CVP analysis - CHAPTER Cost-Volume-Profit Analysis c In...

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CHAPTER Cost-Volume-Profit Analysis c In Brief Managers need to estimate future revenues, costs, and profits to help them plan and monitor operations. They use cost-volume-profit (CVP) analysis to identify the levels of operating activity needed to avoid losses, achieve tar- geted profits, plan future operations, and monitor organizational performance. Managers also analyze operational risk as they choose an appropriate cost structure. This Chapter Addresses the Following Questions: Q1 What is cost-volume-profit (CVP) analysis, and how is it used for decision making? Q2 How are CVP calculations performed for a single product? Q3 How are CVP calculations performed for multiple products? Q4 What is the breakeven point? Q5 What assumptions and limitations should managers consider when using CVP analysis? Q6 How are margin of safety and operating leverage used to assess operational risk? ch03.qxd 9/27/04 4:06 PM Page 86
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87 I n the early 1980s, personal computers were still somewhat a novelty. At that time, Coleco manufactured a small computer called Adam. In addition, it sold Colecovision games for home computers. Coleco marketed Adam and its computer games heavily, hoping in 1982 for a hot seller during the Christ- mas and holiday gift sea- son. However, Adam and Colecovision did not sell well. Coleco found itself close to bankruptcy. Then in 1983 Coleco purchased the license to manufacture Cabbage Patch Dolls. It began pro- duction for Christmas 1983. Coleco widely pub- licized the dolls’ arrival at toy stores, but managers anticipated greater sales of Adam in their production schedules. They did not emphasize production of the Cabbage Patch Dolls. These dolls became hot sellers that Christmas, and inventories were depleted rapidly. The scarcity generated so much interest that customers fought with each other for the dolls and even wrecked some toy stores while try- ing to purchase Cabbage Patch Dolls for the holi- days. Because of the shortage, advertising for the dolls was canceled shortly after their intro- duction. Coleco’s managers continued to think that the company’s reputation would be based on com- puters. However, Cabbage Patch Dolls became their most successful product for the next several years. After success with Cab- bage Patch Dolls and ac- tion figure toys called Masters of the Universe, Coleco continued to aim for hot sellers. This strat- egy involved a great deal of uncertainty, and by 1988 the company was bankrupt. S OURCES: L. Brannon and A. McCabe, “Time-Restricted Sales Appeals,” Cornell Hotel and Restaurant Administration Quarterly, August/September 2001, pp. 47–53; and K. Fitzgerald, “Toys Face Scrooge-Like Christmas,” Advertising Age , September 19, 1988, pp. 30–32. COLECO: FAULTY FORECASTS 87 ch03.qxd 9/27/04 4:06 PM Page 87
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88 CHAPTER 3 COST-VOLUME-PROFIT ANALYSIS Key Decision Factors for Coleco What went wrong with Coleco’s decision to emphasize production of Adam instead of Cab- bage Patch Dolls? The problems began with uncertainties about which products would be popular at Christmas. Coleco’s managers could not know which products would sell best.
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