Of output units is the only revenue driver and cost

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1. # of output units is the only revenue driver and cost driver. 2. Total Costs can be divided into Variable Costs & Fixed Costs . 3. Total Revenue and total costs are linear within the relevant range. 4. Unit selling price, unit variable costs, and fixed costs are known & constant. 5. Single product or constant sales mix. 6. Time value of money effect ignored. Formula: Sales = = *EBT = EAT + Taxes = EAT ÷(1 –Taxes) Contribution Margin Contribution Margin Ratio Fixed Costs + * EBT Contribution Margin Ratio © Dr. Liang H Chen, 2017
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Target Operating Income Fixed or Variable Amount of Profit The Break-even Point Fixed Amount of Profit Before & After Tax Variable Amount of Profit Before & After Tax (Additional Q) Break-even CM = FC Profit Before Tax CM = FC + Profit (EBT) or Profit After Tax (EAT) Profit Before Tax CM =FC + Profit (EBT) or Profit After Tax (EAT) = Units Per Unit Approach = $ Ratio approach EAT ÷ (1-Tx) = EBT = $ = units Profit Before Tax: S – x%S – FC = y%S* y%S = treated as an additional VC S – x%S – y%S* = FC Profit After Tax: EAT ÷ (1-Tx) = EBT z%S ÷ (1-Tx) = y%S S – x%S – y%S* = FC FC + EAT÷(1-Tx) CM Ratio FC + EAT÷(1-Tx) $CM (unit) FC + 0 CM Ratio FC + 0 $CM (unit) © Dr. Liang H Chen, 2017
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Degree of Operating Leverage What? The effects that Fixed Costs have on changes in Operating Income (EBT) as changes occur in units sold and contribution margin. Choice of incurring Fixed Costs vs. Variable Costs Example Company A (Manufacturing) Company B (Service) DOL CM ÷ EBT = 5X $750,000 ÷ $150,000 = 5 10% sales x 5 = 50% EBT CM ÷ EBT = 2X $300,000 ÷ $150,000 = 2 10% sales x 2 = 20% EBT Conclusio n Higher Fixed Costs Higher Operating Leverage Small changes in Sales Large changes in Operating Income © Dr. Liang H Chen, 2017
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Composite (Multiple) CVP The Break-even Point for Multiple products Sales BE = $72,000 ÷ $9 = 8,000 composite units Sales Break-event unit/$ for each product: © Dr. Liang H Chen, 2017
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