CVP: 1. Target Net Profit Managers can also use CVP analysis to determine the total sales, in units and dollars, needed to reach a target net profit. At the break-even point: Applications of CVP: 1. Target Net Profit Break-even Fixed costs = olume in units Contribution margin per unit Sales Revenue = Total Cost Sales Revenue = Variable cost + Fixed cost Contribution Margin Technique Equation Technique Target sales volume in units = Fixed expenses + Target net income Contribution margin per unit Target sales= Variable expenses + Fixed expenses + Target net income Target sales revenue in \$ = Fixed expenses + Target net income Contribution margin ratio Example: Target Profit Bright Days president want the advertising campaign to produce profits of \$40,000 to the company. The sales revenue per unit is \$36, the unit variable cost is \$24 and the total fixed cost is \$60,000 Fixed costs Break-even = volume in units Contribution margin per unit \$60,000 \$12 = Break-even in \$ = = 5,000 units Fixed costs Contribution margin ratio = \$60,000 33.33% =\$180,000 Example: Target Profit Bright Days president want the advertising campaign to produce profits of \$40,000 to the company. The sales revenue per unit is \$36, the unit variable cost is \$24 and the total fixed cost is \$60,000 Target = Fixed costs + Desired profit volume in units Contribution margin per unit Target Sales in \$ = Fixed costs + Desired profit Contribution margin ratio Proof??? Example Here is the proof Sales revenue Variable cost Contribution margin Fixed Cost Net Income Target Profit Check Yourself Matrix, Inc. manufactures one model of lawnmower the sells for \$175 each. Variable expenses to produce the lawnmower are \$100 per unit. Total fixed costs are \$225,000 per month, and management wants to earn a profit in the coming month of \$37,500. Use the contribution method to determine how many lawnmowers Matrix must sell next month: 1. 3,000. 2. 3,500. 3. 4,000. 4. 4,500. Applications of CVP: 2. Margin of Safety The margin of safety shows far sales how can fall below the planned level before losses occur. = Planned sales Break-even sales Margin of safety Units Dollars Percentage Applications of CVP: 2. Margin of Safety Budgeted sales Break-even sales Margin of safety Margin of = Safety % Margin of Safety % In Units 4,375 (1,875) In Dollars \$ 122,500 (52,500) Budgeted sales Break-even sales Budgeted sales = = Margin of Safety Operating Leverage Risk Preference % Applications of CVP: 3. Sensitivity Analysis Multiple Changes in Key Factors Changes in Prices Changes in Variable Cost Changes in Fixed Cost CVP is used as a tool to answer what if questions Assessing the Pricing Strategy Cost-Plus Pricing Price products at variable cost plus some percentage of the variable, normally 50%. Prestige Pricing Price products with a premium because the product is new or has a prestigious name brand. Target Pricing Price products at the market price and then control costs to be profitable at the market price. 3-31 Assessing the Pricing Strategy The Marketing Department at Bright Day suggests that a price drop from \$36 per bottle to \$28 per bottle will make Delatine a more attractive product to sell. The president wants to know what such a price drop would have on the companys stated goal of producing a \$40,000 profit. You have been asked to determine the number of bottles that must be sold to earn the \$40,000 profit at the new \$28 selling price per bottle. See if you can provide an answer to the president before going to the next screen! Target profits = \$40,000 Unit SP = \$36 \$28 Unit VC = \$24 Total FC = \$60,000 Effects of Changes in Sales Price Step 1 New Selling Price Per Bottle \$ 28 Variable Expenses Per Bottle 24 New Contribution Margin \$4 Step 2 Target Fixed costs + Desired profit = Volume in units Contribution margin per unit Step3 = Proof Changes in Variable Costs Bright Day is considering an alternative mixture for Delatine along with new packaging. This new product would sell for \$28 per bottle and have a variable cost per bottle of \$12. The president is not in favor of the new product but wants to know how many units must be sold to produce the desired profit of \$40,000. You have been asked to determine the units that must be sold and the total sales revenue that will be produced! Target profits = \$40,000 Unit SP = \$28 Unit VC = \$24 \$12 Total FC = \$60,000 Changes in Variable Costs Step 1 New Selling Price Per Bottle \$ 28 Variable Expenses Per Bottle 12 New Contribution Margin \$ 16 Step 2 Target Fixed costs + Desired profit = volume in units Contribution margin per unit Step3 = Target profits = \$40,000 Unit SP = \$28 Unit VC = \$12 Total FC = \$60,000\$30,000 Bright Days president has asked you to determine the required sales volume if advertising costs were reduced to \$30,000, from the planned level of \$60,000. Changes in Fixed Costs Target \$30,000 + \$40,000 = volume (units) \$16 Units sold Revenue @ \$28 Variable Expenses @ \$12 Contribution Margin @\$16 Fixed Expenses Net Income = 4,375 units Income 4,375 \$ 122,500 (52,500) 70,000 (30,000) \$ 40,000 Target profits = \$40,000 Unit SP = \$28\$25 Unit VC = \$12 Total FC = \$30,000 Decrease in Sales Price with an Increase in Sales Volume The marketing manager believes reducing the sales price per bottle to \$25 will increase sales volume by 625 units. Previous sales volume was: Target \$30,000 + \$40,000 = volume (units) \$16 = 4,375 units Anticipated changes: In Dollars New selling price Variable costs per unit Contribution margin \$ 25 (12) \$ 13 Previous units sold Additional units sold Expected sales volume Accept or Reject Proposal? In 4,375 625 5,000 Target profits = \$40,000 Unit SP = \$28\$25 Unit VC = \$12 Total FC = \$30,000 Decrease in Sales Price with an Increase in Sales Volume Current Situation Income Units sold Revenue @ \$28 Variable Expenses @ \$12 Contribution Margin @\$16 Fixed Expenses Net Income Because budgeted income will ?, the proposal should be ? Proposed Situation Income Units sold Revenue @ \$25 Variable Expenses @ \$12 Contribution Margin @\$13 Fixed Expenses Net Income Target profits = \$40,000 Unit SP = \$28 Unit VC = \$12 Total FC = \$30,000\$42,000 Increased in Fixed Costs and Increase in Sales Volume After the previous project was rejected, the advertising manager believes that buying an additional \$12,000 in advertising can increase sales volume to 6,000 units. The contribution margin will remain at \$16. Should the company buy the additional advertising? Profit = Contribution margin Fixed cost Profit = Proposed Situation Current Situation Units sold Revenue @ \$28 Variable Expenses @ \$12 Contribution Margin @\$16 Fixed Expenses Net Income Income 4,375 Units sold Revenue @ \$28 Variable Expenses @ \$12 Contribution Margin @\$16 Fixed Expenses Net Income Income 6,000 Target profits = \$40,000 Unit SP = \$28\$25 Unit VC = \$12\$8 Total FC = \$30,000\$22,000 Change in Several Variables Management has been able to reduce variable costs to \$8 per bottle and decides to reduce the selling price per bottle to \$25 (so the contribution margin is now \$17). Further, management believes that if advertising is cut to \$22,000, the company can still expect sales volume to be 4,200 units. Should management adopt this plan? Target profits = \$40,000 Unit SP = \$28\$25 Unit VC = \$12\$8 Total FC = \$30,000\$22,000 Change in Several Variables Profit = Contribution margin Fixed cost Profit = Proposed Situation Current Situation Units sold Revenue @ \$28 Variable Expenses @ \$12 Contribution Margin @\$16 Fixed Expenses Net Income Income 4,375 Units sold Revenue @ \$25 Variable Expenses @ \$8 Contribution Margin @\$17 Fixed Expenses Net Income Income 4,200 Applications of CVP: 3.Sensitivity Analysis CVP Analysis and ComputerBased Spreadsheets Exhibit 3.3 The use of spreadsheets simplifies the examination of multiple changes in key factors in a CVP model. Use of these models is a cost-benefit issue. Performing Sensitivity Analysis Using Spreadsheet Software After reviewing the spreadsheet analysis, Bright Days management team is convinced it should undertake radio advertising for Delatine. Management considers a new product, Delatine that has a sales price of \$36 and variable costs of \$24 per bottle. Fixed costs are \$60,000. Breakeven is 5,000 units. Target costing is employed to reengineer the product and reduces variable cost per unit to \$12. To earn the desired profit of \$40,000, sales volume decreases to 6,250 units. Management wants to earn a \$40,000 profit on Delatine. The sales volume to achieve this profit level is 8,334 bottles sold. Target costing is applied and fixed costs are reduced to \$30,000. The sales volume to earn the desired \$40,000 profit is 4,375 units. Marketing advocates a target price of \$28 per bottle. The sales volume required to earn a \$40,000 profit increases to 25,000 bottles. In view of the 57.14% margin of safety, management decides to add Delatine to its product line. Cost-Volume-Profit Limitations CVP is limited by a number of underlying assumptions. 1 The selling price is constant. 2 Costs are linear. 3 The multiproduct sales mix is constant. 4 Inventory levels in manufacturing companies are constant. 5 All CVP variables are within the relevant range. 3-45 We made it! Perform multiple-product breakeven analysis.
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Chapter8RiskandRatesofReturn StandAloneRisk PortfolioRisk RiskandReturn:CAPM/SML81InvestmentReturnsTherateofreturnonaninvestmentcanbecalculatedasfollows:(Expectedendingvalue Cost)Return=CostForexample,if\$1,000isinvestedand\$1,100isreturnedafte
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Chapter9StocksandTheirValuation FeaturesofCommonStock DeterminingCommonStockValues PreferredStock91FactsaboutCommonStockRepresentsownershipOwnershipimpliescontrolStockholderselectdirectorsDirectorselectmanagementManagementsgoal:Maximizethestock
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Chapter 10 The Cost of Capital Sources of Capital Component Costs WACC Adjusting for Flotation Costs Adjusting for Risk101What sources of longterm capital do firms use?102Calculating the Weighted Average Cost of Capital103Should our analysis focus
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Chapter11TheBasicsofCapitalBudgetingShouldwebuildthisplant?111Whatiscapitalbudgeting?Analysisofpotentialadditionstofixedassets.Longtermdecisions;involvelargeexpenditures.Veryimportanttofirmsfuture.112StepstoCapitalBudgeting1. EstimateCFs(inf