CVP ANALYSIS REVIEW PROBLEM WITH SOLUTION

Voltar Company manufactures and sells a specialized cordless telephone for high electromagnetic radiation environments. The
company’s contribution format income statement for the most recent year is given below:

Total Per unit % of sales

Sales (20 000 units) $1 200 000 $60 100%

Variable expenses 900 000 45 75%

Contribution margin 300 000 15 25%

Fixed costs 240 000

Operating income $60 000

Management is anxious to increase the company’s profit and has asked for an analysis of a number of items.

Required:

1. Compute the company’s CM ratio and variable expense ratio.

CMu 60−45 15
 CM ratio = = = =25 %
SPu 60 60
VC u 45
 VC ratio = = =75 %
SPu 60

2. Compute the company’s break-even point in both unit sales and dollar sales. Use the equation method.

240000
 BEP in Quantity : (Q * CMu) – FC = 0 ; 15Q – 240 000 = 0 ; Q = = 16 000 units
15
FC 240 000
 BEP in $ = = = $960 000
CM % 0.25

3. Assume that an increase in unit sales causes total sales to increase by $400,000 next year. If cost behavior patterns
remain unchanged, by how much will the company’s net operating income increase? Use the CM ratio to compute
your answer.

As there is no increase in the Fixed costs, total increase in CM will increase the operating income by the same amount

 Increase in CM and operating income ; $400 000 * 25% = $100 000

4. Refer to the original data. Assume that next year management wants the company to earn a profit of at least $90,000.
How many units will have to be sold to earn this target profit?
  Equation method :
o Profit = CMu * Q – FC
o $90 000 = 15Q – 240 000
o 15Q = 240 000 + 90 000
330 000
o Q= =22000 Units
15

 Formula method :
FC +OI 240 000+90 000
Q= = = 22 000 units
CMu 15

5. Refer to the original data. Compute the company’s margin of safety in both dollar and percentage form.

 Margin of safety in $ = expected revenue – BEP in $ = 1 200 000 – 960 000 = $240 000

Margin of safety ∈$ 240 000
 Margin of safety in % = = =0.2=20 %
expected revenue 1200 000

6. Degree of operating leverage:

a. Compute the company’s degree of operating leverage at the present level of sales.

total CM 300 000

Degree of operating leverage = = =5 X
Operatingincome 60 000

b. Assume that through a more intense effort by the sales staff, the company’s unit sales increase by 8%
next year. By what percentage would you expect net operating income to increase? Use the degree of
operating leverage to obtain your answer.

Net income will increase 5 times the increase of sales : 8% * 5 = 40% # $60 000 * 40% = $24 000

Expected net income : $60 000 + 24 000 = $84 000

c. Verify your answer to part (b) by preparing a new contribution format income statement showing an 8%
increase in unit sales.

TOTAL PER UNIT %

Sales revenue (1 200 000 * 1.08) $1 296 000 $60 100

Variable costs (900 000 * 1.080 972 000 45 75%

Contribution margin 324 000 15 25%

Fixed costs 240 000

Operating income (60 000 *1.4) $84 000

7. Refer to the original data. In an effort to increase sales and profits, management is considering the use of a higher-
quality speaker. The higher-quality speaker would increase variable costs by $3 per unit, but management could
eliminate one quality inspector who is paid a salary of $30,000 per year. The sales manager estimates that the higher-
quality speaker would increase annual unit sales by at least 20%.
 a. Assuming that changes are made as described above, prepare a projected contribution format income
statement for next year. Show data on a total, per unit, and percentage basis.

Vc : + $3, $48 per unit ; FC : - $30 000, 210 000 ; units sold : + 20% (4 000 units) total of 24 000
units

TOTAL PER UNIT %

Sales revenue (24 000 units*$60 $1 440 000 $60 100

Variable costs (24000 * $48 ) 1 152 000 48 80%

Contribution margin (24 000 * 12) 288 000 12 20%

Fixed costs 210 000

Operating income $78 000

b. Compute the company’s new break-even point in both unit sales and dollar sales. Use the formula
method.

BEP in Q : (CM u*Q) – FC =0 = 12Q – 210 000 = 0, Q = 210 000/12 = 17 500 Units

BEP in $ : 17 500 units * $60 = $1 050 000

c. Would you recommend that the changes be made?

Yes, based on these data, the changes should be made. The changes increase the company’s net operating income from
the present $60,000 to $78,000 per year. Although the changes also result in a higher break-even point (17,500 units as
compared to the present 16,000 units), the company’s margin of safety actually becomes greater than before:
Margin of safety in dollars=Total sales-Break-even sales=$1,440,000-$1,050,000=$390,000
As shown in (5), the company’s present margin of safety is only $240,000.
Thus, several benefits will result from the proposedchanges.