Course Title: Accounting for manager

1. The XYZ Company has three major products, whose contribution margins are shown below in Table 1.1.
Table 1.1. Presents description of the mixed products and related contribution margin

Description Product
A B C
Sales Price $ 13 $12 $6.5
Variable cost per unit 8 6 4
CM/Unit 5 6 2.5
Total fixed costs are $100,000.
Question
(a) the break-even point in units in total and for each product if the three products are sold in the
proportions of 30%,50%, and 20%, and
(b)the break-even point in total and for each product if the sales mix ratio changes to 50%, 30%,
and 20%
2. Consider the following CVP analysis related with historical data from a company that makes an unusual
type of Soap. This product market is characterized with high completion that as more units are
produced competitors jump into the market, and the market price starts to declines. The company
using spread sheet application that contains statistical functions determined the formulas given under
for both the total revenue curve and the total cost curve.

R( x) = (–X 2 ÷ 100) + 10x------------------------------------- (1)

C(X) = 700 + 2X---------------------------------------- (2)
Questions
A. Compute breakeven units. Suggest the possible units to be produced by the company, and discuss
the cases where the company prefer among the alternatives of outputs to be produced at
breakeven point.
B. Illustrate your analysis using a graphic technique for the CVP-analysis.
3. Fill in the missing amounts in each of the four case situations below. Each case is independent of the
others.
a. Assume that only one product is being sold in each of the four following case situations:

Case Units Sold Sales Variable Contribution Fixed Net Income (Loss)
Expenses Margin per Unit Expenses
1 20,000 $ 220,000 $ 140,000 $ A $ 55,000 $B 4. A
2 C 147,000 D 8 34,000 8,000 B
3 15,000 E 75,000 12 F 14,000 C
4 8,000 320,000 G H 110,000 (30,000)
Manufacturing Corp. is using 10,000 units of part no. 300 as a component to assemble one of its
products. It costs the company $18 per unit to produce it internally, computed as follows:

1
 Direct materials $ 42,000
Direct labor 51,000
Variable overhead 42,000
Fixed overhead 45,000
Total Cost 180,000
An outside vendor has just offered to supply the part for $16 per unit. If the company stops producing
this part, one-third of the fixed overhead would be avoided. Should the company make or buy?
(Show calculation to support your decision).
5. Products A and B are produced jointly in Department Z. Each product can be sold as is at the split-
off point or processed further. During January, Department Z recorded a joint cost of $150,000. The
following data for January are available:

Produc Quantity Selling price per unit Costs after Split-off

t
At split-off If processed further
A 10,000 Units $5 $8 60,000
B 20,000 1.50 2 20,000

Analyze whether individual products should be processed beyond the split-off point, using:
(That means support your answer with the following format of calculations):
(a) The total project approach
(b) The incremental approach
(c) The opportunity cost approach
6. Relay Corporation manufactures batons. Relay can manufacture 300,000 batons a year at a variable
cost of $750,000 and a fixed cost of $450,000. Based on Relay’s predictions, 240,000 batons will be
sold at the regular price of $5 each. In addition, a special order was placed for 60,000 batons to be
sold at a 40 percent discount off the regular price. By what amount would income be increased or
decreased as a result of the special order? (Show the step to support your decision)
7. The Discount Drug Company has three major product lines: drugs, cosmetics, and housewares. The
company provides the following sales and cost information for the month of May for the store in total
and for each separate product line (000 omitted):

Drug Cosmetics Housewares Total

Sales $240 $ 300 $360 $ 900
Less: Variable expenses 160 180 200 540

CM $ 80 $120 $160 $360

Less: Fixed costs
Salaries $34 $40 $46 $120
Advertising 30 50 40 120
Other fixed costs 40 20 40 100
Total $104 $110 $126 $340
Net income $(24) $10 $34 $20

2
 The salaries represent wages paid to employees engaged directly in each product line area. Besides,
the advertising represents direct advertising of each product line, and is avoidable if the line is
dropped. Other fixed costs, which are all committed costs, will continue and will split equally between
cosmetics and house wares.
1. Prepare a combined income statement for cosmetics and house wares on the assumption that drugs
are discontinued with no effects on sales of the other product lines.
2. On the basis of the analysis in question 1, would you advise dropping the drugs line?
8. Cardinal Company needs 20,000 units of a certain part to use in its production cycle. The following
information is available:
Cost of cardinal to make the part:
Direct materials $4
Direct labor 17
Variable overhead 7
Fixed overhead 10
$38
Cost to buy the part from the Oriole company $42

If Cardinal buys the part from Oriole instead of making it, Cardinal could not use the released
facilities in another manufacturing activity. Sixty percent of the fixed overhead applied will continue,
regardless of what decision is made.
What do you advise to the firm managers: shall the firm buy or make the product? ==>>

Q1

Break-Even Points Formula based on Units: The Break-even point is calculated by dividing the fixed
costs by the sales price per unit minus the variable cost per unit.  Break-Even Point (Units) = Fixed
Costs ÷ (Sales Price per Unit – Variable Cost per Unit). How to Calculate Break Even Point (Units and
Sales Dollars)

Calculating the break-even point for a business is important to determine its profitability.
If you are a small business owner or have just started your own business, doing a break-even analysis is
important. It will help you determine if your business is sustainable or not, if the costs are too high or if the
princess is too low to reach the break-even point at the right time. It will help you forecast your business’s
profitability, revenue and growth.

3
What is the Break-Even Point?

A break-even point for a business refers to a stage where total revenue equals the total cost. At this point, your
business is neither going through a loss nor a profit which means you are getting the same amount as you are
spending on your business. For small businesses hitting the break-even point is the first step toward success
and making the business profitable.
A break-even point formula is an important tool for your business. It will help you determine when your
business will become profitable. You can then strategies your  business plan accordingly to gain success. It will
help you forecast your growth and profitability but also help you to promote your new product, cut down
expenses, stay ahead of the competition, etc.
How to Calculate Break-Even Points?

There are two basic ways to calculate a business break-even point – one is based on the number of units of
product sold, and the other is based on the points in sales dollars.
Break-Even Points Formula based on Units: 

The Break-even point is calculated by dividing the fixed costs by the sales price per unit minus the variable cost
per unit.
Break-Even Point (Units) = Fixed Costs ÷ (Sales Price per Unit – Variable Cost per Unit)
 Fixed Costs: Fixed costs includes costs that do not change or change slightly and are not dependent on
the number of products sold. Examples of fixed costs for a business are rent, utility expenses, production
facilities, and service-based costs like advertising, PR, etc.
 Sales Price per unit: It is the sales price of each product that the customer has to pay to buy the product.
 Variable Costs per unit: Variable costs refer to costs that change frequently. These costs are directly
linked to the product’s production and include costs for hiring labour or material used. Variable cost is
calculated by dividing total variable costs by total units produced (Total Variable Costs ÷ Total Units
Produced).
Example: 
Let’s take an example to understand better the break-even point formula and how to calculate it.
Neil has a protein supplement company that wants to introduce a new flavour. Before launching this new
flavour, he wants to determine how it will impact his company’s finances. That’s why he decided to calculate the
break-even point to find out if it was worth the investment.
Fixed Costs = $2400
Variable Costs = .50 (per item produced)
Sales Price = $2
Break-even Point = $2400/($2 – $.50) = 1600
This means Neil has to sell 1600 items to reach the break-even point.
Break-Even Points Formula based on Sales Dollars:

It is calculated by dividing the fixed cost by the contribution margin.

Break-Even Point (Units) = Fixed Costs ÷ Contribution Margin
Contribution Margin: Contribution margin is the difference between an item’s variable cost and its selling cost.
Contribution Margin = Price of Product – Variable Costs
Example: 
Taking the same example, we discussed above.  

4
 Fixed Costs = $2400
Contribution Margin = 1.25 -$0.5 = 0.75
Break-even Point = $2400/0.75 = $3200
This means Neil needs to generate revenue of $3200 by selling the protein supplements to reach the break-
even point. 
Top Break Even Point Calculators

Good Calculators
Good Calculators is a free and simple break-even calculator.

Apart from that, it also provides various other calculators like Salary and Income tax calculator, Depreciation
Calculator, Forex calculator, Loan calculator, etc. 
Nase – Break-even Analysis Calculator

This is another free calculator for calculating the break-even point. This calculator provides a graphical
representation of break-even point analysis and provides a report based on your input.
Startupbonsai – Break-Even Calculator

This break-even calculator by Startupbonsai provides the total units and money needed to reach the break-even
point.
Break-Even Point Formula
Formula to Calculate Break-Even Point (BEP)
The formula for break-even point (BEP) is very simple and calculation for the same is done by dividing the total
fixed costs of production by the contribution margin per unit of product manufactured.
Break Even Point in Units = Fixed Costs/Contribution Margin
The contribution margin per unit can be calculated by deducting variable costs towards the production of
each product from the selling price per unit of the product. Mathematically it is represented as,
Contribution margin = Selling price per unit – Variable cost per unit
Therefore, the formula for break-even point (BEP) in units can be expanded as below,
Break Even Point in Units = Fixed Costs/(Selling price per unit – Variable cost per
 You are free to use this image on your website, templates, etc., Please provide us with an attribution link

Steps to Calculate Break-Even Point (BEP)

1. Firstly, the variable cost per unit has to be calculated based on variable costs from the  profit and loss
account and the quantity of production. Variable costs will vary in direct relation to the production or sales
volume. The variable costs primarily include raw material cost, fuel expense, packaging cost, and other costs that
are directly proportional to the production volume.
2. Next, the fixed costs have to be calculated from the profit and loss account. Fixed costs do not vary according to
the production volume. The fixed costs include (not exhaustive) interest expense, taxes paid, rent, fixed salaries,
depreciation expense, labor cost, etc.
3. Now, the selling price per unit is calculated by dividing the total operating income by the units of production.
4. Next, the contribution margin per unit is computed by deducting the variable cost per unit from the selling price
per unit.
5. Finally, the break-even point in units is derived by dividing the fixed costs in step 2 by the contribution margin
per unit calculated in step 4.

5
 Examples
You can download this Break-Even Point Formula Excel Template here –  Break-Even Point Formula Excel
Template
Example #1
Let us assume a company ABC Ltd which is in the business of manufacturing of widgets. The fixed costs add up
to $80,000, which consists of asset depreciation, executive salaries, lease, and property taxes. On the other hand,
the variable cost associated with the manufacturing of widgets has been calculated to be $0.70 per unit, which
consists of raw material cost, labor expense, and  sales commission. The selling price of a widget is $1.50 each.
The below-given Template contains the data about ABC company.
Particulars Amount

Selling Price Per Unit $1.50

Variable Cost Per Unit $0.70

Fixed Cost $80,000

Contribution Margin Per Unit

Contribution margin per unit = $1.50 – $0.70

 Contribution margin per unit = $0.80
Based on the above, the calculation of the break-even point can be done as-

i.e. Break-even points in units = $80,000 / $0.80

 Break-even points in units = 100,000
Therefore, ABC Ltd has to manufacture and sell 100,000 widgets in order to cover its total expense, which
consists of both fixed and variable costs. At this level of sales, ABC Ltd will not make any profit but will just break
even.
Example #2
Let us consider a restaurant PQR Ltd selling pizza. The selling price is $15 per pizza, and the monthly sales are
1,500 pizzas. Additionally, the following information for a month is available.
Variable cost –
Variable cost = $8,000 + $1,000
 Variable cost = $9,000
Therefore, Variable Cost per unit = $9,000 / 1,500 = $6

6
 Fixed Cost
i.e. Fixed cost = $4,000 + $3,000 + $1,300 + $700
 Fixed cost = $9,000
Contribution Margin Per Unit –
Therefore,
Contribution margin per unit = $15 – $6
 Contribution margin per unit = $9
Based on the above, calculation of the break-even point can be determined as,
i.e. Break-even points in units = $9,000 / $9
 Break-even points in units = 1,000
Therefore, PQR Ltd has to sell 1,000 pizzas in a month in order to break even. However, PQR is selling 1,500
pizzas monthly, which is higher than the break-even quantity, which indicates that the company is making a
profit at the current level.
Break-Even Point (BEP) Calculator
You can use the following Break-Even Point Formula Calculator.
Fixed Costs 0

Contribution Margin 0

Break Even Point in Units 0

Fixed
Costs
0
=
= 0
Break Even Point in Units =
Contribu
0
tion
Margin

How to calculate break even point for multiple products

ookΕκτύπωσηΑγαπημέναΠερισσότερα...
When running a business is important to know what is your break even point so you can set correctly a level of
viable sales goals. In every business, there are fixed and variables costs, break even point is the level where
revenue equals the total cost, which means that you do not make or lose money.
There are various methods to calculate this point but let's see an example of the one that covers multiple
products.
how to calculate break-even point for multiple products
First, we have to know the price of each product and the variable cost so we can calculate the contribution
margin of each unit. Let's say that we offer three major products and the percentage of sales that we expect
from each is one
Product 1: 20 %
Product 2: 50 %
Product 3: 30 %

7
 Product 1 Product 2 Product 3
       price per Unit 17 $ 34 $ 50 $
  -   variable cost per unit  2$  4$  6$
 =   contribution margin per unit 15 $ 30 $ 44 $
 x    sales mix percentage 20% 50% 30%
 
Weighted Average Contribution Margin = 31.2 $
 
Total fixed costs include bills like office rent, utility bills, in general, all the costs that will have to be paid even
the business has no revenue. Let's take a rough estimate of 3000 $.
Break Even Point = Fixed Costs / Weighted Average Contribution Margin
we have to sell approximately 96 unit in total or  19 units from product 1, 40 units from product 2 and from
product 3 29 units
Now we know approximately the number form each unit that we have to sell so as not to have any losses.
At the business level also we have to take into consideration special tax laws that apply in the country that the
business has his base. For example, in the case of Greece, we have designed a special business calculator
on how is breakeven point is calcucated  including to find profit margins, taxes, and social insurance as a
freelance or as a sole proprietorship business. Break-even analysis with multiple products
 Posted in: Cost volume and profit relationships (explanations)
By: Rashid Javed | Updated on: September 20th, 2022
The method of calculating break-even point of a single product company has been discussed in the  break-even
point analysis article. In this article, we would explain the procedure of calculating break-even point of a multi-
product company. A multi-product company means a company that sells two or more products.
The procedure of computing break-even point of a multi-product company is a little more complicated than that
of a single product company. Let’s start with the formula.
Formula:
A multi product company can compute its break-even point using the following formula:

For computing break-even point of a company with two or more products, we must know the sales percentage
of individual products in the total sales mix. This information is used in computing weighted average selling
price and weighted average variable expenses.
In the above formula, the weighted average selling price is worked out as follows:
(Sale price of product A × Sales percentage of product A) + (Sale price of product B × Sale percentage of
product B) + (Sale price of product C × Sales percentage of product C) + …….
and the weighted average variable expenses are worked out as follows:
(Variable expenses of product A × Sales percentage of product A) + (Variable expenses of product B × Variable
expenses of product B) + (Variable expenses of product C × Sales percentage of product C) + …….
When weighted average variable expenses per unit are subtracted from the weighted average selling price per
unit, we get weighted average contribution margin per unit. Therefore, the above formula can also be written as
follows:

An example would be very helpful to understand the whole procedure. Consider the following example of a multi
product company:
Example:
8
The Monster company manufactures three products – product X, product Y and product Z. The variable
expenses and sales prices of all the products are given below:

The total fixed expenses of the company are $50,000 per month. For the coming moth. Monster expects the
sale of three products in the following ratio:
Product X: 20%;
Product Y: 30%;
Product Z: 50%
Required: Compute the break-even point of Monster company in units and dollars for the coming month.
Solution:
Monster company sells three products and is, therefore, a multi product company. Its break-even point can be
computed by applying the above formula:

= $50,000 / $95* – $55**

= $50,000 / $40
= 1,250 units
*Weighted average selling price:
= ($200 × 20%) + ($100 × 30%) + ($50 × 50%)
= $40 + $30 + $25
= $95
**Weighted average variable expenses:
= ($100 × 20%) + ($75 × 30%) + ($25 × 50%)
= $20 + 22.50 + 12.50
= $55
The company will have to sell 1,250 units to break-even. Now I would compute the number of units of each
product to be sold:
Product X (1,250 × 20%): 250 units
Product Y (1,250 × 30%): 375 units
Product Z (1,250 × 50%): 625 units
Total:250 units + 375 units + 625 units = 1,250 units
As the number of units of each individual product to be sold have been computed, I can compute the break
even point in dollars as follows:

The break-even point of Monster company is $118,750. It can be verified by preparing a contribution
margin income statement as follows:

9
Sales mix and break-even point analysis
 Posted in: Cost volume and profit relationships (explanations)
By: Rashid Javed | Updated on: September 29th, 2022
What is sales mix?
The proportion in which a multi-product company sells its products is referred to as sales mix. Companies
involved in selling two or more products try to sell their products in a proportion or mix that maximizes their total
profit. The term sales mix is not applicable to a seller who sells only a single product.
A business with low sales volume may earn more profit than a business with high sales volume if it has a larger
proportion of high margin products in its total sales mix. However, a company is not always free to sell any
number of units of a high contribution margin product because the sales largely depend on a number of factors
that the sellers can’t fully control in short run. These factors include general demand for the product, company’s
current market share, availability of inputs like raw materials, company’s production capacity, and restrictions
imposed by the country’s government etc. Since the product sales are impacted by many uncontrollable and
semi-controllable factors, the companies put their best effort to achieve and maintain a sales mix that can
generate the highest profit for them.
Shift in sales mix and break-even point
Usually, different products have different sales prices, variable expenses and contribution margin associated
with them. Therefore, any change in proportion in which the products are sold has a significant impact on the
overall break-even point (BEP) of the seller. In CVP analysis, this change is generally known as ‘change in
sales mix’ or ‘shift in sales mix’.
Let’s take an example to understand how the concept of sales mix works and how a shift in sales mix impacts
the break-even point of a multi product seller:
Example:
The NORAN company sells two products; product X and product Y. The information about sales price, variable
expenses per unit and total fixed expenses is given below:

The total monthly fixed expenses of the company are $270,000. The   company wants to generate a sales
revenue of $1,000,000 in the next month. To obtain this goal the company has the following options:
(i). Sell 6,000 units of product X and 7,000 units of product Y.
(ii). Sell 14,000 units of product X and 3,000 units of product Y.
Required:
1. Prepare contribution margin income statement and calculate break-even point if NORAN decides to
select option (i).
2. Prepare contribution margin income statement and calculate break-even point if NORAN decides to
select option (ii).
10
 3. Whichever is the better option, (i) or (ii)?
4. Explain the reason of change in break-even point in dollars (if any).
Solution:
(1). If option (i) is chosen

 Break-even point = Total fixed expenses / Overall  contribution margin ratio

= $270,000/.54*
= $500,000
 *540,000/1,000,000
(2). If option (ii) is chosen:

 Break-even point = Total fixed expenses / Overall contribution margin ratio

= $270,000/.46*
= $586,957
 *460,000/1,000,000
(3) The better option to choose:
Option (a) is better than option (b) because it generates more net operating income for the company.
(4). The reason of change in break-even point:
A change in sales mix generally have a very strong effect on the break-even point of multi-product sellers. For
instance, we can see that the break-even sales in dollars are $500,000 under first option but $586,957 under
second option, even the total sales revenue assumed under both the options is the same – $1,000,000.
It means, under second option we need to generate $86,700 more in sales revenue just to break-even. This is
because the shift in sales mix from a high contribution margin product (i.e., product Y) to a low contribution
margin product (i.e., product X) has dropped the NORAN’s overall contribution margin ratio from 0.54 to 0.46
and, hence, increased the revenue needed to break-even.
Important point to remember
Students should learn that a shift in sales mix from high contribution margin product(s) to low contribution
margin product(s) increases the dollar sales required to break-even and vice versa. This is because the

11
products that generate higher contribution margin leave a greater portion of revenue to cover fixed expenses
and ultimately contribute a greater amount towards net operating income.
This partially answers the question why some sellers are able to earn higher profit than others, even with fewer
sales revenue.

Relevance and Uses The XYZ Company has three major products, whose contribution margins are
shownbelow in Table 1.1. Table 1.1.  Presents description of the mixed products and related
contribution margin   Description Product A B C Sales Price $ 13 $12 $6.5 Variable cost per unit 8
6 4 CM/Unit 5 6 2.5 Total fixed costs are $100,000. Question (a) the break-even point in units in
total and for each product if the three products are sold in the proportions of 30%,50%, and 20%,
and  (b)the break-even point in total and for each product if the sales mix ratio changes to 50%,
30%, and 20%
Question
1. The XYZ Company has three major products, whose contribution margins are shownbelow in Table
1.1.
Table 1.1.  Presents description of the mixed products and related contribution margin
 
Description Product

A B C
Sales Price $ 13 $12 $6.5
Variable cost per unit 8 6 4
CM/Unit 5 6 2.5
Total fixed costs are $100,000.
Question
(a) the break-even point in units in total and for each product if the three products are sold in the
proportions of 30%,50%, and 20%, and
 (b)the break-even point in total and for each product if the sales mix ratio changes to 50%, 30%, and
20%
Eg.1.XYZ Co. has the following sales mix for its three products: A, 35%; B, 45%; and C, 20%. Fixed costs
total $400,000 and the weighted-average contribution margin is $100. How many units of product A must
be sold to break-even? a. 800. b. 14,00. с. 1,800. d. 4,000 e. None of the answers is correct.

Question

12
Transcribed Image Text:XYZ Co. has the following sales mix for its three products: A, 35%; B, 45%;
and C, 20%. Fixed costs total $400,000 and the weighted-average contribution margin is $100. How many
units of product A must be sold to break-even? a. 800. O b. 14,00. O C. 1,800. d. 4,000 O e. None of the
answers is correct.
Eg.2.Roberto, Inc. manufactures products A and B. Both products have a contribution margin ratio
of 40%. Information about both products follows. Product A Product B Selling price per unit
Variable cost per unit 20 $ 15 12 9 Contribution margin per unit $ 8 Labor time 4 minutes 2
Minutes Assume that labor time is the constrained resource and only a total of 3,000 minutes is
available. Product A has a total demand of 500 units and product B has a total demand for 600
units. Considering the constraint, how many units of product B should be produced to maximize
profits? O 500 units 450 units O 550 units 600 units.
Question
Can you show me how to work this problem? I thought that I would multiplied the demand for unit B
which is $600 by the contribution margin per labor time which I thought was three.

13
Transcribed Image Text:Roberto, Inc. manufactures products A and B. Both products have a
contribution margin ratio of 40%. Information about both products follows. Product A Product B Selling
price per unit Variable cost per unit 20 $ 15 12 9 Contribution margin per unit 8 Labor time 4 minutes 2
Minutes Assume that labor time is the constrained resource and only a total of 3,000 minutes is available.
Product A has a total demand of 500 units and product B has a total demand for 600 units. Considering
the constraint, how many units of product B should be produced to maximize profits? O 500 units 450
units O 550 units O 600 units.
Q: break-even units,
A: Weighted average contribution margin = (Contribution margin of Product A * Weight of Product A) +…

Q: Based on the below examples (1&2), how can I figure out which contribution margin is needed to…
A: 1. Contribution Margin Per Unit = Sales x (1 - variable cost %) = 28 per unit x (1 - 0.65) = $9.80…

Q: Two different product lines are produced and sold by BANANABA Manufacturing Corp. Data with
respect…
A: a) Contribution margins Banana = C1 = 10-5 = 5 Babana = C2 = 4 -2 =2 Weighted average contribution…

14
Q4. Part E43 is used in one of Ran Corporation's products. The company's Accounting Department
reports the following costs of producing the 12,000 units of the part that are needed every year.
Per Unit $4.50 $1.20 $2.70 $3.00 $2.30 $1.80 Direct materials. Direct labor Variable
overhead... Supervisor's salary Depreciation of special equipment. Allocated general overhead. An
outside supplier has offered to make the part and sell it to the company for $14.70 each. If this
offer is accepted, the supervisor's salary and all of the variable costs, including direct labor, can
be avoided. The special equipment used to make the part was purchased many years ago and has no
salvage value or other use. The allocated general overhead represents fixed costs of the entire
company. If the outside supplier's offer were accepted, only $5,000 of these allocated general
overhead costs would be avoided. What is the relevant cost to make the part? State answer in
total dollars NOT per unit and as a positive number.
Question
1. What is the relevant cost to make the part? State answer in total dollars NOT per unit and as a
positive number. 2. Should Ran Corporation make the part? 3. What should Ran ignore? Why? 4. What
would be the impact on total Net Income if Ran Corporation accepted the supplier's offer? Show a
negative for a loss, positive for a gain.

Transcribed Image Text:Part E43 is used in one of Ran Corporation's products. The company's
Accounting Department reports the following costs of producing the 12,000 units of the part that are
needed every year. Per Unit $4.50 $1.20 $2.70 $3.00 $2.30 $1.80 Direct materials. Direct labor.
Variable overhead... Supervisor's salary Depreciation of special equipment. Allocated general overhead.
An outside supplier has offered to make the part and sell it to the company for $14.70 each. If this
offer is accepted, the supervisor's salary and all of the variable costs, including direct labor, can be
avoided. The special equipment used to make the part was purchased many years ago and has no salvage
value or other use. The allocated general overhead represents fixed costs of the entire company. If the
outside supplier's offer were accepted, only $5,000 of these allocated general overhead costs would be

15
avoided. What is the relevant cost to make the part? State answer in total dollars NOT per unit and as a
positive number.
Eg.3 Travers Company is contemplating the acceptance of a special order has the following unit cost
behavior, based on 10,000 units (the total capacity of their factory). Travers Company is presently
manufacturing 7000 units in their factory. Direct Materials $5 Direct Labor $11 Variable Overhead $9
Fixed Overhead $6 Poppins Company wants to purchase 2,000 units at a special unit price of $33. The
normal price per unit is $40. In addition, a special stamping machine will have to be purchased for $4,992
in order to stamp the company's logo on the product. What is the amount of the incremental income (loss)
from accepting the order? (your answer should be the total incremental profit or loss for ALL 2000
units, not just one unit) If your answer is a loss, put a minus sign in front of your answer. Input your
answer without dollar signs or commas. DON'T ROUND ANY NUMBER EXCEPT YOUR FINAL ANSWER.
Travers Company is contemplating the acceptance of a special order has the following unit cost
behavior, based on 10,000 units (the total capacity of their factory). Travers Company is presently
manufacturing 7000 units in their factory. Direct Materials $5 Direct Labor $11 Variable Overhead
$9 Fixed Overhead $6 Poppins Company wants to purchase 2,000 units at a special unit price of
$33. The normal price per unit is $40. In addition, a special stamping machine will have to be
purchased for $4,992 in order to stamp the company's logo on the product. What is the amount of
the incremental income (loss) from accepting the order? (your answer should be the total
incremental profit or loss for ALL 2000 units, not just one unit) If your answer is a loss, put a
minus sign in front of your answer. Input your answer without dollar signs or commas. DON'T
ROUND ANY NUMBER EXCEPT YOUR FINAL ANSWER.

16
Question
Transcribed Image Text:Travers Company is contemplating the acceptance of a special order has the
following unit cost behavior, based on 10,000 units (the total capacity of their factory). Travers Company
is presently manufacturing 7000 units in their factory. Direct Materials $5 Direct Labor $11 Variable
Overhead $9 Fixed Overhead $6 Poppins Company wants to purchase 2,000 units at a special unit price of
$33. The normal price per unit is $40. In addition, a special stamping machine will have to be purchased
for $4,992 in order to stamp the company's logo on the product. What is the amount of the incremental
income (loss) from accepting the order? (your answer should be the total incremental profit or loss for
ALL 2000 units, not just one unit) If your answer is a loss, put a minus sign in front of your answer. Input
your answer without dollar signs or commas. DON'T ROUND ANY NUMBER EXCEPT YOUR FINAL
ANSWER. rch ASUS f8 f9 f10 f11 f12 f6 X & 3 4. 5 6.
Eg 4- Question: 
BHO Manufacturing Corp. Is Using 10,000 Units Of Part No. 300 As A Component To Assemble One Of
Its Products. It Costs The Company $18 Per Unit To Produce It Internally, Computed As Follows: Direct
Materials $ 45,000 Direct Labor 50,000 Variable Overhead 40,000 Fixed Overhead 45,000 Total Cost
$180.000 An Outside Vendor Has Just Offered To Supply The Part
This problem has been solved!
See Answer

17
Transcribed image text: BHO Manufacturing Corp. is using 10,000 units of part no. 300 as a component
to assemble one of its products. It costs the company $18 per unit to produce it internally, computed as
follows: Direct materials $ 45,000 Direct labor 50,000 Variable overhead 40,000 Fixed overhead 45,000
Total cost $180.000 An outside vendor has just offered to supply the part for $16 per unit. If the
company stops producing this part, one-third of the fixed overhead would be avoided. Should the company
make or buy? Make. It's 15,000 cheaper to make internally. Buy. It's 15,000 cheaper to buy from the
vendor. Buy. It's 10,000 cheaper to buy from the vendor. Make. It's 10,000 cheaper to make internally.
Eg5. Make or Buy Decision Meaning
A Make or Buy Decision is a decision made to either manufacture a product/ service in house or buy it
from outside suppliers (outsourcing) based on cost-benefit analysis. A complete or accept decision can be
made using quantitative or qualitative research and most of the time, the results of quantitative analysis
(cost-benefit analysis) are enough to decide on whether to make the product in-house or buy (outsource)
from outside suppliers.
How Does Make or Buy Decision Work?
The decision applies to both goods and services. Businesses compare the cost and benefits of producing
the goods or services within the company and the cost and benefits of getting an outside supplier to
supply the goods and services into consideration. The value here must include all the fees associated with
manufacturing (including material, labor, cost of machinery and space), storing, moving, taxes, etc. and
the corresponding benefits must include benefits in terms of increased margins (for in-house production)
or low capital requirement (for outsourcing).

18
 Analysis for Make or Buy Decision
Let’s discuss the analysis of make or buy decisions.
 Under quantitative analysis, businesses consider all the costs associated with producing the product or
service in-house. These costs include buying and maintaining equipment, cost of the premises (lease, etc.),
raw material cost, conversion cost, cost of fuel and electricity, labor cost, warehousing or storage cost,
shipping cost, and the cost of capital. The benefits include higher margins from in-house production.
 The cost associated with outsourced production includes the product and service, transportation,
warehousing, and storage and labor costs for managing the logistics.
 The decision becomes a little straightforward if the company does not have an idle capacity to produce
the product or service. In this case, the management can opt to hire an outside supplier considering that
it is not of critical importance, and the firm’s intellectual property is not endangered.
 Considering the company has the idle capacity, and it is already incurring a large part of fixed expenses,
it can choose to manufacture in the house if the marginal cost of manufacturing is less than what it will
cost to buy from outside suppliers.
Examples of Make or Buy Decision
Lest discuss examples of make or buy decisions for better understanding.
Make or Buy Decision Example #1
As stated earlier, there may be some factors at play that may influence a company’s company’s decision to
make an item in the house or outsourcing it.
Under such circumstances, two factors are to be considered:
1. Whether surplus capacity is available and
2. The marginal cost of per unit manufacturing
Assume a company is deciding between manufacturing a part in-house that costs $26 per unit, including
direct cost, fixed overheads, and variable overheads, as given in the table below.

Cost Head Cost per Unit ($)

Direct Cost 15

Fixed Overhead 4

Variable Overhead 7

Total Cost 26

The same part is available in the market at $23 per unit, including the cost of buying, shipping, and
warehousing, as shown in the table below.

Cost Head Cost Per Unit ($)

Cost of Part 20

Shipping and Warehousing Cost 3

19
 Cost Head Cost Per Unit ($)

Total Cost 23

Should the Firm Make or Buy the part?

Analysis
If surplus capacity available will remain idle if the component is bought, out of pocket expenses will be
$23 per unit, $1 more than the variable and direct cost of making component which is $22 ($15 + $7).
Hence it is economical to make it. However, if the Firm is utilizing or can utilize the capacity in making
some other part which contributes to say $4 per unit in profits, the effective cost of buying the
component will be $19 ($23 less $4 contribution from other products). In that case, it would be
economical to buy the Component at $23 per unit from outside.
The relevant calculation for making decision may be as follows:

Per Unit Cost Buy & Buy and Use Capacity

Make
Particulars Leave for
($)
Capacity Idle ($) Other Product ($)

Cost of Making/Buying 22 23 23

Contribution from other

– – 4
Product

Net Relevant Cost 22 23 19

Make or Buy Decision Example #2

The smartphone giant Apple Inc. outsources the manufacturing of all its devices to China because
manufacturing is not its core competency. It is also significantly cheaper to assemble the tools in China
due to substantially lower costs. Apple designs its produces in its office in the United States; the
products are then manufactured in China and shipped back to the United States and other countries for
sales.
Factors Considered for Make or Buy Decision
The following are the major factors considered while deciding to make the good or service in-house.
 
 Cost concerns (when it is expensive to outsource)
 Desire to enhance the manufacturing focus
 Intellectual property concerns
 Quality concerns
 Unreliable suppliers
 The need for direct quality control over the product
 Emotional reasons (for example, pride)
 Absence/shortage of competent suppliers
 Insignificant volume for a prospective supplier
 Reduction of shipping and transportation costs

20
 For maintaining a backup source
 Environmental reasons
 Political reasons
The following are the major factors considered while deciding to buy the good or service from the
outside supplier.
 
 Lack of expertise
 Research and specialized know-how of the supplier better than the buyer
 Cost considerations (cheaper to buy the item)
 Insufficient or no manufacturing capacity at the buyer’s end
 De-Risking the sourcing
 Low-volume requirements
 The supplier is more equipped than the buyer
 Procurement and inventory considerations
 Product or service not essential to the firm’s strategy
 Preference of Brand
Advantages of Make or Buy Decision
Some of the advantages of making or buy decisions are as follows:
 The finding helps choose the most efficient option to go about in-house production of outsourcing.
 The decision helps in the strategic maneuver of the business.
 The decision helps save the cost for many businesses.
 Businesses benefit from the lower cost of mistakes if they think strategically about this decision.
Conclusion
The make or buy decision should be taken with utmost care keeping the long-term and short-term
benefits into consideration. There are pros and cons to both make and purchase; however, generally,
businesses tend to outsource function where they do not have a core competency or when the cost of
procuring the components or services from outside suppliers is significantly cheaper.
Eg6. Make-or-Buy Decision
Make-or-Buy decision (also called the outsourcing decision) is a judgment made by management whether
to make a component internally or buy it from the market. While making the decision, both qualitative and
quantitate factors must be considered.
Examples of the qualitative factors in make-or-buy decision are: control over quality of the component,
reliability of suppliers, and impact of the decision on suppliers and customers, etc.
The quantitative factors are actually the incremental costs resulting from making or buying the
component. For example: incremental production cost per unit, purchase cost per unit, production capacity
available to manufacture the component, etc.
The following example illustrates the numerical part of a simple make-or-buy decision.
Example
The estimated costs of producing 6,000 units of a component are:
Per Unit Total
Direct Material $10 $60,000
Direct Labor 8 48,000
Applied Variable Factory 9 54,000
21
Overhead
Applied Fixed Factory Overhead 12 72,000
$1.5 per direct labor dollar
$39 $234,000
The same component can be purchased from market at a price of $29 per unit. If the component is
purchased from market, 25% of the fixed factory overhead will be saved.
Should the component be purchased from the market?
Solution
Per Unit Total
Mak
Buy Make Buy
e
Purchase Price $29 $174,000
Direct Material $10 $60,000
Direct Labor 8 48,000
Variable Overhead 9 54,000
Relevant Fixed Overhead 3 18,000
Total Relevant Costs $30 $29 $180,000 $174,000
Difference in Favor of Buying $1 $6,000
by Irfanullah Jan, ACCA and last modified on May 10, 2013
Make or Buy Decision: Factors, Criteria and Analysis
Article shared by :  <="" div="" style="margin: 0px; padding: 0px; border: 0px; outline:
0px; font-size: 16px; vertical-align: bottom; background: transparent; max-width: 100%;">
ADVERTISEMENTS:
After reading this article you will learn about:- 1. Introduction to Make or Buy Decision 2. Factors Considered
for Make or Buy Decision 3. Criteria 4. Analysis 5. Procedure and Personnel Involved 6. Checklist.
Introduction to Make or Buy Decision:
Make or buy is a valid consideration in any cost reduction or product improvement programme. Advantages and
disadvantages of possible alternatives should be evaluated and the choice that identifies the minimum cost
makes for the final decision.
Make:
ADVERTISEMENTS:
It requires appropriate production equipment, suitable personnel, material, adequate space, supervision, design
standards and involves overheads, maintenance, taxes, insurances, management attention and other indirect
and hidden costs.
It provides work for idle equipment and personnel utilise scrap material, shorten delivery period, permits strict
adherence to the raw material specification and quality of final product. It ensures continuity of supply, may
cost less than purchase and keep design and research information secret.
Buy:
Permits lower investment in facilities, smaller labour force, less handling, lower plant cost for building and
upkeep, less overhead or taxes, insurance and supervision and less problems of man-management relations.
ADVERTISEMENTS:
Buy permits specialisation, allows manufacture by most efficient equipment, lowers inventories, change of
design without loss of investment in equipment or inventory, obtaining best price of product, and supplying
more varied experience and encourages growth of ancillaries.
Whether to make or buy is sometimes referred as a purchasing function, though the decision whether to make
components in one’s own factory or to buy them from market is a top management policy matter.

22
Theoretically, a company has choice of three alternatives before starting for a new product:
1. Purchase the product complete from a contracted manufacturer.
ADVERTISEMENTS:
2. Purchase some components and materials, and manufacture and assemble the balance in its own plants.
3. Manufacture the product completely, starting with the extraction of basic raw materials.
In practice, almost no company considers the third alternative. Some companies choose the first alternative and
obtain a new product completely from another company. These companies usually have no manufacturing units,
but sell the product under their trade marks.
But in general, most of the companies make certain components of a product and buy others. The companies
may buy a component from outside in semi-finished or complete state or buy the raw material only.
Factors Considered for Make or Buy Decision:
ADVERTISEMENTS:
Factors Considered for Buying:
1. What quantities are involved?
2. Will drawings need modification?
3. Whether jigs, tools, gauges are loaned?
ADVERTISEMENTS:
4. Will demand be temporary or permanent?
5. Will demand fluctuate?
6. Are special manufacturing techniques involved?
7. Is there any question of secrecy?
ADVERTISEMENTS:
8. Is there a likely market elsewhere?
9. Are frequent design changes likely?
10. Arrangement for inspection, sampling etc.
11. Retention of own production personnel.
ADVERTISEMENTS:
12. What notice of termination is required?
Factors Considered for Manufacturing:
1. Are patents or copy rights involved?
2. If so, what are the royalties?
3. Have the best prices been obtained?
4. Are the quantities optimized?
ADVERTISEMENTS:
5. Is the previously contracted firm already making something similar which could be added to the new item,
thus reducing production cost?
6. Techniques of production may be special.
7. Is raw material readily available?
8. If free material to be provided?
9. Will any tax be involved?
Criteria for Make or Buy Decision:
Companies prefer own manufacturing and buying only raw material or semi-finished parts.
ADVERTISEMENTS:
Such decision is made in the following cases:
1. Finished product can be made cheaply by the firm than that by the outside suppliers.
2. Finished product only is manufactured by limited number of outside firms, which are unable to meet the
demand.
3. The part has an importance for the firm, and requires extremely close quality control.
4. The part can readily be manufactured with the firm’s existing facilities and the part is similar to other items in
which the company has manufacturing experience.
5. Requires high investment on facilities, which are not available at supplier’s plant.
ADVERTISEMENTS:
6. Has a demand that is both stable and relatively large.
23
Companies will usually buy a finished part from an outside supplier when:
1. They do not have facilities to make it and there are other profitable opportunities for investing company
capital.
2. Existing facilities can be used more economically to make other parts.
3. The skill of personnel employed by company is not readily available to manufacture the part.
4. Patent or other legal barriers prevent the company for making the part.
ADVERTISEMENTS:
5. Demand for the part is either temporary or seasonal.
Analysis for Make or Buy Decision:
There are three types of analysis:
1. Simple cost analysis.
2. Economic analysis.
3. Break-Even-Point analysis.
1. Simple Cost Analysis:
ADVERTISEMENTS:
A make or buy cost analysis involves a determination and comparison of the cost to make the part and the cost
to buy it. The final make or buy decision must be based on a careful weighing of the cost considerations and
various quantitative considerations.
The most difficult make-buy factors to assess are those that will significantly be affected by change in economic
conditions, technological advancement, growth of the firm, or changes in the labour management relations in
the future. Studies show that more mistakes are made in making what could be more profitable to bought than
in buying what could more profitable to be made.
Following major elements should be involved in a ‘make or buy’ cost estimate:
To make:
1. Delivered purchased material costs.
2. Direct labour costs.
3. Any follow-on costs.
4. Incremental inventory carrying costs.
5. Incremental factory overhead costs.
6. Incremental purchasing costs.
7. Incremental managerial costs.
8. Incremental costs of capital.
To buy:
1. Purchase price of the part.
2. Transportation costs.
3. Receiving and inspection costs.
4. Incremental purchasing costs.
5. Any follow-on cost related to quality or service.
To get a clear picture, analyst must carefully evaluate these costs considering the effects of time and capacity
utilisation. Cost figures must include all relevant costs, direct and indirect, and they must reflect the effect of
anticipated cost changes. Since it is difficult to predict future cost levels, estimated average cost figures for the
total time period in question are generally used.
Example 1:
Suppose a supplier has the following unit cost of a part:

24
If the company likes to make this item rather than buy it could reduce the cost of part from Re. 0.60 to Re. 0.42.
If the company has idle equipment that can be used to make the part and have maximum overhead expense of
Re. 0.12 per unit. Further, if the company invests on additional facilities to make the part with the normal
overhead, in that case if the cost of unit is equal to Re. 0.54 then it is worthwhile to make the part.
Example 2:
A detailed simple cost analysis is as follows:

25
On the basis of above cost analysis it is quite clear that the decision must be in favour of buying the part.
2. Economic Analysis:
(a) Buying:
As we know that economic purchase (ordering) quantity is equal to √2AP/C
or Q = √2AP/C
and also we know total cost = Procurement cost/year + Inventory cost per year
Total cost = A × P/Q + Q x C/2
This can further be modified by adding purchase cost/year.
Thus Total cost = A × I + A × P/Q + Q x C/2
where A = Total demand per year
P = Procurement cost per order
C = Annual carrying cost per item/year
Q = Economical purchase (ordering) quantity
I = Purchase price of one unit.
26
(ii) Making:
Further, it can be found out that economical production quantity is equal to

and Total cost = A × I + A × S/Q1 + C(R – A) Q1/2R

where A = Total demand per year
S = Set up cost per lot
C = Annual carrying cost per item/year
Q1 = Economical production quantity
I = Production cost per unit
R = Production rate.
By using above mentioned formulas, an economic analysis can be made in respect of make or buy decision.
This can be understood easily with the help of the following example:
Example 3:
Suppose an item has yearly demand of1000 units.
The different costs regarding make and buy are as follows:

Solution:
(a) Buying:
Economical purchase quantity = Q

Now, calculating the total cost with the help of formula,

Total cost = A × I + A × P/Q + Q × C/2
For different purchase quantities, total cost is calculated, and shown in, Table 37.1.

(b) Making:

27
Similarly while making we have

and total cost table is prepared with the help of formula

Total cost = A × I + A × S/Q1 + C(R – A) Q1/2R

Now plotting the two tables on a graph as shown below.

The decision to buy or make may be made by analysing the minimum cost for each alternative. In this example,
to buy will be the choice as by choosing this we can have saving of Rs. 66 (Rs. 6228 – Rs. 6162) per year.
Such analysis may be used for comparing alternative manufacturing facilities, or to evaluate alternate suppliers.

3. Break-even Analysis:
The decision regarding make or buy can easily be made with the help of break-even-point theory.
How the decisions are made using this theory can be easily understood with the help of
following example:
Example 4:
A manufacturer of motor cycles buys spark plugs at Rs. 8 each. In case he makes it himself, the fixed and
variable costs would be Rs. 10,000 and Rs. 3 per spark plug respectively. Should the manufacturer make or buy
the spark plugs?
Solution:
1. Mathematical Method:
Break-even-point (B.E.P.)
= Fixed cost/Purchasing price – Variable price
= 1000/8-3 = 2000 spark plugs
Thus if the manufacturer needs more than 2000 spark plugs per year, to make is more profitable than to buy.
2. Graphical Method:
A break-even chart is drawn for solving the problem as shown in Fig. 37.2. Draw horizontal line AB at a distance
to show the fixed cost involved in making a spark plug. Draw the line AC for the variable cost to make the part.
When no spark plug is made there is no variable cost and when 4,000 spark plugs will be made the variable cost
28
is Rs. 12,000. Thus the line starts from A and end at B, where total cost is equal to Rs. 10000 + 12000 = Rs.
22,000.

Draw line OD for the cost of buying the spark plug, at point A the cost of no spark plug is zero, whereas for 4000
spark plugs the cost is 8 × 4000 = Rs. 32,000.
We see that break-even-point is P, and OQ is the quantity at BEP. Thus beyond Q (2000 spark plugs) it would
be cheaper to make the spark plugs than buy them. Below Q (2000 spark plugs) it would be cheaper to purchase
the spark plug than to make them.
Break-Even Point Theory:
The break-even point of any two variable situations is the point or the value at which they become equal as a
result of a common variable.
There are following two methods to obtain break-even point:
(a) Mathematical method.
(b) Graphical method.
(а) Mathematical method:
Let cost be the common variable in two situations 1 and 2, then cost equations will be
c1 = f1 (x)……. a function of (x) …(1)
c2 = f2 (x)…… another function of (x) …(2)
c1 — May be as total cost, annual cost, cost per item or cost per day etc. for situation 1.
c2— Same as c1 but application to situation 2.
x—a variable effecting c1 and c2.
To solve for the value of x, let c1 = c2
i.e. f1(x) = f2(x) …(3)
Equation (3) can be solved for obtaining the value of x. The value of x making the cost equal in both the
situations is called “Break-Even Value”. Below this value of x one situation will be economical while above it
another situation will be economical.
(b) Graphical method:
Although the break-even point may be calculated mathematically but it is usually represented graphically
because it enables manager to see more clearly the break-even point and the possibilities for profits and losses.
By using these charts one can predict probable profits at various levels of output.
A break-even chart given in Fig. 37.3 is used to determine break-even point and amount of profit or loss under
varying conditions of output of costs. Sales or expenditure in rupees is represented on vertical axis, while output
(either in quantity or in percentage capacity) is represented on horizontal axis.
Line A represents the “fixed cost”, Line B represents total cost or total expenses, while line C represents sales
revenue and indicates income at various levels of output. The point where lines B and C intersect each other is
“Break-Even Point”. The space between lines B and C to the right of the “Break-Even Point” potential loss. The
amount of loss or profit can be measured on vertical scale.

29
This method can be applied to various management problems. For example, suppose a manager wants to
replace an old lathe machine being used for manufacturing screws by automatic screw machine. Then he must
first know whether it will be profitable or not, for which he must adopt break-even point theory and construct
the chart as explained in Fig. 37.4.

The figure shows that for a production less than Q, it must not be changed whereas for production more than Q
automatic machine or new machine will be economical or in other words below Q manual lathe is cheaper;
beyond Q, automatic machine is cheaper. This break-even point is also known as “cut-even point”.
Some Important Definitions:
(i) Angle of incidence:
It is the angle at which income line or sales line cuts the total cost line. If the angle is large, it is an indication
that profits are being made at a high rate, on the other hand, if the angle is a small, it indicates that less profits
are being made and are achieved under less favourable conditions.
(ii) Margin of safety:
It is the output at full capacity minus the output at “Break-Even Point”. It is expressed as percentage of output at
full capacity. If the margin of safety is small, a small drop in production capacity will reduce the profit greatly.
It can also be expressed as:

(iii) Contribution:

30
It is the difference between sales and variable cost (marginal cost). It is also called as Marginal Profit or Gross
Margin. The marginal profit provides the contribution towards fixed cost and profit.
Contribution = (Sales – Variable cost) which in turn will be equal to fixed cost + Profit.
Break-Even Point Calculations:
Let S = Sales price
V = Variable cost
F = Fixed cost
P = Profit
Now S = F + V + P
or S – V = F + P …(i)
At break-even point, P = 0
... S – V = F …(ii)
Multiplying both sides of Eq. (ii) by S.
... S(S – V) = F × S
or S = F × S/(S – V) = F/(S – V)/S = Fixed cost/Contribution per unit
and sales at B.E.P. = Rs. F × S/(S – V) …(iii)
and No. of units at B.E.P. = Fixed cost/ Contribution/unit = Fixed cost/Marginal Profit/unit …(iv)
Assumptions in Break-Even Analysis:
The various assumptions that underline in these techniques are given as under:
(i) It is assumed that over the entire range of volume of production all costs are perfectly variable.
(ii) It is assumed that over the entire range of volume of production all costs are constant fixed.
(iii) It is assumed that with the physical volume of production all revenue is perfectly variable.
(iv) The volume of sales and volume of production are equal.
(v) It is assumed that for multi-products firms, the product mix should be stable.
Whether to Add or Drop a Product Line:
In this case, following two situations which may arise should be considered:
(a) Should a new product be added in view of the estimated revenue and cost?
(b) If the product is dropped from the line, what would be the consequent effects on revenue and costs?
Example 4:
The following data from a plant is available:

Fixed cost per year = Rs. 7500

Total sales from three products = Rs. 25,000
It is decided by the management to drop the product A and add product D. To find whether the decision is
profitable or not?
Assume sales for products B, C and D as Rs. 26,000.

Solution:
Total fixed cost per year = Rs. 7500.
Sales for the current year = 25,000
Product A contribution = Rs. (10 – 6) = Rs. 4
... Contribution for 20% sales of product A = 10 – 6/10 × 0.20 = 0.08
Similarly for product B, = 6 – 4/6 × 0.30 = 0.10
and for product C = 20 – 12/20 × 0.5 = 0.20
Thus contribution ratio for product A, B and C
31
= 0.08 + 0.10 + 0.20 = 0.38
... Total contribution of sales = 0.38 × 25,000 = Rs. 9500
... Profit = Contribution—Fixed costs = 9500 – 7500 = Rs. 2000
Similarly, the profit or contribution for new product line of products D, B, C
D = 16-6/16 × 10% = 0.06
B = 6 – 4/6 × 0.50 = 0.17
C = 20 – 12/20 × 0.40 = 0.16
... Total contribution ratio = 0.06 + 0.17 + 0.16 = 0.39
... Total contribution from sales = 26,000 × 0.39 = Rs. 10,140
... Profit = 10,140 – 7500 – Rs. 2640.
Hence proposed decision is profitable to accept.
Procedure and Personnel Involved in Make or Buy Decision:
As already said that make-buy decision is a purchase function, but by no means for such decision the material or
purchase manager is wholly responsible.
Since such decisions can shape the company’s future for years to come, such decisions are always reviewed by
the managers of the company. Variable factors that influence make-buy decisions are engineering factors,
labour factors, material factors, space and facility factors. For decision making different experts from these
fields should be consulted. A checklist as given below is quite useful in making such decisions.
Checklist for Make-Buy Decision:
1. Engineering Factors:
(i) If the product is adequately engineered?
(ii) Availability;
(a) Drawings
(b) Blueprints
(c) Specifications
(d) Bill of materials
(e) Sample, if required
2. Labour Factors:
(i) If additional manpower is needed?
(ii) If special training is needed?
(iii) If cost of tooling is considered?
(iv) If work standards are prepared?
(v) If process required for manufacturing is written?
3. Material Factors:
(i) Level of confidence in material prices.
(ii) Whether delivery dates are available?
(iii) Whether material handling has been considered?
(iv) Whether storage facilities have been considered?
(v) Whether purchasing of raw material has been considered?
(vi) Whether scrap allowance has been considered?
4. Space and Facility Factors:
(i) If capital requirement has been considered?
(ii) If space availability has been considered?
(iii) Whether necessary utilities are available?
From the managerial point of view, a systematic procedure for making such decisions should be adopted.
Such procedure should have following five requisites:
1. Provide adequate information to the decision maker.
2. Ensure that the decision maker have the background necessary to recognize and evaluate relevant data.
3. Provide a systematic way, so that proper investigation may be done.
4. Ensure that properly maintained records should be kept for future use.
5. Establish a high powered audit for all important projects after taking decision.

32
 What is a Variable Cost?
Variable overhead costs are costs that change as the volume of production changes or the
number of services provided changes. Variable overhead costs decrease as production output
decreases and increase when production output increases. If there is no production output, then
there would be no variable overhead costs. VC = TC – FC
Variable Cost Formula Since a company’s total costs (TC) equals the sum of its variable (VC) and fixed
costs (FC), the simplest formula for calculating a company’s VCs is as follows. VC = TC – FC More
specifically, a company’s VCs equals the total cost of materials plus the total cost of labor, which are the
two main types.
A Variable Cost is output-dependent and subject to fluctuations based on the production output, so
there is a direct linkage between variable costs and production volume.

How to Calculate Variable Costs (Step-by-Step)

Variable costs are connected to a company’s production volume, i.e. the relationship between these costs
and production output is directly linked.
Unlike fixed costs, these types of costs fluctuate depending on the production output (i.e. the volume) in
a given period. Since costs of variable nature are output-dependent, the costs incurred increase (or
decrease) given varying production volumes.
Variable costs are directly tied to a company’s production output, so the costs incurred fluctuate
based on sales performance (and volume).
If product demand (and the coinciding production volume) exceed expectations — in response, the
company’s variable costs would adjust in tandem.
 Increased Production Output → Greater Variable Costs
 Decreased Production Output → Reduced Variable Costs
As more incremental revenue is produced, the growth in the VCs can offset the monetary benefits from
the increase in revenue (and place downward pressure on the company’s profit margins).
Variable Cost vs. Fixed Cost: What is the Difference?
The differences between variable vs. fixed costs are as follows:

33
 Variable Costs → the amount incurred is directly tied to production volume and fluctuates based on
the output in the given period.
 Fixed Costs → the amount incurred remains the same regardless of production volume.
From the viewpoint of management, costs classified as “variable” are easier to adjust and are more in
their control, while fixed costs must be paid regardless of production volume.
Fixed costs encompass a company’s obligations irrespective of the production output (e.g. rent,
insurance premium) and occur periodically based on a pre-determined schedule, and are usually easier to
predict and budget for.
In contrast, costs of variable nature are generally more difficult to predict, and there is usually more
variance between the forecast and actual results. The amount incurred is directly tied to sales
performance and customer demand, which are variables that can be impacted by “random” factors (e.g.
market trends, competitors, customer spending patterns).
For example, a company executive’s base salary would be considered a fixed cost because the dollar
amount owed by the company is outlined in an employment contract signed by the relevant parties.
But the bonus portion of the executive’s compensation is “variable” since the bonus is performance-based
compensation and contingent on the company reaching certain targets thresholds on performance metrics
such as:
 Share Price
 Revenue
 Profit Margin e.t.c
Variable Cost Formula
Since a company’s total costs (TC) equals the sum of its variable (VC) and fixed costs (FC), the simplest
formula for calculating a company’s VCs is as follows.
VC = TC – FC
More specifically, a company’s VCs equals the total cost of materials plus the total cost of labor, which
are the two main types.
VC = Total Cost of Materials + Total Cost of Labor
Alternatively, a company’s VCs can also be calculated by multiplying the cost per unit by the total number
of units produced.
VC = VC per Unit × Total Number of Units Produced ( VC=(VC/Q X Qt)
Variable Cost per Unit Formula
The average VC — also known as the “variable cost per unit” — equals the total VCs incurred by a
company divided by the total output (i.e. the number of units produced)
Average VC = Total VC ÷ Output-> AVC= VCT/Q
E.g. Calculating the average variation can be useful when it comes to assessing how variable costs are
changing (i.e. rising or declining) as the company continues to grow, and ensures there are no
inefficiencies where the VCs offset the benefit of higher output. Suppose that a consulting company
charged 1,000 hours of services to its clientele.
If the total VCs incurred were $100,000, the VC per unit is $100.00 per hour.
 VC Per Unit(Q) = $100,000 Total VC ÷ 1,000 Hours = $100
If the consulting company continues to scale and the number of clients (and hours billed) increases, the
variable costs also increase — which can place downward pressure on the company’s profit margins.
(I.e. requiring more hiring and a more complex organizational structure).
34
 Variable Cost Examples
 Direct Labor
 Direct Material Cost (e.g. Raw Material)
 Sales Commissions
 Management Bonuses
 Employee Stock-Based Compensation
 Shipping Costs
For example, in the case of an e-commerce company, the delivery and shipping fees associated with each
sale would be classified as a variable cost, while utilities would be a fixed cost.
If a higher volume of products is produced, the amount of delivery and shipping fees also incurred
increases (and vice versa) — but utility costs remain constant regardless.
Operating Leverage Considerations
Operating leverage is defined as the proportion of a company’s total cost structure comprised of fixed
costs.
 High Operating Leverage → Higher Proportion of Fixed Costs.
 Low Operating Leverage → Lower Proportion of Fixed Costs
If a company has low operating leverage — i.e. a higher percentage of variable costs — then each
incremental dollar of revenue can potentially generate lower profits because variable costs would offset
any increases in revenue.
However, the risk associated with high operating leverage is that if customer demand and sales are
lackluster, then the company is restricted in terms of potential areas for cost-cutting.
In effect, a company with low operating leverage can be at an advantage during economic downturns or
periods of underperformance.
Since variable costs are tied to output, lower production volume means fewer costs are incurred, which
eases the cost pressure on a company — but fixed costs must still be paid regardless.
Impact on Break-Even Point (BEP)
The break-even point refers to the minimum output level in order for a company’s sales to be equal to its
total costs.
Break-Even Point = Fixed Costs ÷ Contribution Margin
Suppose a company’s cost structure consists of mostly variable costs — in that case, the inflection point
at which a company starts to turn a profit is lower (i.e. compared to those with higher fixed costs).
The higher the percentage of fixed costs, the higher the bar for minimum revenue before the company
can meet its break-even point.
High operating leverage can benefit companies since more profits are obtained from each incremental
dollar of revenue generated beyond the break-even point.
However, below the break-even point, such companies are more limited in their ability to cut costs
(since fixed costs generally cannot be cut easily). Variable Costs
Costs that vary depending on the volume of activity.
Fixed Cost Definition
Fixed Cost is the cost or expense that is not affected by any decrease or increase in the number of units
produced or sold over a short-term horizon. In other words, it is the type of cost that is not dependent
on the business activity but is rather associated with a period.

35
 It can be seen as expenses incurred by a company irrespective of the level of business activity, which
may include the number of units produced or sales volume achieved. Fixed cost is one of the two major
components of the total cost of production. The other component is the variable cost. Examples are
monthly rental paid for accommodation, salary paid to an employee, etc. However, please note that such
cost is not permanently fixed but changes over time.
Fixed Cost Formula
We can derive this formula by deducting the product of variable cost per unit of production and the
number of units produced from the total cost of production.
Fixed Cost Formula = Total Cost of Production – Variable Cost per Unit * No. of Units Produced
Examples
 Leasing office space is a fixed cost. As long the business operates in the same space, the lease or rent
cost remains the same.
  Utility bills like heating or cooling as per the season changes are another cost not affected by the
change in business operations.
 When a company registers itself on a website domain, a monthly charge is to be paid that remains fixed
irrespective of the activities performed on the website.
 When a company registers itself on a website domain, a monthly charge is to be paid that remains fixed
irrespective of the activities performed on the website.
 When a company integrates its e-commerce platforms with the website to continue communications and
transactions with its customers, there are charges levied for this integration, which are payable monthly.
 When a business starts its operations, then it leases or rents warehouse space whose charge is payable
monthly. This charge does not change even if the business decides to store more or fewer products,
keeping in mind the storage and capacity limits. This warehouse rent is a fixed cost.
 The equipment purchased to produce the products belongs to the business once purchased, which
depreciates over time. Depreciation costs are considered when the company is aware of what time the
equipment needs to be replaced every year.
 Companies hire trucks as per their logistics, and leases on trucks are fixed, which do not change
depending on the number of shipments the company undertakes.
 If a business does its financing with the help of bank loans, then loan payments remain the same
irrespective of the business’s performance. The loan repayment amount is fixed as long as a balance is
paid on that loan.
 Health insurance for a business is fixed as the recurring costs to the insurer are fixed.
Step by Step Calculation of Fixed Cost
Example #1
Let us take the example of company ABC Ltd, a toy manufacturing unit. According to the production
manager, the number of toys manufactured in April 2019 is 10,000. The total cost of production
for that month as per the accounts department stood at $50,000. Calculate the fixed cost of
production if the variable cost per unit for ABC Ltd is $3.50.
Solution:
Given,
 Variable cost per unit = $3.50
 Total cost of production = $50,000
 Number of units produced = 10,000
36
 Cost of production of ABC Ltd for April 2019 can be calculated as,
= $50,000 – $3.50 * 10,000
FC = $15,000
Example #2
Let us take another example of company XYZ Ltd, a shoe manufacturing unit. According to the
production manager, the production information is available for March 2019 is as follows:
 Raw material cost per unit is $25
 Total number of shoe manufacturer is 1,000
 Labor charge is $35 per hour
 Time taken to produce a shoe is 30 minutes
 The total cost of production is $60,000
Calculate the Fixed Cost of production for XYZ Ltd in March 2019.
Solution:
Given,
 Total cost of production = $60,000
 Raw material cost per unit = $25
 Labor cost per hour = $35 per hour
 Time taken to produce a unit = 30 min = 30 / 60 hours = 0.50 hours
 Number of units produced = 1,000
So, the calculation of variable cost per unit will be –

Variable Cost per Unit = Raw Material Cost per Unit + Labour Cost per Hour * Time is Taken to
Produce a Unit (in hours)
Variable Cost per Unit = $25 + $35 * 0.50
Variable Cost per Unit = $42.50
Therefore, the FC of production of XYZ Ltd for the month of March 2019 can be calculated as,
= $60,000 – $42.50 * 1,000
FC = $17,500
Therefore, the FC of production of XYZ Ltd for the month of March 2019 is $17,500.
Please refer given excel template above for detail calculation.

37
 Advantages
 Fixed costs remain at the same level throughout a company’s production process unless any major capital
expenditure is undertaken. For instance, if a company purchases and installs a machine, post that the
company will charge depreciation expense every year irrespective of the level of production.
 It is relatively easier to account for this cost because it does not change in line with the volume of goods
produced or sold.
  Although it does not change with an increase in production volume, per-unit fixed cost decreases, which
is an encouragement for the production team to produce more;
 Production output and costs typically remain the same for a relevant output range.
 It reduces a company’s net income for the accounting period in reduced tax liability, which eventually
cascades to cash savings.
 Cost intensive industries act as a barrier to new entrants or eliminate smaller competitors; it discourages
new competitors from making an entry into the market.
Disadvantages
 One of the major disadvantages is the surge in per-unit fixed cost if a company fails to operate at a
certain minimum production rate. If a company has a large number of such costs, then a fall in production
or sales volume can squeeze the profit margins.
 It is very tough to find any direct relationship between the product and the fixed cost if the company is
into multiple products. As such, at times, the allocation or apportion of cost is done based on the
profitability of each division, which can result in wrong financial productivity measurement.
Conclusion
It can be seen from the above explanations that “fixed cost” is very stable and does not change over
some time. However, higher production or sales volume can result in better absorption of fixed costs,
resulting in improved profitability. As such, it is important to understand the concept of fixed assets as
it can be crucial in achieving profitability targets.
Cost Allocation
The process of identifying, accumulating, and assigning costs to costs objects
What is Cost Allocation?
Cost allocation is the process of identifying, accumulating, and assigning costs to costs objects such as
departments, products, programs, or a branch of a company. It involves identifying the cost objects in a
company, identifying the costs incurred by the cost objects, and then assigning the costs to the cost
objects based on specific criteria.

38
When costs are allocated in the right way, the business is able to trace the specific cost objects that are
making profits or losses for the company. If costs are allocated to the wrong cost objects, the company
may be assigning resources to cost objects that do not yield as much profits as expected.
Types of Costs
There are several types of costs that an organization must define before allocating costs to their
specific cost objects. These costs include:
1. Direct costs
Direct costs are costs that can be attributed to a specific product or service, and they do not need to be
allocated to the specific cost object. It is because the organization knows what expenses go to the
specific departments that generate profits and the costs incurred in producing specific products or
services. For example, the salaries paid to factory workers assigned to a specific division is known and
does not need to be allocated again to that division.
2. Indirect costs
Indirect costs are costs that are not directly related to a specific cost object like a function, product, or
department. They are costs that are needed for the sake of the company’s operations and health. Some
common examples of indirect costs include security costs, administration costs, etc. The costs are first
identified, pooled, and then allocated to specific cost objects within the organization.
Indirect costs can be divided into fixed and variable costs. Fixed costs are costs that are fixed for a
specific product or department. An example of a fixed cost is the remuneration of a project supervisor
assigned to a specific division. The other category of indirect cost is variable costs, which vary with the
level of output. Indirect costs increase or decrease with changes in the level of output.
3. Overhead costs
Overhead costs are indirect costs that are not part of manufacturing costs. They are not related to the
labor or material costs that are incurred in the production of goods or services. They support the
production or selling processes of the goods or services. Overhead costs are charged to the expense
account, and they must be continually paid regardless of whether the company is selling goods or not.
Some common examples of overhead costs are rental expenses, utilities, insurance, postage and
printing, administrative and legal expenses, and research and development costs.
39
Cost Allocation Mechanism
The following are the main steps involved when allocating costs to cost objects:
1. Identify cost objects
The first step when allocating costs is to identify the cost objects for which the organization needs to
separately estimate the associated cost. Identifying specific cost objects is important because they are
the drivers of the business, and decisions are made with them in mind.
The cost object can be a brand, project, product line, division/department, or a branch of the company.
The company should also determine the cost allocation base, which is the basis that it uses to allocate the
costs to cost objects.
2. Accumulate costs into a cost pool
After identifying the cost objects, the next step is to accumulate the costs into a cost pool, pending
allocation to the cost objects. When accumulating costs, you can create several categories where the
costs will be pooled based on the cost allocation base used. Some examples of cost pools include
electricity usage, water usage, square footage, insurance, rent expenses, fuel consumption, and motor
vehicle maintenance.
What is a Cost Driver?
A cost driver causes a change in the cost associated with an activity. Some examples of cost drivers
include the number of machine-hours, the number of direct labor hours worked, the number of payments
processed, the number of purchase orders, and the number of invoices sent to customers.
Benefits of Cost Allocation
The following are some of the reasons why cost allocation is important to an organization:
1. Assists in the decision-making process
Cost allocation provides the management with important data about cost utilization that they can use in
making decisions. It shows the cost objects that take up most of the costs and helps determine if the
departments or products are profitable enough to justify the costs allocated. For unprofitable cost
objects, the company’s management can cut the costs allocated and divert the money to other more
profitable cost objects.
2. Helps evaluate and motivate staff
Cost allocation helps determine if specific departments are profitable or not. If the cost object is not
profitable, the company can evaluate the performance of the staff members to determine if a decline in
productivity is the cause of the non-profitability of the cost objects.
On the other hand, if the company recognizes and rewards a specific department for achieving the
highest profitability in the company, the employees assigned to that department will be motivated to
work hard and continue with their good performance.

What are Variable Costs?

Variable costs are expenses that vary in proportion to the volume of goods or services that a business
produces. In other words, they are costs that vary depending on the volume of activity. The costs
increase as the volume of activities increases and decrease as the volume of activities decreases.

40
The Most Common Variable Costs
 Direct materials
 Direct labor
 Transaction fees
 Commissions
 Utility costs
 Billable labor
Essentially, if a cost varies depending on the volume of activity, it is a variable cost.
Formula for Variable Costs
Total Variable Cost  =  Total Quantity of Output x Variable Cost Per Unit of Output
Variable vs Fixed Costs in Decision-Making
Costs incurred by businesses consist of fixed and variable costs. As mentioned above, variable expenses
do not remain constant when production levels change. On the other hand, fixed costs are costs that
remain constant regardless of production levels (such as office rent). Understanding which costs are
variable and which costs are fixed are important to business decision-making.
For example, Amy is quite concerned about her bakery as the revenue generated from sales are below the
total costs of running the bakery. Amy asks for your opinion on whether she should close down the
business or not. Additionally, she’s already committed to paying for one year of rent, electricity, and
employee salaries.
Therefore, even if the business were to shut down, Amy would still incur these costs until the year-end.
In January, the business reported revenues of $3,000 but incurred total costs of $4,000, for a net loss
of $1,000. Amy estimates that February should experience revenues similar to that of January. Amy’s list
of costs for the bakery is as follows:
A. January fixed costs:
 Rent: $1,000
 Electricity: $200
 Employee salaries: $500
Total January fixed costs: $1,700
B. January variable expenses:
 Cost of flour, butter, sugar, and milk: $1,800
 Total cost of labor: $500
Total January variable costs: $2,300
If Amy did not know which costs were variable or fixed, it would be harder to make an appropriate
decision. In this case, we can see that total fixed costs are $1,700 and total variable expenses are
$2,300.

41
If Amy were to shut down the business, Amy must still pay monthly fixed costs of $1,700. If Amy were
to continue operating despite losing money, she would only lose $1,000 per month ($3,000 in revenue –
$4,000 in total costs). Therefore, Amy would actually lose more money ($1,700 per month) if she were to
discontinue the business altogether.
This example illustrates the role that costs play in decision-making. In this case, the optimal decision
would be for Amy to continue in business while looking for ways to reduce the variable expenses incurred
from production (e.g., see if she can secure raw materials at a lower price).
Example of Variable Costs
Let us consider a bakery that produces cakes. It costs $5 in raw materials and $20 in direct labor to
bake one cake. In addition, there are fixed costs of $500 (the equipment used). To illustrate the
concept, see the table below:

Note how the costs change as more cakes are produced.

Break-even Analysis
Variable costs play an integral role in break-even analysis. Break-even analysis is used to determine the
amount of revenue or the required units to sell to cover total costs. The break-even formula is given as
follows:
Break-even Point in Units  =  Fixed Costs / (Sales Price per Unit – Variable Cost per Unit)
Consider the following example:
Amy wants you to determine the minimum units of goods that she needs to sell in order to reach break-
even each month. The bakery only sells one item: cakes. The fixed costs of running the bakery are $1,700
a month and the variable costs of producing a cake are $5 in raw materials and $20 of direct labor.
Additionally, Amy sells the cakes at a sales price of $30.
To determine the break-even point in units:
Break-even Point in Units = $1,700 / ($30 – $25) = 340 units
Therefore, for Amy to break even, she would need to sell at least 340 cakes a month.

42
Variable Costing Formula (Table of Contents)
 Variable Costing Formula
 Examples of Variable Costing Formula (With Excel Template)
 Variable Costing Formula Calculator
Variable Costing Formula
Variable costing is the expense that changes in proportion with production output. We can say that
expenses depend on the output with a change in the output of production input expense change. If
variable cost increases, production output also increases and if variable cost decreases, product output
also decreases. Total variable cost is equal to the quantity of output into variable cost per unit of output.
It can be expressed as:-

The main element of the variable costing formula is direct labor cost, direct material, and variable
manufacturing overhead. Fixed manufacturing cost is not included because variable costing makes the
cost of goods sold solely available.
Examples of Variable Costing Formula (With Excel Template)
Now, let us take an example to understand Variable Costing formula in a better manner.
You can download this Variable Costing Formula Excel Template here – Variable Costing Formula Excel
Template
Variable Costing Formula – Example #1
A company produces 1000 boxes at an average cost of production of one unit is $20.

The total variable cost of boxes will be:-

Total Variable Cost = Quantity of Output * Variable Cost Per Unit of Output

43
Put the values in the above formula.
 Total Variable Cost = 1000 * 20
 Total Variable Cost = $20,000
So, total variable cost of 1000 boxes is $20,000.
Total expense done in business is the sum of variable cost and fixed cost where fixed cost is fixed
irrespective of quantity manufacture or produced whereas variable cost depends on quantity produced.
Now, let us see one more example to calculate the total variable cost and its dependency on quantity.
Variable Costing Formula – Example #2
A company manufactures plastic bags, the raw material cost for production of 1 bag is $2, labor
cost for manufacturing of 1 plastic bag is $10 and fixed cost of the company is $200. Now, we will
calculate the variable cost and total cost.

 To calculate Cost of Raw Material-

Raw material costs per unit will multiple with the total quantity of plastic bag manufactured.

44
  To calculate Cost of labor –
Labor costs per unit will multiple with the total quantity of plastic bag manufactured.

 Total variable cost is the sum of labor cost and cost of raw material.

 Fixed cost is $200 irrespective of quantity.

45
  Total cost is sum of fixed cost and variable cost.

Total variable cost is calculated by multiplying the quantity of output into variable cost per unit of output
as variable cost depends on the quantity of production which will result in total variable costing of a
product. Total variable cost is variable as it depends on the quantity of the product.
Total Variable Cost = Quantity of Output * Variable cost per unit of output
Variable Cost Per Unit Formula
Variable cost per unit is the cost of one unit of production but it includes only variable cost not fixed one.
It is said variable cost per unit because it depends on the quantity of production. Variable cost per unit is
the sum of labor cost per unit, direct material per unit and direct overhead per unit.
It can be expressed as:-

 Labor cost is taken as labor cost per unit as it depends on the quantity of production.
 Direct material is the raw material cost per unit as it depends on the quantity of production. We
can say that it is directly proportional to the variable cost.
 Direct overhead is another extra cost required for the production of one unit it is variable as it
depends on the quantity of production.
Variable Cost Per Unit Formula Example
Let’s see an example to understand Variable cost per unit better.
A company named Nile Pvt. Ltd produces handmade soaps, cost of raw material per unit is $5, the
labor cost of production per unit is $7, fixed cost for a month is $500, overhead cost per unit is
$1 and salary for office and sales staff is $3,000. Total Production done by the company in one
month is 5,000 now we will calculate the cost of soap per unit.

46
Variable Cost Per Unit is calculated as:
Variable Cost Per Unit = Labor Cost Per Unit + Direct Material Per Unit + Direct Overhead per
Unit

Put a value in the above formula.

 Variable Cost Per Unit = 7 + 5 + 1
 Variable Cost Per Unit = $13
Total Variable Cost is calculated as:
Total Variable Cost = Quantity * Variable Cost Per Unit

47
  Total Variable Cost = 5000 * 13
 Total Variable Cost= $65,000
So, variable cost per unit of soap is $13 and total variable cost of soap is $65,000.
Average Variable Cost & Formula
Average variable cost is the sum of all product’s total variable cost divided by the total number of unit
produced by different products.

It helps to determine the average cost of production of a single unit of product in a company irrespective
of a type of product.
Average Variable Cost Formula Example
A company manufactures plastic boxes and plastic balls. Variable cost per unit of plastic boxes is
$8 and 10,000 boxes are manufactured by the company. Variable cost per unit of plastic balls is
$5 and 15,000 boxes are manufactured by the company.

48
As we know,
Average Variable Cost = (Total Variable Cost of Ball + Total Variable Cost of Plastic Boxes) / Total
Number of Balls and Boxes

Put the value in the above Average Variable Cost formula.

 Average Variable Cost = (8 * 10,000) + (5 * 15,000) / 10,000 + 15,000
 Average Variable Cost = $6.2
So, the average variable cost of plastic balls and boxes is $6.2.
Variable Costing in a Break-even Analysis
The break-even analysis is a vital application of variable costing. It helps to find the amount of revenue or
the units required to cover the total costs of the product. Break-even points in units are fixed cost
divided by sales price per unit minus variable cost per unit. The formula can be written as:-

Break-even Analysis Formula Example

A company produces mugs has a fixed cost of $1,500, variable cost per unit of $20 and sales price
per unit is $30, now we have to calculate break-even point of same.

As we know,
Break-even Points in Units = Fixed Cost / (Sales Price Per Unit – Variable Cost Per Unit)

49
Put the value in the formula.
 Break-even Points in Units = 1,500 /(30-20)
 Break-even Points in Units = 150 Units
So, the company needs to sell 150 units of mugs to make the profit.
Significance and Uses of Variable Costing Formula 
There are many uses of variable costing formula they are as follows:-
 Variable Costing Formula helps in profit planning and margin set-up.
 Variable Costing Formula is a major tool for cost control and a flexible budget.
 Variable Costing plays a vital role in decision making.
 Variable Costing Formula helps to decide the price of a product.
 Variable Costing Formula helps to determine break-even point.
Variable Costing Formula Calculator
You can use the following Variable Costing Calculator

Quantity of Output 0

Variable Cost per Unit of Output 0

Total Variable Cost Formula 0

Total Variable Cost =Quantity of Output x Variable Cost per Unit of Output
Formula =

= 0 x 0 = 0

Recommended Articles

50
Q2- CVP Analysis Guide
Cost, Volume, Profit
What is CVP Analysis?
Cost-Volume-Profit Analysis (CVP analysis), also commonly referred to as Break-Even Analysis, is a way
for companies to determine how changes in costs (both variable and fixed) and sales volume affect a
company’s profit. With this information, companies can better understand overall performance by looking
at how many units must be sold to break even or to reach a certain profit threshold or the margin of
safety.

Components of CVP Analysis

There are several different components that together make up CVP analysis.  These components involve
various calculations and ratios, which will be broken down in more detail in this guide.
The main components of CVP analysis are:
1. CM ratio and variable expense ratio
2. Break-even point (in units or dollars)
3. Margin of safety
4. Changes in net income
5. Degree of operating leverage

51
In order to properly implement CVP analysis, we must first take a look at the contribution margin format
of the income statement.
CVP Analysis Setup
The regular income statement follows the order of revenues minus cost of goods sold and gives gross
margin, while revenues minus expenses lead to net income. A contribution margin income statement
follows a similar concept but uses a different format by separating fixed and variable costs.
The contribution margin is the product’s selling price, less the variable costs associated with producing
that product. The value can be given in total dollars or per unit.
Contribution Margin (CM) Income Statement Example:
Consider the following example in order to calculate the five important components listed above.
XYZ Company has the following contribution margin income statement:
Total Per Unit

Sales (20,000 units) $1,200,000 $60

Less: Variable costs -$900,000 -$45

Contribution Margin $300,000 $15

Less: Fixed costs -$240,000

Net income $60,000

#1 CM Ratio and Variable Expense Ratio
CM ratios and variable expense ratios are numbers that companies generally want to see to get an idea of
how significant variable costs are.
CM Ratio = Contribution Margin / Sales
Variable Expense Ratio = Total Variable Costs / Sales
A high CM ratio and a low variable expense ratio indicate low levels of variable costs incurred.
#2 Break-Even Point
The break-even point (BEP), in units, is the number of products the company must sell to cover all
production costs. Similarly, the break-even point in dollars is the amount of sales the company must
generate to cover all production costs (variable and fixed costs).
The formula for break-even point (BEP) is:
BEP =Total Fixed Costs /CM per Unit
The BEP, in units, would be equal to 240,000/15 = 16,000 units. Therefore, if the company sells 16,000
units, the profit will be zero and the company will “break-even” and only cover its production costs.
#3 Changes in Net Income (What-if Analysis)
It is quite common for companies to want to estimate how their net income will change with changes in
sales behavior. For example, companies can use sales performance targets or net income targets to
determine their effect on each other.
In this example, if management wants to earn a profit of at least $100,000, how many units must the
company sell?
We can apply the appropriate what-if formula below:

52
No. of units = (Fixed Costs + Target Profit) / CM Ratio
Therefore, to earn at least $100,000 in net income, the company must sell at least 22,666 units.
To learn more, launch our financial modeling courses!
#4 Margin of Safety
In addition, companies may also want to calculate the margin of safety. This is commonly referred to as
the company’s “wiggle room” and shows by how much sales can drop and yet still break even.
The formula for the margin of safety is:
Margin of Safety = Actual Sales – Break-even Sales
The margin of safety in this example is:
Actual Sales – Break-even Sales = $1,200,000 – 16,000*$60 = $240,000
This margin can also be calculated as a percentage in relation to actual sales: 240,000/1,200,000 = 20%.
Therefore, sales can drop by $240,000, or 20%, and the company is still not losing any money.
#5 Degree of Operating Leverage (DOL)
Finally, the degree of operating leverage (DOL) can be calculated using the following formula:
DOL = CM / Net Income
So, the DOL in this example is $300,000 / 60,000 = 5.
The DOL number is an important number because it tells companies how net income changes in relation to
changes in sales numbers. More specifically, the number 5 means that a 1% change in sales will cause a
magnified 5% change in net income.
Many might think that the higher the DOL, the better for companies. However, the higher the number,
the higher the risk, because a higher DOL also means that a 1% decrease in sales will cause a magnified,
larger decrease in net income, ultimately decreasing its profitability.
CVP Analysis and Decision Making
Putting all the pieces together and conducting the CVP analysis, companies can then make decisions on
whether to invest in certain technologies that will alter their cost structures, and determine the effects
on sales and profitability much quicker.
For example, let’s say that XYZ Company from the previous example was considering investing in new
equipment that would increase variable costs by $3 per unit but could decrease fixed costs by $30,000.
In this decision-making scenario, companies can easily use the numbers from the CVP analysis to
determine the best answer.
The hardest part in these situations involves determining how these changes will affect sales patterns –
will sales remain relatively similar, will they go up, or will they go down? Once sales estimates become
somewhat reasonable, it then becomes just a matter of number crunching and optimizing the company’s
profitability.
What is Break Even Analysis?
Break Even Analysis in economics, business, and cost accounting refers to the point in which total cost
and total revenue are equal. A break-even point analysis is used to determine the number of units or
dollars of revenue needed to cover total costs (fixed and variable costs).

53
Image: CFI’s Budgeting & Forecasting Course.
Formula for Break Even Analysis
The formula for break-even analysis is as follows:
Break Even Quantity = Fixed Costs / (Sales Price per Unit – Variable Cost Per Unit)
Where:
 Fixed Costs are costs that do not change with varying output (e.g., salary, rent, building
machinery).
 Sales Price per Unit is the selling price (unit selling price) per unit.
 Variable Cost per Unit is the variable costs incurred to create a unit.
It is also helpful to note that sales price per unit minus variable cost per unit is the contribution
margin per unit. For example, if a book’s selling price is $100 and its variable costs are $5 to make the
book, $95 is the contribution margin per unit and contributes to offsetting the fixed costs.
Example of Break Even Analysis
Colin is the managerial accountant in charge of Company A, which sells water bottles. He previously
determined that the fixed costs of Company A consist of property taxes, a lease, and executive salaries,
which add up to $100,000. The variable cost associated with producing one water bottle is $2 per unit.
The water bottle is sold at a premium price of $12. To determine the break-even point of Company A’s
premium water bottle:
Break Even Quantity = $100,000 / ($12 – $2) = 10,000
Therefore, given the fixed costs, variable costs, and selling price of the water bottles, Company A would
need to sell 10,000 units of water bottles to break even.
For more information about variable costs, check out the following video:
Graphically Representing the Break Even Point
The graphical representation of unit sales and dollar sales needed to break even is referred to as the
break-even chart or Cost Volume Profit (CVP) graph. Below is the CVP graph of the example above:

54
Explanation:
1. The number of units is on the X-axis (horizontal) and the dollar amount is on the Y-axis (vertical).
2. The red line represents the total fixed costs of $100,000.
3. The blue line represents revenue per unit sold. For example, selling 10,000 units would generate
10,000 x $12 = $120,000 in revenue.
4. The yellow line represents total costs (fixed and variable costs). For example, if the company sells
0 units, then the company would incur $0 in variable costs but $100,000 in fixed costs for total
costs of $100,000. If the company sells 10,000 units, the company would incur 10,000 x $2 =
$20,000 in variable costs and $100,000 in fixed costs for total costs of $120,000.
5. The break-even point is at 10,000 units. At this point, revenue would be 10,000 x $12 = $120,000
and costs would be 10,000 x 2 = $20,000 in variable costs and $100,000 in fixed costs.
6. When the number of units exceeds 10,000, the company would be making a profit on the units sold.
Note that the blue revenue line is greater than the yellow total costs line after 10,000 units are
produced. Likewise, if the number of units is below 10,000, the company would be incurring a loss.
From 0-9,999 units, the total costs line is above the revenue line.
Download the Free Template
Enter your name and email in the form below and download the free template now!

55
CVP Analysis Template
* By submitting your email address, you consent to receive email messages (including discounts and
newsletters) regarding Corporate Finance Institute and its products and services and other matters
(including the products and services of Corporate Finance Institute's affiliates and other organizations).
Interpretation of Break Even Analysis
As illustrated in the graph above, the point at which total fixed and variable costs are equal to total
revenues is known as the breakeven point. At the breakeven point, a business does not make a profit or
loss. Therefore, the breakeven point is often referred to as the “no-profit” or “no-loss point.”
The break-even analysis is important to business owners and managers in determining how many units (or
revenues) are needed to cover fixed and variable expenses of the business.
Therefore, the concept of break-even point is as follows:
 Profit when Revenue > Total Variable Cost + Total Fixed Cost
 Break-even point when Revenue = Total Variable Cost + Total Fixed Cost
 Loss when Revenue < Total Variable Cost + Total Fixed Cost.
=Formula to Calculate Break-Even Point (BEP)
The formula for break-even point (BEP) is very simple and calculation for the same is done by dividing
the total fixed costs of production by the contribution margin per unit of product manufactured.
Break Even Point in Units = Fixed Costs/Contribution Margin

56
 The contribution margin per unit can be calculated by deducting variable costs towards the production
of each product from the selling price per unit of the product. Mathematically it is represented as,
Contribution margin = Selling price per unit – Variable cost per unit
Therefore, the formula for break-even point (BEP) in units can be expanded as below,
Break Even Point in Units = Fixed Costs/(Selling price per unit – Variable cost per unit)
Steps to Calculate Break-Even Point (BEP)
1. Firstly, the variable cost per unit has to be calculated based on variable costs from the profit and
loss account and the quantity of production. Variable costs will vary in direct relation to the
production or sales volume. The variable costs primarily include raw material cost, fuel expense,
packaging cost, and other costs that are directly proportional to the production volume.
2. Next, the fixed costs have to be calculated from the profit and loss account. Fixed costs do not
vary according to the production volume. The fixed costs include (not exhaustive) interest expense,
taxes paid, rent, fixed salaries, depreciation expense, labor cost, etc.
3. Now, the selling price per unit is calculated by dividing the total operating income by the units of
production.
4. Next, the contribution margin per unit is computed by deducting the variable cost per unit from the
selling price per unit.
5. Finally, the break-even point in units is derived by dividing the fixed costs in step 2 by the
contribution margin per unit calculated in step 4.
Example #1
Let us assume a company ABC Ltd which is in the business of manufacturing of widgets. The fixed
costs add up to $80,000, which consists of asset depreciation, executive salaries, lease, and
property taxes. On the other hand, the variable cost associated with the manufacturing of widgets
has been calculated to be $0.70 per unit, which consists of raw material cost, labor expense,
and sales commission. The selling price of a widget is $1.50 each.
The below-given Template contains the data about ABC company.

Particulars Amount

Selling Price Per Unit $1.50

Variable Cost Per Unit $0.70

Fixed Cost $80,000

Contribution Margin Per Unit

57
 Contribution margin per unit = $1.50 – $0.70
 Contribution margin per unit = $0.80
Based on the above, the calculation of the break-even point can be done as-

i.e. Break-even points in units = $80,000 / $0.80

 Break-even points in units = 100,000
Therefore, ABC Ltd has to manufacture and sell 100,000 widgets in order to cover its total expense,
which consists of both fixed and variable costs. At this level of sales, ABC Ltd will not make any profit
but will just break even.
Example #2
Let us consider a restaurant PQR Ltd selling pizza. The selling price is $15 per pizza, and the
monthly sales are 1,500 pizzas. Additionally, the following information for a month is available.

58
 Variable cost –
Variable cost = $8,000 + $1,000
 Variable cost = $9,000
Therefore, Variable Cost per unit = $9,000 / 1,500 = $6
Fixed Cost –

i.e. Fixed cost = $4,000 + $3,000 + $1,300 + $700

 Fixed cost = $9,000
Contribution Margin Per Unit –
Therefore,
Contribution margin per unit = $15 – $6
 Contribution margin per unit = $9
Based on the above, calculation of the break-even point can be determined as,

i.e. Break-even points in units = $9,000 / $9

 Break-even points in units = 1,000
Therefore, PQR Ltd has to sell 1,000 pizzas in a month in order to break even. However, PQR is selling
1,500 pizzas monthly, which is higher than the break-even quantity, which indicates that the company is
making a profit at the current level.
Break-Even Point (BEP) Calculator
You can use the following Break-Even Point Formula Calculator.

Fixed Costs 0

Contribution Margin 0

Break Even Point in Units 0

Break Even Point in Units =

Fixed Costs 0

59
 =
= 0

Contribution
0
Margin

Relevance and Uses

It is very important to understand the concept of break-even point formula as it is used to determine the
minimum volume of sales quantity required to achieve no profit any loss situation so as to cover the fixed
and the variable costs associated with the manufacturing.
In other words, it is used to assess at what point a project will become profitable by equating the total
revenue with the total expense. At this point, you need to decide whether the current plan is feasible or
whether the selling price needs to be raised or whether the operating cost needs to be controlled or both
the price and the cost needs to be revised. Another very important aspect that needs to address is
whether the products under consideration will be successful in the market.
In short, the break-even point should be conducted before the start of a business, whether a new
venture or a new product line, in order to have a clear idea of the risks involved and decide whether if
the business is worth it.
Q5- Products A and B are produced jointly in Department Z. Each product can be sold as is at the...
Products A and B are produced jointly in Department Z. Each product can be sold as is at the split-off
point or processed further. During January, Department Z recorded a joint cost of $150,000. The
following data for January are available:
Selling Prices per UnitCosts after
Produc -If Processed
Quantity At Split-Off Split-Off
t Further
A 10,000 units$5 $8 $40,000
B 20,000 1SO 2 5,000
Analyze whether individual products should be processed beyond the split-off point, using:
(a) The total project approach (or comparative statement approach)
(b) The incremental (differential) approach
(c) The opportunity cost approach

- (b) (a) Difference At Split-Off At Completion (Increment) Sales $50,000 $80,000 $30,000 Costs ----
40,000 40,000 Net revenue $50,000 $40,000 $ (10,000) (c) If Processed Sales $ 80,000 costs:

60
 Additional 40,000 Opportunity cost of not selling at split-off 50,000 Loss $(10,000) Based on any one of
the three methods, product A should be sold at the split-off point. (b) (a) Difference At Split-Off At...
Steps to Calculate Break-Even Point (BEP)
1. Firstly, the variable cost per unit has to be calculated based on variable costs from the profit and
loss account and the quantity of production. Variable costs will vary in direct relation to the
production or sales volume. The variable costs primarily include raw material cost, fuel expense,
packaging cost, and other costs that are directly proportional to the production volume.
2. Next, the fixed costs have to be calculated from the profit and loss account. Fixed costs do not
vary according to the production volume. The fixed costs include (not exhaustive) interest expense,
taxes paid, rent, fixed salaries, depreciation expense, labor cost, etc.
3. Now, the selling price per unit is calculated by dividing the total operating income by the units of
production.
4. Next, the contribution margin per unit is computed by deducting the variable cost per unit from the
selling price per unit.
5. Finally, the break-even point in units is derived by dividing the fixed costs in step 2 by the
contribution margin per unit calculated in step 4.
Examples
Break-Even Point Formula Excel Template
Example #1
Let us assume a company ABC Ltd which is in the business of manufacturing of widgets. The fixed
costs add up to $80,000, which consists of asset depreciation, executive salaries, lease, and
property taxes. On the other hand, the variable cost associated with the manufacturing of widgets
has been calculated to be $0.70 per unit, which consists of raw material cost, labor expense,
and sales commission. The selling price of a widget is $1.50 each.
The below-given Template contains the data about ABC company.

Particulars Amount

Selling Price Per Unit $1.50

Variable Cost Per Unit $0.70

Fixed Cost $80,000

Contribution Margin Per Unit

61
 Contribution margin per unit = $1.50 – $0.70
 Contribution margin per unit = $0.80
Based on the above, the calculation of the break-even point can be done as-

i.e. Break-even points in units = $80,000 / $0.80

 Break-even points in units = 100,000
Therefore, ABC Ltd has to manufacture and sell 100,000 widgets in order to cover its total expense,
which consists of both fixed and variable costs. At this level of sales, ABC Ltd will not make any profit
but will just break even.
Example #2
Let us consider a restaurant PQR Ltd selling pizza. The selling price is $15 per pizza, and the
monthly sales are 1,500 pizzas. Additionally, the following information for a month is available.

62
 Variable cost –
Variable cost = $8,000 + $1,000
 Variable cost = $9,000
Therefore, Variable Cost per unit = $9,000 / 1,500 = $6
Fixed Cost –
i.e. Fixed cost = $4,000 + $3,000 + $1,300 + $700
 Fixed cost = $9,000
Contribution Margin Per Unit –
Therefore,
Contribution margin per unit = $15 – $6
 Contribution margin per unit = $9
Based on the above, calculation of the break-even point can be determined as,
i.e. Break-even points in units = $9,000 / $9
 Break-even points in units = 1,000
Therefore, PQR Ltd has to sell 1,000 pizzas in a month in order to break even. However, PQR is selling
1,500 pizzas monthly, which is higher than the break-even quantity, which indicates that the company is
making a profit at the current level.
Break-Even Point (BEP) Calculator
You can use the following Break-Even Point Formula Calculator.

Fixed Costs 0

Contribution Margin 0

Break Even Point in Units 0

63
 Fixed Costs
0

=
Break Even Point in Units = = 0

Contribution
0
Margin

=What is the Contribution Margin?

The contribution margin is a measurement through which we understand how much a company’s net sales
will contribute to the fixed expenses and the net profit after covering the variable expenses.  So, we
deduct the total variable expenses from the net sales while calculating the contribution.
Contribution Margin Formula
To calculate this ratio, we need to look at the net sales and the total variable expenses. Here’s the
formula –
Contribution Margin = Net Sales – Total Variable Expenses
It can be expressed in another way as well.
Contribution Margin = Fixed Expenses – Net Income
In situations where there’s no way we can know the net sales, we can use the above formula to find out
the contribution.
Example
Good Company has net sales of $300,000. It has sold 50,000 units of its products. The variable
cost of each unit is $2 per unit. Find out the contribution, contribution margin per unit, and
contribution ratio.
 The company has net sales of $300,000.
 The number of units sold was 50,000 units.
 Selling price per unit would be = ($300,000 / 50,000) = $6 per unit.
 The variable cost per unit is $2 per unit.
 Contribution margin per unit formula would be = (Selling price per unit – Variable cost per unit) = ($6 –
$2) = $4 per unit.
 Contribution would be = ($4 * 50,000) = $200,000.
 Contribution ratio would be = Contribution / Sales = $200,000 / $300,000 = 2/3 = 66.67%.
In this example, if we had been given the fixed expenses, we could also find out the firm’s net profit.
Uses
You may ask why we need contributions. We need a contribution to find out the break-even point.
We will look at how contribution becomes useful in finding the break-even point.
Let’s say that a firm’s fixed expenses are $100,000. The variable cost of the firm is $30,000. We need
to find out the break-even point.
We will find out the break-even point by using the concept of contribution.
Contribution Margin = Net Sales – Variable Cost = Fixed Cost + Net Profit
Here, we can write –
Net Sales – Variable Cost = Fixed Cost + Net Profit
At the break-even point, the key assumption is that there will be no profit or no loss.

64
 Then,
 Net Sales – Variable Cost = Fixed Cost + 0
 Or. Net Sales – $30,000 = $100,000
 Or, Net Sales = $100,000 + $30,000 = $130,000.
That means $130,000 of net sales, and the firm would be able to reach the break-even point.
Contribution Margin Calculator
You can use the following Calculator

Net Sales 0

Total Variable Expenses 0

Contribution Margin Formula 0

Contribution Margin Formula = Net Sales – Total Variable Expenses

0 – 0 = 0
Calculate Contribution Margin in Excel (with excel template)
You can easily calculate the ratio in the template provided.

The contribution margin ratio per unit formula would be = (Selling price per unit – Variable cost per unit)

The contribution would be = (Margin per Unit * Number of Units Sold)

65
The contribution ratio would be = margin / Sales

You can download this template here – Contribution Margin Ratio Excel Template

Question:Q6
Relay Corporation manufactures batons. Relay can manufacture 300,000 batons a year at a variable cost
of $750,000 and a fixed cost of $450,000. Based on Relay's predictions, 240,000 batons will be sold at
the regular price of $5 each. In addition, a special order was placed for 60,000 batons to be sold at a 40
percent discount off the regular price. By what amount would the income be increased or decreased as a
result of the special order?
(a) $60,000 decrease
(b) $30,000 increase
(c) $36,000 increase
(d) $180,000 increase
Incremental Analysis
Incremental analysis is a significant part of CVP (Cost-volume Profit) analysis. It is used to determine the
additional cost and profit of two alternatives. A complete incremental analysis is necessary to estimate
the profitability and decision-making.
Answer and Explanation:
Option (b) is correct.
The income will increase by $30,000 as a result of special order.
Working note:
Sales price ($5 x (1 -
$3.00
0.40)

Q7= V. Discount Drug Company has three major product lines:...get 1

The discount drug company should drop ‘Drugs Division’. Explanation: Drugs Division. Total sales = $ 700.
Avoidable costs = $ 800. Loss = $ 100. Explanation: Cosmetics Division. Total sales = $ 600. Avoidable

66
 costs = $ 400. Profit = $ 200. b. If discount drug company could rent cosmetics and drug areas, then.
Revenue = $ 150. Loss of profit = $ 200 - $ 100 = $ 100
=Formula to Calculate Markup
Markup formula calculates the amount or percentage of profits derived by the company over the
product’s cost price. It is calculated by dividing the company’s profit by the cost price of the product
multiplied by 100, as it is shown in the percentage terms.
Markup refers to the difference between the average selling price per unit of a good or service and the
average cost incurred per unit. Conversely, it can be said that it is the additional price over and above the
total cost of the good or service, which is the profit for the seller. Mathematically it is represented as,
Markup = Average Selling Price per Unit – Average Cost per Unit

Another formula that can be used based on the information available in the income statement is the
calculation of markup by initially deducting the cost of goods sold from the sales revenue and then
dividing the value by the number of units sold. Mathematically it is represented as,
Markup Formula= (Sales Revenue – Cost of Goods Sold) / Number of Units Sold
Although the former formula is more popularly used, the latter can be as useful as the former since the
information is easily available from the income statement.
Markup Calculation (Step by Step)
Below are the steps for markup calculation –
1. The formula for markup is very simple. The entire set of information required for its calculation is
already contained in the income statement. The first step in calculating markup from the income
statement is to figure out the sales revenue and the cost of goods sold. Also, figure out the
number of units sold during the accounting period.
2. Now, divide the sales revenue and the cost of goods sold by the units sold to get the average
selling price per unit and the average cost per unit, respectively.

Average selling price per unit = Sales revenue / No. of units sold.
Average cost per unit = cost of goods sold / No. of units sold
3. Finally, markup can be calculated by deducting the average cost per unit from the average selling
price per unit.
Examples
You can download this Markup Formula Excel Template here – Markup Formula Excel Template

67
 Example #1
If a product is sold for $200 per unit and the cost per unit of production is $130, then the calculation of
markup will be,
 = $200 – $130 = $70
Example #2
Let us consider an example to calculate the markup for a company called XYZ Limited. XYZ Limited is in
the business of manufacturing customized roller skates for both professional and amateur skaters. At
the end of the financial year, XYZ Limited earned $150,000 in total net sales for the sale of 1,000 units
along with the following expenses.
 Salaries: (+) $50,000
 Rent: (+) $20,000
 Cost of Goods Sold = (Salaries + Rent)
 Cost of Goods Sold = $70,000
 Therefore, Average selling price per unit = $150,000 / 1,000 = $150 and
 Average cost per unit = $70,000 / 1,000 = $70
Finally,
 Markup = $150 – $70 = $80
Markup Calculator
You can use the following calculator

Average Selling Price Per Unit 0

Average Cost Per Unit 0

Markup Formula 0

Average Selling Price Per Unit – Average Cost Per

Markup Formula =
Unit

0 – 0 = 0
Markup Calculation in Excel
Now let us take Apple Inc.’s published financial statement Example for the last three accounting
periods. Based on publicly available financial information, the Markup of Apple Inc. can be calculated for
the accounting years 2016 to 2018.
The below excel template contains the information required for the calculation.

68
We have calculated average selling price and average cost price using the below-given formula-

So the below-given template has the values of Average selling price and average cost price for the
markup calculation.

In the below given excel template, we have used the markup calculation.

69
So, the Markup of Apple Inc. will be-

The above table shows that the markup per unit of various products for Apple Inc. has been continuously
improving from $305 to $364 during the above mentioned period. This indicates the market strength
that Apple Inc. relishes.
Uses
The understanding of markup is very important for a business as it governs a company’s pricing strategy,
which is one of the most significant parts of a business. The markup of a good or service should be
adequate to cover all the operating expenses and make a profit, which is the ultimate objective of any
business. The extent of markup permitted to a retailer can determine the amount of money he can make
70
 from selling every unit of the product. The higher the markup, the higher the selling price to the
consumer. And more the money the retailer will make and vice versa. The selling price that the retailer
charges can be an indicator of the strength of that retailer in the market.

 Q8-

Question
Answered step-by-step
Cardinal Company needs 20,000 units of a certain part to use in its production cycle. The following
information is available: Cost of cardinal to make the part: Direct materials $4 Direct labor 17 Variable
overhead 7 Fixed overhead 10 $38 Cost to buy the part from the Oriole company $42 If Cardinal buys
the part from Oriole instead of making it, Cardinal could not use the released facilities in another
manufacturing activity. Sixty percent of the fixed overhead applied will continue, regardless of what
decision is made. What do you advise to the firm managers: shall the firm buy or make the product?
AIl Recommended Answer:
The steps for solving this problem are as follows:
1. Calculate the total cost of the part, including the cost of the direct materials and the cost of the
direct labor.
2. Calculate the cost to buy the part from the Oriole Company.
3. Compare the costs of buying the part from Oriole and making the part. If making the part is cheaper,
Cardinal should make the part. If buying the part is cheaper, Cardinal should buy the part.
4. Apply the 60% fixed overhead to the total cost of the part to get the total cost of making the part.
5. Compare the total cost of making the part with the cost of buying the part from Oriole. If making the
part is cheaper, Cardinal should make the part.
View Answer
Best Match Video Recommendation:
Solved by verified expert

71
Q8 addi
Question: Cardinal Company Needs 20,000 Units Of A Certain Part To Use In Its Production Cycle. The
Following Information Is Available: Cost To Cardinal To Make The Part: Direct Materials $4 Direct Labor
$16 Variable Overhead $8 Fixed Overhead Applied $10 $38 Cost To Buy The Part From The Oriole
Company $36 If Cardinal Buys The Part From Oriole Instead Of Making It,
This problem has been solved!
You'll get a detailed solution from a subject matter expert that helps you learn core concepts.
See Answer

72
Show transcribed image text
Expert Answer 
100% (1 rating)
Direct Material $4 Direct Labor $16 Variabl…View the full answer

Transcribed image text: Cardinal Company needs 20,000 units of a certain part to use in its production
cycle. The following information is available: Cost to Cardinal to make the part: Direct materials $4
73
Direct labor $16 Variable overhead $8 Fixed overhead applied $10 $38 Cost to buy the part from the
Oriole Company $36 If Cardinal buys the part from Oriole instead of making it, 60% of the fixed
overhead applied will continue. Cardinal cannot use the released facilities in another manufacturing
activity, regardless of what decision is made. In deciding whether to make or buy the part, the total
relevant costs to make the part are: Round to a whole number.

Answers
1. The XYZ Company has three major products, whose contribution margins are shown1 answer below »
Course Title: Accounting for manager 1. The XYZ Company has three major products, whose contribution
margins are shown below in Table 1.1. Table 1.1. Presents description of the mixed products and related
contribution margin Description Product A B C Sales Price $ 13 $12 $6.5 Variable cost per unit 8 6 4
CM/Unit 5 6 2.5 Total fixed costs are $100,000. Question (a) the break-even point in units in total and
for each product if the three products are sold in the proportions of 30%, 50%, and 20%, and (b) the
break-even point in total and for each product if the sales mix ratio changes to 50%, 30%, and 20%
2. Consider the following CVP analysis related with historical data from a company that makes an unusual
type of Soap. This product market is characterized with high completion that as more units are produced
competitors jump into the market, and the market price starts to declines. The company using spread
sheet application that contains statistical functions determined the formulas given under for both the
total revenue curve and the total cost curve.
R(x) = (–X 2 ÷ 100) + 10x------------------------------------- (1)
C(X) = 700 + 2X---------------------------------------- (2)
Questions A. Compute breakeven units. Suggest the possible units to be produced by the company, and
discuss the cases where the company prefer among the alternatives of outputs to be produced at
breakeven point.
B. Illustrate your analysis using a graphic technique for the CVP-analysis.
3. Fill in the missing amounts in each of the four case situations below. Each case is independent of the
others. a. Assume that only one product is being sold in each of the four following case situations: Case
Units Sold Sales Variable Expenses Contribution Margin per Unit Fixed Expenses Net Income (Loss) 1
20,000 $ 220,000 $ 140,000 $ A $ 55,000 $ B 2 C 147,000 D 8 34,000 8,000 3 15,000 E 75,000 12 F
14,000 4 8,000 320,000 G H 110,000 (30,000)
4. ABC Manufacturing Corp. is using 10,000 units of part no. 300 as a component to assemble one of its
products. It costs the company $18 per unit to produce it internally, computed as follows: Direct
materials $ 42,000 direct labor 51,000 Variable overhead 42,000 fixed overhead 45,000 Total Cost
180,000 An outside vendor has just offered to supply the part for $16 per unit. If the company stops
producing this part, one-third of the fixed overhead would be avoided. Should the company make or buy?
(Show calculation to support your decision).
5. Products A and B are produced jointly in Department Z. Each product can be sold as is at the split-off
point or processed further. During January, Department Z recorded a joint cost of $150,000. The
following data for January are available: Product Quantity Selling price per unit Costs after Split-off At
split-off If processed further A 10,000 Units $ 5 $ 8 60,000 B 20,000 1.50 2 20,000 Analyze whether
individual products should be processed beyond the split-off point, using: ( That means support your
answer with the following format of calculations):
(a) The total project approach
74
(b) The incremental approach
(c) The opportunity cost approach
6. Relay Corporation manufactures batons. Relay can manufacture 300,000 batons a year at a variable
cost of $750,000 and a fixed cost of $450,000. Based on Relay’s predictions, 240,000 batons will be sold
at the regular price of $5 each. In addition, a special order was placed for 60,000 batons to be sold at a
40 percent discount off the regular price. By what amount would income be increased or decreased as a
result of the special order? (Show the step to support your decision)
7. The Discount Drug Company has three major product lines: drugs, cosmetics, and housewares. The
company provides the following sales and cost information for the month of May for the store in total
and for each separate product line (000 omitted): Drug Cosmetics Housewares Total Sales $240 $ 300
$360 $ 900 Less: Variable expenses 160 180 200 540 CM $ 80 $120 $160 $360 Less: Fixed costs
Salaries $34 $40 $46 $120 Advertising 30 50 40 120 Other fixed costs 40 20 40 100 Total $104 $110
$126 $340 Net income $(24) $10 $34 $20 The salaries represent wages paid to employees engaged
directly in each product line area. Besides, the advertising represents direct advertising of each product
line, and is avoidable if the line is dropped. Other fixed costs, which are all committed costs, will continue
and will split equally between cosmetics and house wares.
1. Prepare a combined income statement for cosmetics and house wares on the assumption that drugs are
discontinued with no effects on sales of the other product lines.
2. On the basis of the analysis in question 1, would you advise dropping the drugs line?
8. Cardinal Company needs 20,000 units of a certain part to use in its production cycle. The following
information is available: Cost of cardinal to make the part: Direct materials $4 Direct labor 17 Variable
overhead 7 Fixed overhead 10 $38 Cost to buy the part from the Oriole company $42 If Cardinal buys
the part from Oriole instead of making it, Cardinal could not use the released facilities in another
manufacturing activity. Sixty percent of the fixed overhead applied will continue, regardless of what
decision is made. What do you advise to the firm managers: shall the firm buy or make the product?
Company "A" started the period with 85 units in beginning inventory that cost $2.60 each. During
the period, the company purchased inventory items as follows. Company sold 315 units after
purchase 3 for $10.80 each. Purchase, No. of Items, Cost1 290 $ 3.102 195 $ 3.203 50 $
3.60Companies cost of goods sold under FIFO would be
Question
Company "A" started the period with 85 units in beginning inventory that cost $2.60 each. During the
period, the company purchased inventory items as follows. Company sold 315 units after purchase 3 for
$10.80 each. Purchase, No. of Items, Cost
1 290 $ 3.10
2 195 $ 3.20
3 50 $ 3.60
Companies cost of goods sold under FIFO would be
Step 1

75
Step 2

76
Step 3
Therefore, the Cost of goods sold: $ 934
Ask a Homework Question!
Subscribe to bartleby learn and ask 30 homework questions each month. Subject matter experts are on
standby 24/7 when you’re stuck and questions are typically answered in as fast as 30 minutes.*
ASK A QUESTION
*Response times may vary by subject and question complexity. Median response time is 34 minutes for
paid subscribers and may be longer for promotional offers.format_list_bulleted
Problem 1MCQ: If beginning inventory is $20,000, purchases are $185,000, and ending inventory is
$30,000, what is...
Q: Inventory information for Part 311 of Marigold Corp. discloses the following information for the…
A: “Since you have asked multiple question, we will solve the first question for you. If you want any…

Q: Vegas started the period with 80 units in beginning inventory that costs $7.50 each. During the…
A: Inventory valuation method includes: FIFO Method LIFO Method Weighted average method   Under
the…

Q: Garrison Company uses the retail method of inventory costing. It started the year with an
Inventory…
A: Markup is the difference between the cost and sales price that is considered as profit for the…

Q: The GMA corporation shows the folowing data related to an item of Inventory Inventory, January
1 100…
A: Cost of goods available = (100 x P50) + (300 x P54) + (90 x P60) = P26,600

Q: The following units of an item were available for sale during the year: Beginning inventory 44…
77
A: FIFO: FIFO stands for First-In, First-Out.  In this method inventory purchased first will be sell…

Q: Co. C has the following units of beginning inventory and purchases for the year: beginning
inventory…
A: Under FIFO method, units which are purchased first are sold first .  Under FIFO method , ending…

Q: The GMA corporation shows the folowing data related to an item of Inventory Inventory, January
1 100…
A: Total cost of goods available = (100 x P50) + (300 x P54) + (90 x P60) = P26,600

Q: The following Inventory transactions apply to Green Company for Year 2. January 1 April 1
August 1…
A: FIFO: First In First Out Sales on April 1 will be first sold from the beginning inventory. Sales on…

Q: 2) Orpa Company had a beginning inventory of 430 units with a total cost of $2,580. During the
year…
A: Total units available for sale = Beginning units + Purchases  = 430+600+700+450+550 = 2730 units…

Q: At the beginning of the current period, Haitijah Industries has 150 units of a product with a
unit…
A: under FIFO Method  the goods which bought first will be sold first  under LIFO method the goods…

question_answer
Q: A company reports the following beginning inventoryand purchases, and it ends the period with
30…
A: FIFO method means First in First Out. It means inventory which is purchased first will be sold…

question_answer
Q: Brocken Co. has the following data related to an item of inventory: Inventory, May 1 3,000 units
(@…
A: From the given information, Number of units sold = Opening inventory+Purchases-Closing inventory…

Q: During the current period, Haitijah sells 340 units.   A. Assume Haitijah uses the FIFO method.
…
A: “Since you have posted a question with multiple sub-parts, we will solve first three sub-parts for…

Q: Acme-Jones Corporation uses a weighted-average perpetual inventory system. August 2, 10 units

were…
A: 1. COST OF GOODS SOLD : = NUMBER OF UNITS SOLD X WEIGHTED AVERAGE COST PER UNIT  2.
WEIGHTED AVERAGE…

Q: Brocken Co. has the following data related to an item of inventory: Inventory, May 1 3,000 units
@…
A: FIFO  Method - This is a FIrst In First out  Method where in Cost of Goods is calculated where the…

78
Q: The GMA corporation shows the following data related to an item of Inventory Inventory,
January 1…
A: UNDER FIFO (FISRT IN , FIRST OUT) METHOD THE ASSETS PURCHASED OR ACQUIRED FIRST
ARE DISPOSED OF…

Q: nventory information for Part 311 of Whispering Corp. discloses the following information for
the…
A: Introduction: LIFO: LIFO stands for Last In First Out which means last received inventory to be sold…

Q: Mission Company provided the following information for the year 2021: Jan. 01 Inventory on hand
200…
A: Total units available for sale  = 200 + 300 + 500 = 1000 units   Total units sold = 400 + 400 = 800…

Q: Tomasino's inventory records show the following data at January 31: Beginning inventory Jan. 1
Jan.…
A: First in First Out Method (FIFO) In first in first out method inventory valuation is taken from the…

Q: Given the following: Number purchased Cost per unit Total January 1 inventory 39 $…
A: Click to see the answer

Q: The GMA corporation shows the following data related to an item of Inventory Inventory,
January 1…
A: FIFO: FIFO stands for First-In, First-Out.  In this method inventory purchased first will be sell…

Q: Thelen's inventory records show the following data at January 31: Beginning inventory Jan. 1
Jan. 10…
A: LIFO stands for last in first out. It is a method of valuing inventories in which the goods…

Q: Pronghorn Company uses the periodic inventory method and had the following inventory
information…
A: Since you have posted a question with multiple sub-parts, we will solve the first three sub-parts…

Q: Inventory information for Part 311 of Tamarisk Corp. discloses the following information for the…
A: Since you have posted a question with multiple sub-parts, we will solve the first three subparts for…

Q: Required information   [The following information applies to the questions displayed below.] 
During…
A: Click to see the answer

Q: The following units of an inventory item were available for sale during the year: Beginning…
A: The question is multiple choice question. Required  Choose the Correct Option.

Q: Smalley, Inc., purchased items of inventory as follows:Jan. 4 100 units @ $2.00Jan. 23 120
units @…
A: First in first out: It refers to the method of inventory valuation that calculates the balance of…

79
Q: A firm that sells a single product had a beginning inventory of 10,000 units with a total cost of…
A: FIFO means the first in first out which means that goods purchased first will be sold first.…

Q: 6‫ כ‬Bader Company has a beginning merchandise inventory of $15,000. During the period,
purchases were…
A: The total cost of opening inventory and the manufacturing costs incurred during the year is the cost…

Q: A company reports the following beginning inventoryand purchases, and it ends the period with
30…
A: FIFO method means First in First Out. It means inventory which is purchased first will be sold…

Q: 8. Celine Company provided the following data relating to an inventory item. Total cost
1,000,000…
A: Under Moving Average inventory valuation method, the average cost of each inventory item in stock is…

Q: Bonita Company had 100 units in beginning inventory at a total cost of $12,00O. The company…
A: 1. FIFO Method - Under FIFO Method, Inventory purchased first is sold first. 2. LIFO Method -
Under…

Q: XYZ Co uses the periodic inventory system to account for inventories. Its beginning inventory  is…
A: LIFO means last in first out where as FIFO means first in first out. Inventory and cost of goods…

Q: A company had inventory on November 1 of 5 units at a cost of $27 each. On November 2,
they…
A: "Since you have asked multiple questions, we will solve first question for you. If you want any…

Q: XYZ Co uses the periodic inventory system to account for inventories. Its beginning inventory  is…
A: a. FIFO method:

Q: Wan Tan Corp. made the following four inventory purchases in June: June 1 150 units $5.20
June 10…
A: Inventory valuation method includes: FIFO Method LIFO Method Weighted average cost method
FIFO…

Q: Glasgow Enterprises started the period with 60 units in beginning inventory that cost $2.00 each.
…
A: FIFO being a method of valuing inventory sells, that inventory first, which has been bought…

Q: Niles Co. has the following data related to an item of inventory: Inventory, March 1 400 units
@…
A: Under FIFO method, goods purchased first should be sold first. Therefore, COGS under the FIFO
method…

Q: Wynn started the period with 80 units in beginning inventory that costs $7.50 each. During the…

80
A: The inventory can be valued using various methods as LIFO, FIFO and weighted average method.

question_answer
Q: XYZ Co uses the periodic inventory system to account for inventories. Its beginning inventory  is…
A: First in First out (FIFO) is one of the inventory valuation methods in which the earliest inventory…

question_answer
Q: Thelen's inventory records show the following data at January 31: Beginning inventory Jan. 1
Jan. 10…
A: LIFO method: Last-in, first-out (LIFO) method is one of the inventory valuation methods under which…

question_answer
Q: Bleistine Company had the following transactions for the month. Beginning inventory Purchased
Jun. 1…
A: FIFO stands for first in first out , which means inventory which was purchased firsts are sold…

question_answer
Q: Given the following: Number Cost purchased Total per unit $ 3 $ 105 January 1 inventory April 1
June…
A: Under FIFO method, it is assumed that first units comes in are the first unit goes out. So the…

question_answer
Q: Company Y had the following transactions in Year 2. The perpetual FIFO inventory system is
used. 1.…
A: There are different accounting methods of available to record the inventory out of which the company…

question_answer
Q: me following units of an item were available for sale during the year: eginning inventory 20,000…
A: The perpetual method of inventory is an effective as well as accurate method for recording the…

question_answer
Q: Warwick Co. has the following data related to an item of inventory: Inventory, March 1
Purchase,…
A: Since you have asked multiple questions, we will solve the first question for you. If you want any…

Knowledge Booster

Learn more about Accounting for Merchandise Inventory

Need a deep-dive on the concept behind this application? Look no further. Learn more about this topic,
accounting and related others by exploring similar questions and additional content below.
Concept explainers

Article
Inventory Valuation
arrow_forward
81
Before discussing the topic inventory valuation let’s discuss the meaning of inventory. In accounting,
inventory is also known as stock. Inventory means all the finished goods, materials, merchandise that a
business holds for the purpose of selling it in…

Similar questions
arrow_back_iosarrow_forward_ios


Sales mix and break-even analysis Conley Company has fixed costs of 17,802,000. The unit selling

price, variable cost per unit, and contribution margin per unit for the companys two products

follow: The sales mix for products Yankee and Zoro is 80% and 20%, respectively. Determine the

break-even point in units of Yankee and Zoro.

arrow_forward

Manufacturing builds and sells switch harnesses for glove boxes. The sales price and variable cost

for each follows: Their sales mix is reflected in the ratio 4:4:1. If annual fixed costs shared by

the three products are $1 8840 how many units of each product will need to be sold in order

forJj to break even?

arrow_forward

Morris Industries manufactures and sells three products (AA, BB, and CC). The sales price and

unit variable cost for the three products are as follows: Their sales mix s reflected as a ratio of

5:3:2. Annual fixed costs shared by the three products are $25,000 per year. What are total

82
 variable costs for Morris with their current product mix? Calculate the number of units of each

product that will need to be sold in order for Morris to break even. What is their break-even

point in sales dollars? Using an income statement format, prove that this is the break-even point.

arrow_forward

Manatoah Manufacturing produces 3 models of window air conditioners: model 101, model 201, and

model 301. The sales price and variable costs for these three models are as follows: The current

product mix is 4:3:2. The three models share total fixed costs of $430,000. Calculate the sales

price per composite unit. What is the contribution margin per composite unit? Calculate

Manatoahs break-even point in both dollars and units. Using an income statement format, prove

that this is the break-even point.

arrow_forward

Salvador Manufacturing builds and sells snowboards, skis and poles. The sales price and variable

cost for each follows: Their sales mix is reflected in the ratio 7:3:2. If annual fixed costs shared

by the three products are $196,200, how many units of each product will need to be sold in order

for Salvador to break even?

arrow_forward

83
 Abilene Industries manufactures and sells three products (XX, W, and ZZ). The sales price and

unit variable cost for the three products are as follows: Their sales mix is reflected as a ratio of

4:2:1. Annual fixed costs shared by the three products are $345.000 per year. What are total

variable costs for Abilene with their current product mix? Calculate the number of units of each

product that will need to be sold in order for Abilene to break even. What is their break-even

point in sales dollars? Using an income statement format, prove that this is the break-even point.

ered: The XYZ Company has three major… | bartleby

== The Ronowski Company has three product lines of belts—A, B, and C— with contribution margins of $3,
$2, and $1, respectively. The president foresees sales of 200,000 units in the coming period, consisting
of 20,000 units of
A, 100,000 units of
B, and 80,000 units of
C. The company’s fixed costs for the period are $255,000.
1) What is the company’s breakeven point in units, assuming that the given sales mix is maintained?
2) If the sales mix is maintained, what is the total contribution margin when 200,000 units are sold?
What is the operating income?
3) What would operating income be if 20,000 units of A, 80,000 units of B, and 100,000 units of C were
sold?
4) What is the new breakeven point in units if these relationships persist in the next period?
Answer 1 :
Given Data:
1 .Belts with contribution margins:
 A=$3,
 B=$2
 C=$1,
2.Sales = 200,000 units  
 A=20,000 units
 B=100,000 units of
 C=80,000 units
3.Fixed costs= $255,000.
Formula:
 Break-even point (units)= Total fixed costs / (weighted average selling price - weighted average variable
expense)
84
 weighted participation of each line in the total sales:
Sales= 200,000
A= 20,000/200,000= 0.10
B= 100,000/200,000= 0.50
C= 80,000/200,000= 0.40
 Weighted average contribution margin= 3*0.10 + 2*0.5 + 1*0.4
 Weighted average contribution margin = 1.7
 Break-even point (units)= 255,000/1.7= 150,000 units
The company's Break Even Point is $150000 units.
Answer 2)
 Total contribution margin= 20,000*3 + 100,000*2 + 80,000
 Total contribution margin= $340,000
The total contribution margin when 200,000 units are sold is $340,000.
 Operating income= contribution margin - fixed costs
 Operating income= 340,000 - 255,000
 Operating income= $85,000
The operating income is $85000.
Answer 3:
 A= 20,000 units
 B= 80,000 units
 C= 100,000 units
 Total contribution margin= 20,000*3 + 80,000*2 + 100,000
Total contribution margin= $320,000  
 Operating income= contribution margin - fixed costs
 Operating income= 320,000 - 255,000
 Operating income= $65,000
The operating income be if 20,000 units of A, 80,000 units of B, and 100,000 units of C were sold
is $65000.
Answer 4:
Given Data:
 Sales= 200,000
 A= 20,000/200,000= 0.10
 B= 80,000/200,000= 0.40
 C= 100,000/200,000= 0.50  
Weighted average contribution margin= 3*0.10 + 2*0.4 + 1*0.5
 Weighted average contribution margin= 1.6
Break-even point (units)= 255,000/1.6
Break-even point (units)= 159,375 units

85
==A product has a contribution margin of $2.50 per unit and a selling price of $25 per unit. Fixed
costs are $20,000. Assuming new technology increases the unit contribution margin by 50 percent
but increases total fixed costs by $13,750, what is the new breakeven point in units?A. 9,000 units
B. 13.500 units
C. 3,667 units
D. 3,333 units

 25) Profitable companies often prefer to issue debt rather than : 1947999
25) Profitable companies often prefer to issue debt rather than preferred stock because
A) debt creates less risk for the company.
B) interest payments are fixed but preferred shareholders expect dividends to grow.
C) preferred shares dilute the voting rights of common shareholders but bonds do not.
D) interest on debt is deductible for tax purposes, but preferred dividends are not.
26) In the event of bankruptcy, preferred stockholders and common stockholders have the same claim on
the firm's assets.
27) A company may issue multiple classes of preferred stock.
28) The cumulative dividend feature is necessary to protect the rights of preferred stockholders.
29) Preferred stock cannot be retired.
30) To determine the value of a share of preferred stock, the discount rate used is the annual dividend
percent.
31) The value of preferred shares is affected by changes in interest rates.
32) Miller/Hershey's preferred stock is selling at $54 on the market and pays an annual dividend of
$4.20 per share.
a.What is the expected rate of return on the stock?
b.If an investor's required rate of return is 9%, what is the value of the stock for that investor?
c.Considering the investor's required rate of return, does this stock seem to be a desirable investment?
33) Discuss two reasons why preferred stock would be viewed as less risky than common stock to
investors.
34) Determine the rate of return on a preferred stock that costs $50 and pays a $6 per share dividend.
15) The required rate of return TKF preferred has fallen : 1947998
15) The required rate of return on TKF preferred has fallen from 5.75% at the time of issue to the
present rate of 5%.  The stock now sells for $115.  What was the original price?
A) $75.61
B) $132.25
C) $114
D) $100
16) Preferred stock is similar to a bond in which of the following ways?
A) Preferred stock always contains a maturity date.
B) Both investments provide a fixed income.
C) Both contain a growth factor similar to common stock.
D) None of the above.

86
17) Solitron Manufacturing Company preferred stock is selling for $14. If it has a yearly dividend of $1,
what is your expected rate of return if you purchase the stock at its market price (round your answer to
the nearest .1%).
A) 25.0%
B) 14.2%
C) 7.1%
D) 9.3%
18) An decrease in the ________ will increase the value of preferred stock.
A) expected rate of return
B) life of the investment
C) dividend paid
D) both A and C
19) Texon's preferred stock sells for $85 and pays $11 each year in dividends. What is the required rate
of return?
20) What is the value of a preferred stock that pays a $2.10 dividend to an investor with a required rate
of return of 6% (round your answer to the nearest $1)?
A) $35
B) $23
C) $17
D) $21
21) Which of the following formulas is appropriate to find the value of preferred stock with a fixed
dividend?
A) Value of preferred stock = Annual Preferred Stock Dividend (1 + growth rate)/Market's Required
Yield on Preferred Stock
B) Value of preferred stock = Annual Preferred Stock Dividend (1 + growth rate)/Market's Required
Yield on Preferred Stock - growth rate
C) Value of preferred stock = Annual Preferred Stock Dividend/Market's Required Yield on Preferred
Stock
D) Value of preferred stock = Annual Preferred Stock Dividend/Investor's Required Yield on Preferred
Stock
22) An issue of preferred stock currently sells for $52.50 per share and pays a constant annual expected
dividend of $2.25 per share. The expected return on this security is
A) 4.29%.
B) 0.04%.
C) 8.33%.
D) 13.33%.
23) Expected cash flow for a preferred stock primarily consists of
A) dividend payments.
B) changes in the price of the stock.
C) interest payments.
D) both A and B.
24) Preferred stock is similar to common stock in that
A) it has no fixed maturity date.
87
B) the nonpayment of dividends can bring on bankruptcy.
C) dividends are limited in amount.
D
 5) Which of the following statements concerning preferred stock correct? : 1947997
5) Which of the following statements concerning preferred stock is correct?
A) Preferred stock generally is more costly to the firm than common stock.
B) Most issues of preferred stock have a cumulative feature.
C) Preferred dividend payments are tax-deductible.
D) Preferred stock is a riskier form of capital to the firm than bonds.
6) World Wide Interlink Corp. has decided to undertake a large project. Consequently, there is a need
for additional funds. The financial manager plans to issue preferred stock with an annual dividend of $5
per share. The stock will have a par value of $30. If investors' required rate of return on this investment
is currently 20%, what should the preferred stock's market value be?
A) $10
B) $15
C) $20
D) $25
7) Davis Gas & Electric issued preferred stock in 1985 that had a par value of $50. The stock pays a
dividend of 7.875%. Assume that shares are currently selling for $62.50. What is the preferred
stockholder's expected rate of return? Round to the nearest 0.01%.
A) 6.30%
B) 7.88%
C) 10.25%
D) 5.02%
8) Murky Pharmaceuticals has issued preferred stock with a par value of $100 and a 5% dividend. The
investors' required yield is 10%. What is the value of a share of Murky preferred?
A) $100
B) $75
C) $50
D) $25
9) Edison Power and Light has an outstanding issue of cumulative preferred stock with an annual fixed
dividend of $2.00 per share. It has not paid the preferred dividend for the last 3 years, but intends to
pay a dividend on the common stock in the coming year. Before Edison can pay a dividend on the common
stock
A) preferred shareholders may cast all their votes for a single director.
B) preferred shareholders must receive dividends totaling $8.00 per share.
C) preferred shareholders must receive $2.00 per share.
D) will not necessarily receive any dividend.
10) Which of the following provisions is unique to preferred stockholders and usually NOT available to
common stockholders?
A) Cumulative dividends feature
B) Voting rights
C) Fixed dividend
88
D) Both A and C
11) Piercing Publishers recently issued preferred stock with a fixed annual dividend of $3.00 per share.
Investors require a 5% return on similar preferred stock issues. The stock is currently selling for $65.
Is the stock a good buy?
A) Yes, as it is undervalued $5.
B) Yes, as it is undervalued $10.
C) No, as it is overvalued $5.
D) No, as it is overvalued $10.
12) Tri State Pickle Company preferred stock pays a perpetual annual dividend of 2 1/2% of its par value.
Par value of TSP preferred stock is $100 per share. If investors' required rate of return on this stock is
15%, what is the value of per share?
A) $37.50
B) $15.00
C) $16.67
D) $6.00
13) Petrified Forest Skin Care, Inc. pays an annual perpetual dividend of $1.70 per share. If the stock is
currently selling for $21.25 per share, what is the expected rate of return on this stock.
A) 36.13%
B) 12.5%
C) 8.0%
D) 13.6%
14) Horizon Communications stock pays a fixed annual dividend of $3.00. Because of lower inflation, the
market's required yield on this preferred stock has gone from 12% to 10%. As a result
A) Horizon's dividend decreased by 6 cents.
B) The value of Horizon's preferred increased by $3.00.
C) The value of Horizon's preferred decreased by $5.00.
D) The value of Horizon's preferred increased by $5.00.
 13) P/E ratios found in published sources or the internet : 1947996
13) P/E ratios found in published sources or on the internet are always computed by dividing the next
period's expected earnings into the current price of the stock.
14) The higher the investor's required rate of return, the higher the P/E ratio will be.
15) Walmart's current earnings per share of $5.02 are expected to grow at a rate of 17% per year for
the next few years. Using a P/E ratio of 13.46, what is a reasonable value for a share of Walmart Stock.
16) RAH Inc. is not publicly traded, but the P/E ratios of it's 4 closest competitors are 15, 15.3, 15.7, and
16.5. RAH's current earnings per share are $1.50. They are expected to grow at 6% for the next few
years. What is a reasonable price for a share of RAH stock?
(15 + 15.3 + 15.7 + 16.5)/4 = 15.625. A reasonable price would be $1.50(1.06)(15.625) = $24.84.
10.3   Preferred Stock
1) UVP preferred stock pays $5.00 in annual dividends. If your required rate of return is 13%, how much
will you be willing to pay for one share?
A) $38.46
B) $26.26
C) $65.46
89
D) $46.38
2) Green Corp.'s preferred stock is selling for $20.83. If the company pays $2.50 annual dividends, what
is the expected rate of return on its stock?
A) 8.33%
B) 12.00%
C) 2.50%
D) 20.00%
3) Sacramento Light & Power issued preferred stock in 1998 that had a par value of $85. The preferred
stock pays a dividend of 5.75%. Investors require a rate of return of 6.50% today on this stock. What is
the value of the preferred stock today? Round to the nearest $1.
A) $100
B) $85
C) $75
D) $16
4) Which of the following statements is true?
A) Preferred stockholders are entitled to dividends before common stockholders can receive dividends.
B) Preferred stock, like common stock, usually has no maturity; i.e., the corporation does not pay back the
investment.
C) The market value of preferred stock, like bonds, will usually fluctuate in value primarily as the result
of market rates of interest.
D) All of the above.
 3) The P/E ratio calculated by dividing A) the current stock : 1947995
3) The P/E ratio is calculated by dividing
A) the current stock price by stockholders' equity.
B) total assets by net income.
C) the current stock price by earnings per share.
D) the current stock price by operating cash flow per share.
4) The GAP's most recent earnings per share were $1.75. Analysts forecast next year's earnings per
share at $1.88. If the appropriate P/E ratio is 15, a share of GAP stock should be valued at
A) $28.20.
B) $26.25.
C) $27.23.
D) $8.57.
5) The retail analyst at Morgan-Sachs values stock of the GAP at $38.00 per share. They are using the
average industry "forward" P/E ratio of 17. Their forecasted earnings per share for next year is
A) $0.54.
B) $1.50.
C) $2.24.
D) There is not enough information calculate earnings per share.
6) Home Depot stock is currently selling for $75 per share. Next year's dividend is expected to be
$1.56; next year's earnings per share are expected to be $4.16. Home Depot's P/E ratio is
A) .055.
B) 18.
90
C) 2.14.
D) 48.
7) McDonald's stock currently sells for $103. It's expected earnings per share are $5.50. The average
P/E ratio for the industry is 24. If investors expected the same growth rate and risk for McDonald's as
for an average firm in the same industry, it's stock price would
A) stay about the same.
B) rise.
C) fall.
D) there is not enough information.
8) If the ROE on a new investment is less than the firm's required rate of return
A) the investment increases the firm's value.
B) the investment leaves the firm's value unchanged.
C) the effect on the firm's value is unpredictable.
D) the investment reduces the firm's value.
9) Zorba's is a small chain of restaurants whose stock is not publicly traded. The average P/E ratio for
similar restaurant chains is 16.5; the P/E ratio for the S&P 500 Index is 15.2. This year's earnings were
$1.21 per share and next year's earnings are forecasted at $1.46 per share. A reasonable price for a
share of Zorba's stock is
A) $24.09.
B) $19.96.
C) $20.23.
D) $16.50.
10) Apple stock is now selling for $460 per share. The P/E ratio based on current earnings is 10.98 and
the P/E ratio based on expected earnings is 10.16. The expected growth rate in Apples earnings must be
A) 2.39%.
B) 8.07%.
C) -7.5%.
D) 5.5%.
48) Draper Company's common stock paid a dividend last year : 1947994
48) Draper Company's common stock paid a dividend last year of $3.70. You believe that the long-term
growth in the dividends of the firm will be 8% per year. If your required return for Draper is 14%, how
much are you willing to pay for the stock?
49) Determine the rate of return on a $25 common stock that pays a dividend of $2.50 in year 1 and
grows at a rate of 5%.
50) You are considering the purchase of AMDEX Company stock. You anticipate that the company will pay
dividends of $2.00 per share next year and $2.25 per share the following year. You believe that you can
sell the stock for $17.50 per share two years from now. If your required rate of return is 12%, what is
the maximum price that you would pay for a share of AMDEX Company stock?
51) You can purchase one share of Sumter Company common stock for $80 today. You expect the price of
the common stock to increase to $85 per share in one year. The company pays an annual dividend of $3.00
per share. What is your expected rate of return for Sumter stock?
10.2   The Comparables Approach to Valuing Common Stock
1) If a stock has a much higher than normal P/E ratio, investors probably expect
91
A) slow growth in earnings.
B) rapid growth in earnings.
C) large increases in the price of the stock.
D) a declining stock price.
2) Which of the following factors will influence a firm's P/E ratio?
A) The investors' required rate of return
B) Firm investment opportunities
C) General market conditions
D) All of the above
41) Cumulative voting gives each share of stock a number : 1947993
41) Cumulative voting gives each share of stock a number of votes equal to the number of directors being
elected to the board.
42) The expected rate of return implied by a given market price equals the required rate of return for
investors at the margin.
43) Stock valuation is more precise than bond valuation as stock cash flows are more certain.
44) The stock valuation model D1/(Rc - g) requires Rc > G.
45) Is the following common stock priced correctly? If no, what is the correct price?
Price= $26.25
Required rate of return = 13%
Dividend year 0= $2.00
Dividend year 1= $2.10
46) The common stock of Cranberry, Inc. is selling for $26.75 on the open market. A dividend of $3.68 is
expected to be distributed, and the growth rate of this company is estimated to be 5.5%. If Richard
Dean, an average investor, is considering purchasing this stock at the market price, what is his expected
rate of return?
Question : 31) You considering the purchase of common stock that just : 1947992
31) You are considering the purchase of common stock that just paid a dividend of $6.50 per share.
Security analysts agree with top management in projecting steady growth of 12% in dividends and
earnings over the foreseeable future. Your required rate of return for stocks of this type is 18%. How
much should you expect to pay for this stock?
A) $86
B) $94
C) $108
D) $121
E) $242
32) You are considering the purchase of Wahoo, Inc. The firm just paid a dividend of $4.20 per share.
The stock is selling for $115 per share. Security analysts agree with top management in projecting steady
growth of 12% in dividends and earnings over the foreseeable future. Your required rate of return for
stocks of this type is 17.5%. If you were to purchase and hold the stock for three years, what would the
expected dividends be worth today?
A) $12.60
B) $9.21
C) $17.12
92
D) $15.55
E) $11.46
33) A share of common stock just paid a dividend of $3.25 per share. The expected long-run growth rate
for this stock is 18%. If investors require a rate of return of 24%, what should the price of the stock
be?
A) $57.51
B) $62.25
C) $71.86
D) $63.92
34) Common stockholders expect greater returns than bondholders because
A) they have no legal right to receive dividends.
B) they bear greater risk.
C) in the event of liquidation, they are only entitled to receive any cash that is left after all creditors are
paid.
D) all of the above.
35) WSU Inc. is a young company that does not yet pay a dividend. You believe that the company will
begin to pay dividends 5 years from now, and that the company will then be worth $50 per share. If your
required rate of return on this risky stock is 20%, what is the stock worth today?
A) $40
B) $10
C) $20.09
D) $0.00
36) Common stockholders are essentially creditors of the firm.
37) Common stock represents a claim on residual income.
38) The growth rate of future earnings is determined by return on equity and the profit-retention rate.
39) The stockholder's expected rate of return consists of a dividend yield and interest.
40) When bankruptcy occurs, the claims of the common shareholders may go unsatisfied
Question : 11) Little Feet Shoe Co. just paid a dividend of : 1947990
11) Little Feet Shoe Co. just paid a dividend of $1.65 on its common stock. This company's dividends are
expected to grow at a constant rate of 3% indefinitely. If the required rate of return on this stock is
11%, compute the current value of per share of LFS stock.
A) $20.63
B) $21.24
C) $15.00
D) $55.00
12) Marshall Manufacturing has common stock which paid a dividend of $1.00 a share last year. You
expect the stock to grow at 5% per year. If the appropriate rate of return on this stock is 12%, how
much are you willing to pay for the stock today?
A) $13.00
B) $15.00
C) $17.00
D) $19.00

93
13) Marble Corporation's ROE is 17%. Their dividend payout ratio is 20%. The last dividend, just paid, was
$2.58. If dividends are expected to grow by the company's sustainable growth rate indefinitely, what is
the current value of Marble common stock if its required return is 18%?
A) $14.33
B) $18.27
C) $47.67
D) $66.61
14) Fris B. Corporation stock is currently selling for $42.86. It is expected to pay a dividend of $3.00 at
the end of the year. Dividends are expected to grow at a constant rate of 3% indefinitely. Compute the
required rate of return on FBC stock.
A) 10%
B) 33%
C) 7%
D) 4.3%
15) You are evaluating the purchase of Cool Toys, Inc. common stock that just paid a dividend of $1.80.
You expect the dividend to grow at a rate of 12%, indefinitely. You estimate that a required rate of
return of 17.5% will be adequate compensation for this investment. Assuming that your analysis is
correct, what is the most that you would be willing to pay for the common stock if you were to purchase
it today? Round to the nearest $.01.
A) $36.65
B) $91.23
C) $51.55
D) $74.82
16) A stock currently sells for $63 per share, and the required return on the stock is 10%. Assuming a
growth rate of 5%, calculate the stock's last dividend paid.
A) $1
B) $3
C) $5
D) $7
17) A decrease in the ________ will cause an increase in common stock value.
A) growth rate
B) required rate of return
C) last paid dividend
D) both B and C
18) Acme Consolidated has a return on equity of 12%. If Acme distributes 60% of earnings as dividends,
its expected growth rate will be
A) new 4.80%.
B) 7.20%.
C) 12%.
D) 6%.
19) An investor is contemplating the purchase of common stock at the beginning of this year and to hold
the stock for one year. The investor expects the year-end dividend to be $2.00 and expects a year-end

94
price for the stock of $40. If this investor's required rate of return is 10%, then the value of the stock
to this investor is
A) $36.36.
B) $38.18.
C) $33.06.
D) $34.88.
20) A firm just paid $2.00 on its common stock and expects to continue paying dividends, which are
expected to grow 5% each year, from now to infinity. If the required rate of return for this stock is 9%,
then the value of the stock is
A) $50.00.
B) $40.00.
C) $54.50.
D) $52.50.
Question : 1) The XYZ Company, whose common stock currently selling for : 1947989
1) The XYZ Company, whose common stock is currently selling for $40 per share, is expected to pay a
$2.00 dividend in the coming year. If investors believe that the expected rate of return on XYZ is 14%,
what growth rate in dividends must be expected?
A) 5%
B) 14%
C) 9%
D) 6%
2) The expected rate of return on a share of common stock whose dividends are growing at a constant
rate (g) is which of the following?
A) (D1 + g)/Vc
B) D1/Vc + g
C) D1/g
D) D1/Vc
3) Green Company's common stock is currently selling at $24.00 per share. The company recently paid
dividends of $1.92 per share and projects growth at a rate of 4%. At this rate, what is the stock's
expected rate of return?
A) 4.08%
B) 8.00%
C) 12.00%
D) 8.80%
4) Common stockholders are essentially
A) creditors of the firm.
B) managers of the firm.
C) owners of the firm.
D) all of the above.
5) Butler, Inc.'s return on equity is 17% and management retains 75% of earnings for investment
purposes. Based on this information, what will be the firm's growth rate?
A) 4.25%

95
B) 22.67%
C) 44.12%
D) 12.75%
6) If a company has a return on equity of 25% and wants a growth rate of 10%, how much of ROE should
be retained?
A) 40%
B) 50%
C) 60%
D) 70%
7) ________ gives minority shareholders more power to elect board of directors.
A) Preemptive right
B) Majority voting
C) Proxy fights
D) Cumulative voting
8) You are evaluating the purchase of Cellars, Inc. common stock that just paid a dividend of $1.80. You
expect the dividend to grow at a rate of 12% for the next three years. You plan to hold the stock for
three years and then sell it. You estimate that a required rate of return of 17.5% will be adequate
compensation for this investment. Calculate the present value of the expected dividends.
A) $4.91
B) $5.40
C) $9.80
D) $6.80
9) You are evaluating the purchase of Charbridge, Inc. common stock which currently pays no dividend and
is not expected to do so for many years.  Because of rapidly growing sales and profits, you believe the
stock will be worth $51.50 in 3 years.  If your required rate of return is 16%, what is the stock worth
today?
A) $59.74
B) $51.25
C) $32.99
D) $0.00 because stocks that do not pay dividends have no value.
10) CEOs naming friends to the board of directors and paying them more than the norm is an example of
the
A) agency problem.
B) preemptive right.
C) majority voting feature.
D) proxy fights.
Question : 13) What the value of a bond that has a : 1947979
13) What is the value of a bond that has a par value of $1,000, a coupon rate of $80 (annually), and
matures in 11 years? Assume a required rate of return of 11%, and round your answer to the nearest $10.
A) $320.66
B) $1,011.00
C) $813.80
D) $790.79
96
14) What is the value of a bond that matures in three years, has an annual coupon payment of $110, and a
par value of $1,000? Assume a required rate of return of 11%, and round your answer to the nearest $10.
A) $970
B) $1,330
C) $330
D) $1,000
15) Bond ratings directly affect a bond's
A) spread over the Treasury yield.
B) coupon rate.
C) maturity date.
D) call provisions.
16) The discount rate used to value a bond is
A) the coupon interest rate.
B) determined by the issuing company.
C) fixed for the life of the bond.
D) the market rate of interest.
17) As interest rates, and consequently investors' required rates of return, change over time, the
________ of outstanding bonds will also change.
A) maturity date
B) coupon interest payment
C) par value
D) price
18) Mango Company bonds pay a semiannual coupon rate of 6.4%. They have eight years to maturity and
face value, or par, of $1,000. Compute the value of Mango bonds if investors' required rate of return is
5%.
A) $1,090.48
B) $883.66
C) $1,006.83
D) $950.00
19) Terminator Bug Company bonds have a 14% coupon rate. Interest is paid semiannually. The bonds have
a par value of $1,000 and will mature 10 years from now. Compute the value of Terminator bonds if
investors' required rate of return is 12%.
A) $1,114.70
B) $1,149.39
C) $894.06
D) $1,000.00
20) Brookline, Inc. just sold an issue of 30-year bonds for $1,107.20. Investors require a rate of return
on these bonds of 7.75%. The bonds pay interest semiannually. What is the coupon rate of the bonds?
A) 7.750%
B) 11.072%
C) 9.375%
D) 8.675%

97
21) Applebee sold an issue of 30-year, $1,000 par value bonds to the public. The coupon rate of 8.75% is
payable annually. It is now five years later, and the current market rate of interest is 7.25%. What is the
current market price (intrinsic value) of the bonds? Round off to the nearest $1.
A) $715
B) $1,171
C) $1,225
D) $697
22) Six years ago, Colt, Inc. sold an issue of 30-year, $1,000 par value bonds. The coupon rate of 5.25% is
payable annually. Investors presently require a rate of return of 8.375%. What is the current market
price (intrinsic value) of the bonds? Round off to the nearest $1.
A) $1,050
B) $932
C) $681
D) $1,111
 3) A $1,000 par value 10-year bond with a 10% : 1947978
3) A $1,000 par value 10-year bond with a 10% coupon rate recently sold for $900. The yield to maturity
A) is 10%.
B) is greater than 10%.
C) is less than 10%.
D) cannot be determined.
4) Sterling Corp. bonds pay 10% annual interest and are selling at 97. The market rate of interest
A) is less than 10%.
B) is greater than 10%.
C) equals 10%.
D) cannot be determined.
5) The Blackburn Group has recently issued 20-year, unsecured bonds rated BB by Moody's. These bonds
yield 443 basis points above the U.S. Treasury yield of 2.76%.  The yield to maturity on these bonds is
A) 4.43%.
B) 7.19%.
C) 12.23%.
D) mortgage bonds.
6) Colby & Company bonds pay semiannual interest of $50. They mature in 15 years and have a par value
of $1,000. The market rate of interest is 8%. The market value of Colby bonds is (round to the nearest
dollar)
A) $1,173.
B) $743.
C) $1,000.
D) $827.
7) Caldwell, Inc. sold an issue of 30-year, $1,000 par value bonds to the public. The bonds carry a 10.85%
coupon rate and pay interest semiannually. It is now 12 years later. The current market rate of interest
on the Caldwell bonds is 8.45%. What is the current market price (intrinsic value) of the bonds? Round
off to the nearest $1.
A) $751
98
B) $1,177
C) $1,220
D) $976
8) MI has a $1,000 par value, 30-year bond outstanding that was issued 20 years ago at an annual coupon
rate of 10%, paid semiannually. Market interest rates on similar bonds are 7%. Calculate the bond's price.
A) $956.42
B) $1,000.00
C) $1,168.31
D) $1,213.19
9) Davis & Davis issued $1,000 par value bonds at 102. The bonds pay 12% interest annually and mature in
30 years. The market rate of interest is (round to the nearest hundredth of a percent)
A) 12.00%.
B) 11.71%.
C) 10.12%.
D) 11.29%.
10) What is the yield to maturity of a nine-year bond that pays a coupon rate of 20% per year, has a
$1,000 par value, and is currently priced at $1,407? Assume annual coupon payments.
A) 21.81%
B) 6.14%
C) 12.28%
D) 11.43%
11) What is the expected rate of return on a bond that matures in seven years, has a par value of $1,000,
a coupon rate of 14%, and is currently selling for $911?  Assume annual coupon payments.
A) 7.81%
B) 15.36%
C) 15.61%
D) 16.22%
12) What is the expected rate of return on a bond that pays a coupon rate of 9% paid semi-annually, has
a par value of $1,000, matures in five years, and is currently selling for $1071?
A) 7.28%
B) 8.40%
C) 3.64%
D) 4.21%
Question : Use the following information to answer the following question(s).   Beta Market1 Firm A1.25
Firm : 1947974
Use the following information to answer the following question(s).
 
Beta
Market 1
Firm A 1.25
Firm B 0.6
Market Return 10% Risk Free Rate2%
 
99
17) The market risk premium is
A) 2%.
B) 4%.
C) 6%.
D) 8%.
18) Firm A's risk premium is
A) 4%.
B) 6%.
C) 8%.
D) 10%.
19) Firm B's risk premium is
A) 2.66%.
B) 4.8%.
C) 6.3%.
D) 8.1%.
20) The required rate of return for Firm A is
A) 8%.
B) 12%.
C) 16%.
D) Cannot be determined with information given.
21) U. S. Treasury bills can be used to approximate the risk-free rate.
22) Long-term bonds issued by large, established corporations are commonly used to estimate the risk-
free rate.
23) The market beta changes frequently with economic conditions.
24) The S&P 500 Index is commonly used to estimate the market rate of return.
25) The security market line (SML) intercepts the Y axis at the risk-free rate.
26) The security market line can drawn by connecting the risk-free rate and the expected return on the
market portfolio
Question : 6) The security market line (SML) relates risk to return, : 1947973
6) The security market line (SML) relates risk to return, for a given set of market conditions. If
expected inflation increases, which of the following would most likely occur?
A) The market risk premium would increase.
B) Beta would increase.
C) The slope of the SML would increase.
D) The SML line would shift up.
7) The security market line (SML) relates risk to return, for a given set of market conditions. If risk
aversion increases, which of the following would most likely occur?
A) The market risk premium would increase.
B) Beta would increase.
C) The slope of the SML would increase.
D) The SML line would shift up.

100
8) The Elvis Alive Corporation, makers of Elvis memorabilia, has a beta of 2.35. The return on the market
portfolio is 12%, and the risk-free rate is 2.5%. According to CAPM, what is the risk premium on a stock
with a beta of 1.0?
A) 12.00%
B) 22.33%
C) 9.5%
D) 14.5%
9) Bell Weather, Inc. has a beta of 1.25. The return on the market portfolio is 12.5%, and the risk-free
rate is 5%. According to CAPM, what is the required return on this stock?
A) 20.62%
B) 9.37%
C) 14.37%
D) 15.62%
10) The rate on six-month T-bills is currently 5%. Andvark Company stock has a beta of 1.69 and a
required rate of return of 15.4%. According to CAPM, determine the return on the market portfolio.
A) 11.15%
B) 6.15%
C) 17.07%
D) 14.11%
11) You are going to invest all of your funds in one of three projects with the following distribution of
possible returns:
Project 1 Project 2
Standard Deviation 12% Standard Deviation 19.5%
Probability Return Probability Return
50% Chance 20% 30% Chance 30%
50% Chance -4% 40% Chance 10%
30% Chance -20%
Project 3
Standard Deviation 12%
Probability Return
10% Chance 30%
40% Chance 15%
40% Chance 10%
10% Chance -21%
If you are a risk-averse investor, which one should you choose?
A) Project 1
B) Project 2
C) Project 3
12) The expected return on the market portfolio is currently 11%. Battmobile Corporation stockholders
require a rate of return of 23.0%, and the stock has a beta of 2.5. According to CAPM, determine the
risk-free rate.
A) 17.5%
B) 2.75%
101
C) 3.0%
D) 9.2%
13) Hefty stock has a beta of 1.2. If the risk-free rate is 7% and the market risk premium is 6.5%, what
is the required rate of return on Hefty?
A) 14.8%
B) 14.4%
C) 12.4%
D) 13.5%
14) The market risk premium is measured by
A) beta.
B) market return less risk-free rate.
C) T-bill rate.
D) standard deviation.
15) Marjen stock has a required return of 20%. The expected market return is 15%, and the beta of
Marjen's stock is 1.5. Calculate the risk-free rate.
A) 4%
B) 5%
C) 6%
D) 7%
16) You are thinking about purchasing 1,000 shares of stock in the following firms:
Number of Shares Firm's Beta
Firm A 100 0.75
Firm B 200 1.47
Firm C 200 0 .82
Firm D 600 1.60
If you purchase the number of shares specified, then the beta of your portfolio will be:
A) 1.16.
B) 1.35.
C) 1.00.
Q2- Today we will take a look at Cost-Volume-Profit (CVP) analysis and the Break-even point (BEP) in
sales.
Cost-Volume-Profit Analysis
The Cost-Volume-Profit  (CVP) analysis is a method of cost accounting. It looks at the impact of changes
in production costs and sales on operating profits. Performing the CVP, we calculate the Break-even point
for various sales volume and cost structure scenarios, to help management with the short-term decision-
making process. As it focuses mainly on the Break-even point, it is commonly referred to as Break-even
Analysis.
When performing a CVP analysis, we need to consider the following inherent assumptions:
 Selling price is constant for varying quantities of sold units;
 Fixed Costs are consistent at the specified production levels;
 Variable Costs per unit do not vary between different numbers of produced units;
 All manufactured items are sold in the same period;
 Costs are classified as Fixed or Variable; no semi-fixed costs can exist in the analysis;

102
  All costs are only affected by changes in the activity.
The CVP formula shows us the sales volume needed to cover costs and break even. The recipe for the
break-even sales is:

We know where Fixed Costs come from, now let us look at the contribution margin.
Contribution margin
To calculate the CVP equation, we first take a look at the Contribution Margin.

The Contribution Margin (CM) is a basic calculation in CVP analysis. It represents the profit the company
has made, to cover Fixed Costs. We can also calculate it on a per-unit basis. Another calculation is the
Contribution Margin ratio:

We can conclude that whenever the Contribution Margin is more than the Fixed Costs, the business is
profitable.
Break-even point
The volume of production and sales where all relevant costs are covered by the revenue is called the
break-even point (BEP). This is where the business breaks even and can start generating income. The BEP
represents the level of sales where net income = zero, the point where Sales = Total Variable Costs +
Total Fixed Costs, and Contribution Margin = Total Fixed Costs.
To calculate the break-even amount, we divide the Total Fixed Costs over the Contribution Margin ratio:

103
Another way to calculate the break-even amount is as follows:

To calculate the quantity of the break-even point, we use the following formula:

Another way to calculate the break-even point in units is to look at the break-even equation:

By solving the equation for Q, we can find the break-even point in volume of units.
Targeted income
We can also calculate the CVP equation to get the required sales volume to realize the desired target
profit (targeted income).
We add the target income to the Fixed Costs:

If we are calculating the break-even sales for the whole company, and not for a division, we can then also
add the income tax we have to cover with sales, to arrive at the targeted income. Then we will adjust the
formula as follows:

104
CVP Graph and example
We can also graphically present the CVP analysis. Let us look at an example to create a CVP analysis
Graph.
Let us start with the following data:
 Total Fixed Costs are 100,000 euros;
 Variable Costs per unit are 2,20 euros;
 Selling Price per unit is 4,00 euros.
Using those we can calculate the Total Costs (Variable and Fixed) and Sales Revenue for different volume
levels:

We can then calculate the Break-even point using the formulas we discussed above.
Contribution Margin per Unit = Selling Price – Variable Costs per unit
= 4.00 – 2.20
= 1.80 euros per unit
The Break-even volume is = Total FC / CM per Unit
= 100,000 / 1.80
= 55,556 units
The corresponding break-even sales will be the break-even volume multiplied by the selling price of 4.00
euros, or:
55,556 * 4.00 = 222,222 euros.
To plot this in Excel we use an XY Scatter data series on top of our Line series, and we also present it
proportionally from the number of XY Scatter data points (look at the Excel file available for download
at the end of the article).
We then get the following chart or CVP Graph:

105
The graphical representation of the CVP analysis shows us the following:
 The blue line shows our sales, increasing as the volume increases, multiplied by the selling price of
4.00 euros;
 The brown line shows fixed costs, which are not affected by sales volume and remain constant;
 The grey line shows our variable costs, at 2.20 euro per unit;
 The yellow line shows total costs (fixed costs + variable costs) for the respective sales volume;
 The break-even point is at the sales volume where sales revenue crosses above the total costs
line, which means that we start to generate net income from this point on;
 Based on our calculations, we know that the company will break even when 55,556 units are sold for
222,222 euros.
Contribution margin income statement
Let us look at a more financial representation of the CVP analysis. If we present the calculations in the
income statement format, we get the contribution income statement, which is primarily used for internal
purposes in companies. By calculating the break-even volume with a targeted pre-tax income of 45,000
euros, we get 80,556 units. Calculating sales and variable costs for this quantity, we get the following:

106
Looking at CVP this way we get a more comprehensive view of required sales volumes to get a 45,000
euros pre-tax income. This income statement shows us that to get the targeted income; we have to
achieve the respective sales and keep variable and fixed costs at the specified levels.
Benefits and Limitations of CVP
The CVP analysis is easy to implement financial analysis technique that can help us with decision making
for production volumes. However, we must consider the following benefits and limitations that it faces:
 (+) CVP provides a simple understanding of the sales required to break even or achieve a desired
profitability;
 (+) It helps decision-makers with forecasting cost and profit based on activity changes;
 (+) CVP also helps management decide on the optimum levels of production, to maximize profits;
 (-) CVP assumes the scale of production doesn’t affect Total Fixed Costs, which is rarely the case
in real-life scenarios;
 (-) Variable Costs are expected to vary proportionally with production/sales volume, which doesn’t
happen in reality;
 (-) CVP assumes costs are either Fixed or Variable when in fact a lot of costs are semi-fixed, and
their separation to fixed and variable components may not always be achievable.
Conclusion
The Cost-Volume-Profit analysis is a short-run marginal analysis method that can help us with decision
making in regards to optimum production and sales volumes. However, we must keep in mind the
assumptions that it makes, which can be hard to set correctly. If the reality deviates too much from the
initial assumptions, we might get a CVP analysis that provides us with conclusions that are not very
beneficial for the company.
107
 CVP Analysis Problems and Solutions
Contents [show]
Cost Volume Profit Analysis Unsolved Problems PDF
Previous Lesson: Process Costing Problems and Solutions
Next Lesson: Functional Budgets Problems and Solutions
Problem # 1:
Assume that as an investor, you are planning to enter the construction industry as a panel formwork
supplier. The potential number of forthcoming projects, you forecasted that within two years, your fixed
cost for producing formworks is Rs. 300,000. The variable unit cost for making one panel is Rs.  15.  The
sale price for each panel will be Rs. 25. If you charge Rs. 25 for each panel, how many panels you need to
sell in total, in order to start making money?
Solution:

Answer: Break-Even in Units = 30,000 panels

 
>> Practice Cost Volume Profit Analysis MCQs. 
Problem # 2:
Suppose you intend to open a franchise business to supply a nationally-known line of women’s shoes.  
You’ve found a good location in Abbottabad to open your shop, and have determined that the average
prices and costs of operating the store are:
Price = Rs. 50 per pair                                             Cost = Rs. 30 per pair Rent = Rs. 2,500 per month       
Insurance = Rs. 500 per month Utilities & Telephone = Rs. 300 per month
In addition, you plan to hire two sales ladies on a commission basis of 10% in order to provide them with
incentive to sell shoes.  You are required determine the breakeven point in Rupees?
Solution:

108
 Answer: Break-Even in Rupees = Rs. 11,000
 
>> Readings Cost Volume Profit Analysis.
 
Problem # 3:
A manufacturing company supplies its products to construction job sites. The average monthly fixed cost
per site is Rs. 4,500, while each unit cost Rs. 35 to produce and selling price is Rs. 50 per unit. Determine
the monthly breakeven volume.
 
Solution:

Answer: Break-Even in Volume = 300

 
>> Further Readings Process Costing.
 
 
Problem # 4:
A store sells t-shirts.  The average selling price is Rs. 15 and the average variable cost (cost price) is Rs.
9.  Thus, every time the store sells a shirt it has Rs. 6 remaining after it pays the manufacturer.  This Rs.
6 is referred to as the unit contribution.
 
(a) Suppose the fixed costs of operating the store (its operating expenses) are Rs. 100,000 per year. 
Find Break-even in units?

Solution:
Answer: Break-Even in Units = 16,667 T-shirts
 
(b) If the owner desired a profit of Rs. 25,000, what will be break-even point in Rupees?
Solution:

109
 Answer: Break-Even in Rupees = 16,667
  (c) If fixed costs rose to Rs. 110,000, break-even in units volume would be?   Solution:

Answer: Break-Even in Units = 18,333 T-shirts

  (d) If the average selling price rose to Rs.16, break even volume would fall?   Solution:

Answer: Break-Even in Volume = 14,286 T-shirts

Workshop Solutions ACCT603 Management Accounting Semester One 2018: Week Five

Question 1
Brown Corporation has sales of 2,000 units at $70 per unit. Variable expenses are 40% of the selling
price. If total fixed expenses are $44,000, what is the degree of operatingleverage?
Solutions
Contribution margin = Sales - Variable expenses = (2,000 units × $70 per unit) - (2,000 units × 0.40 × $70 per unit) = $140,000 - $56,000 = $84,000

Net operating income = Contribution margin -Fixed expenses = $84,000 - $44,000 = $40,000
Degree of operating leverage = Contribution margin ÷ Net operating income = $84,000 ÷ $40,000 = 2.1
Question 2
Steeler Corporation is planning to sell 100,000 units for $2.00 per unit and will break even at this level of
sales. Fixed expenses will be $75,000. What are the company's variable expenses per unit?
Solutions
Unit sales to break even = Fixed expenses ÷ Unit CM 100,000 units = $75,000 ÷ Unit CM Unit CM = $75,000 ÷ 100,000 units = $0.75 per unit Unit CM = Selling price per unit - Variable

expenses per unit $0.75 per unit = $2.00 per unit - Variable expenses per unit Variable expenses per unit = $2.00 per unit - $0.75 per unit = $1.25 per unit

Question 3
Menlo Company distributes a single product. The company’s sales and expenses for last month follow:
Total Per Unit
110
 Sales $ 310,000 $ 20

Variable expenses 217,000 14

Contribution margin 93,000 $6

Fixed expenses 72,000

Net operating income $ 21,000

Required:
 1) What is the monthly break-even point in unit sales and in dollar sales?
 2) Without resorting to computations, what is the total contribution margin at the break-even point?
 3-a) How many units would have to be sold each month to earn a target profit of $42,000? Use the
formula method.
 3-b) Verify your answer by preparing a contribution format income statement at the target sales level.
 4) Refer to the original data. Compute the company's margin of safety in both dollar and percentage
terms
 5) What is the company’s CM ratio? If monthly sales increase by $99,000 and there is no change in
fixed expenses, by how much would you expect monthly net operating income to increase?
Solutions:

Alternative solution:

or at $20 per unit, $240,000

2.
The contribution margin is $72,000 because the contribution margin is equal to the fixed expenses at the
break-even point.

3-b.

Sales (19,000 units × $20 per unit) $380,000

Variable expenses (19,000 units × $14 per

($266,000)
unit)

Contribution margin $114,000

Fixed expenses ($72,000)

Net profit $42,000

4. Margin of safety in dollar terms:

Margin of safety in percentage terms:

5. The CM ratio is 30%.

Expected total contribution margin: $409,000 × 30% $ 122,700

111
Present total contribution margin: $310,000 × 30% 93,000

Increased contribution margin $ 29,700

Given that the company’s fixed expenses will not change, monthly net operating income will also increase
by $29,700.
Question 4
Cheryl Montoya picked up the phone and called her boss, Wes Chan, the vice president of marketing at
Piedmont Fasteners Corporation: “Wes, I’m not sure how to go about answering the questions that came
up at the meeting with the president yesterday.”
“The president wanted to know the break-even point for each of the company’s products, but I am having
trouble figuring them out.”
“I’m sure you can handle it, Cheryl. And, by the way, I need your analysis on my desk tomorrow morning at
8:00 sharp in time for the follow-up meeting at 9:00.”
Piedmont Fasteners Corporation makes three different clothing fasteners in its manufacturing facility in
North Carolina. Data concerning these products appear below:
Velcro Metal Nylon

Normal annual sales

100,000 200,000 400,000
volume

Unit selling price $1.65 $1.50 $0.85

Variable expense per unit $1.25 $0.70 $0.25

Total fixed expenses are $400,000 per year.
All three products are sold in highly competitive markets, so the company is unable to raise its prices
without losing unacceptable numbers of customers.
The company has an extremely effective lean production system, so there is no beginning or ending work
in process or finished goods inventories.
Required:
 1. What is the company’s over-all break-even point in dollar sales?
 2. Of the total fixed expenses of $400,000, $20,000 could be avoided if the Velcro product is
dropped, $80,000 if the Metal product is dropped, and $60,000 if the Nylon product is dropped. The
remaining fixed expenses of $240,000 consist of common fixed expenses such as administrative salaries
and rent on the factory building that could be avoided only by going
 out of business entirely. a. What is the break-even point in unit sales for each product?
 b. If the company sells exactly the break-even quantity of each product, what will be the overall profit
of the company?
Solutions
1.
The overall break-even sales can be determined using the CM ratio.
Velcro Metal Nylon Total

Sales $ 165,000 $ 300,000 $ 340,000 $ 805,000

112
Variable expenses 125,000 140,000 100,000 365,000

Contribution margin $ 240,000

$ 40,000 $ 160,000
440,000

Fixed expenses
400,000

Net operating income $ 40,000

Contribution margin $440,00

= 0.5466
CM ratio = = 0

$805,00
Sales
0

2.
 The issue is what to do with the common fixed cost when computing the break-evens for the individual
products. The correct approach is to ignore the common fixed costs. If the common fixed costs are
included in the computations, the break-even points will be overstated for individual products and
managers may drop products that in fact are profitable.
a.
The break-even points for each product can be computed using the contribution margin approach as
follows:
Velcro Metal Nylon

Unit selling price $ 1.65 $ 1.50 $ 0.85

Variable cost per unit  1.25  0.70  0.25

$ 0.40 $ 0.80 $ 0.60

Unit contribution margin (a)

Product fixed expenses (b)

$ 20,000 $ 80,000 $ 60,000

Unit sales to break even (b)

÷ 50,000 100,000 100,000
 (a)
b.
If the company were to sell exactly the break-even quantities computed above, the company would lose
$240,000—the amount of the common fixed cost. This can be verified as follows:
Velcro Metal Nylon Total

Unit sales 50,000 100,000 100,000

Sales $ 317,500
$ 82,500 $150,00 $ 85,000

113
 0

Variable expenses 62,500 70,000 25,000 157,500

Contribution
$ 20,000 $ 80,000 $ 60,000 160,000
margin

Fixed expenses 400,000

$ (240,000)
Net operating loss

Question-22: What are the mixed costs?

Answer: Mixed costs are costs that contain both a variable and a
fixed cost component and change overall, but not in proportion, to
changes in the level of activity.
Question-23: What is the High-Low Method?
Answer: The high-low method is a mathematical method used to
classify mixed costs into fixed and variable components using the
total costs incurred at high and low activity levels.
Question-24: What is the operating leverage? and how to calculate
the degree of operating leverage?
Answer: The operating leverage is a measure of net business
income’s sensitivity to a specific dollar change of percentage sales.
Degree of operating leverage = Contribution Margin/Net Operating
Income
Question-25: What is the sales mix?
Answer: The term sales mix refers to the relative proportions in
Q4- Solved Problems Vvc
Last Updated on Fri, 02 Dec 2022 | Factory Overhead
5.1 The Alpha Omega Food Giant Company owns and operates a chain of 125 supermarkets. Budgeted data
for the Cypress store are as follows:
Annual sales $425,000
Annual cost of goods sold and other operating expenses 382,000
Annual building ownership costs (not included above) 20,000
The company can lease the building to a large flower shop for $4,000 per month. Decide whether to
continue operating this store or to lease, using:
1. The total project (or comparative statement) approach
2. The incremental (or relevant cost) approach
3. The opportunity cost approach
SOLUTION
1. The total project (or comparative statement) approach is shown below:
Continue Operation Lease

114
Sales revenue $425,000 $48,000 ($4,000 x 12 months) Less: Costs Cost of goods sold and cash operating
expenses $382,000 —
Building ownership costs 20,000 $20,000
Total costs $402,000 $20,000
Net income $ 23,000 $28,000
TTie company should lease the building.
2. Note that building ownership costs are not relevant because they are the same for each alternative.
TTie incremental (or relevant cost) approach gives the following:
Cash inflow from continuing operation ($425,000 - $382,000) $43,000 Less: Income from leasing 48,000
Incremental loss from continuing operation $ (5,000)
Therefore, the company should not continue the operation of the Cypress store.
3. The opportunity cost approach can be shown as follows:
Sales revenue $425,000 Less: Costs
Cost of goods sold and other operating expenses $382,000
Opportunity cost of leasing 48,000
Total costs $430,000
Difference in favor of leasing $ 5,000
5.2 The Spartan Company has an annual plant capacity of 25,000 units. Predicted data on sales and costs
are given below.
Sales (20,000 units @ $50) $1,000,000 Manufacturing costs:
Variable (materials, labor, and overhead) $40 per unit
Fixed overhead $30,000 Selling and administrative expenses:
Variable (sales commission—$1 per unit) $2 per unit
Fixed $7,000
A special order has been received from outside for 4,000 units at a selling price of $45 each. This order
will have no effect on regular sales. The usual sales commission on this order will be reduced by one-half.
Should the company accept the order? Show supporting computations.
SOLUTION
Incremental revenue (4,000 units @ $45) $180,000 Less: Incremental costs
Variable manufacturing (4,000 units @ $40) 160,000
Variable selling and administrative (4,000 @ $1.50) 6,000
Incremental gain in favor of accepting the order $ 14,000
5.3 Although the Missouri Company has the capacity to produce 16,000 units per month, current plans call
for monthly production and sales of only 10,000 units at $15 each. Costs per unit are as follows:

Direct materials $ 5.00

Direct labor 3.00
Variable factory overhead 0.75
Fixed factory overhead 1.50
1. Should the company
Variable selling expense 0.25 accept a special order
Fixed administrative expense 1.00 for 4,000 units @ $10?
$11.50

115
2. What is the maximum price the Missouri Company should be willing to pay an outside supplier who is
interested in manufacturing this product?
3. What would be the effect on the monthly contribution margin if the sales price was reduced to $14,
resulting in a 10 percent increase in sales volume?
SOLUTION
1. The company should accept the special order because the proposed $10 sales price covers all variable
manufacturing costs, which are:
Direct materials $5.00 per unit Direct labor 3.00 Variable factory overhead 0.75
Total $8.75 per unit
If variable selling expense is applied to this order, there would still be a unit contribution margin of $1,
or $4,000 in total.
2. Assuming that fixed costs cannot be reduced, and that variable costs such as direct labor really are
variable, the company would be willing to pay an outside supplier as much as the variable manufacturing
costs, that is, $8.75.
3. The effect on the monthly contribution margin if the sales price was reduced to $14 would be:
Present contribution margin [10,000 units ($15 - $9)] $60,000
Proposed contribution margin [(11,000 units ($14 - $9)] 55,000
Reduction in contribution margin $ 5,000
5.4 George Jackson operates a small machine shop. He manufactures one standard product which is
available from many other similar businesses and also manufactures custom-made products. His
accountant prepared the annual income statement shown below.
Custom Sales Standard Sales Total
Sales $50,000 $25,000 $75,000
Material $10,000 $ 8,000 $18,000
Labor 20,000 9,000 29,000
Depreciation 6,300 3,600 9,900
Power 700 400 1,100
Rent 6,000 1,000 7,000
The
Heat and light 600 100 700
Other 400 900 1,300
$44,000 $23,000 $67,000
$ 6,000 $ 2,000 $ 8,000
depreciation charges are for machines used in the respective product lines. The power charge is
apportioned on the estimate of power consumed. The rent is for the building space, which has been leased
for 10 years at $7,000 per year. The rent and heat and light are apportioned to the product lines based
on amount of floor space occupied. All other costs are current expenses and are identified with the
product line causing them.
A valued custom-parts customer has asked Mr. Jackson if he would manufacture 5,000 special units for
him. Mr. Jackson is working at capacity and would have to give up some other business in order to take
this special order. Though he cannot renege on custom orders already agreed to, he could reduce the
output of his standard product by about one-half for one year while producing the specially requested
custom part. The customer is willing to pay $7 for each part. The material cost will be about $2 per unit

116
and the labor will be $3.60 per unit. Mr. Jackson will have to spend $2,000 for a special device which will
be discarded when the job is done.
1. Calculate and present the following costs related to the 5,000-unit custom order:
(a) The incremental cost of the order
(b) The full cost of the order
(c) The opportunity costs of accepting the order
(d) The sunk costs related to the order
2. Should Mr. Jackson accept the special order? Explain your answer.
(CMA, adapted)
SOLUTION
1. (a) The incremental cost of the order is calculated as follows:
Costs incurred to fill order:
Special overhead 2,000
Total $30,000
Costs reduced for standard products:
Material $ 4,000
Labor 4,500
Other 450
Total incremental costs $21,050
Depreciation, rent, and heat and light are not affected by the order, since they are committed fixed
costs and thus continue regardless of the order. Power might be affected, depending on the particular
requirements of the special units. It is assumed here that the same amount of power will be used in each
case.
(b) The full cost of the order is
Costs incurred to fill order [from (a)] $30,000 Depreciation 1,800
Power 200
Rent 500
Heat and light _50
$32,550
(c) The opportunity cost of taking the order is the net cash flow given up:
Sales of standard product $12,500
Less: Material $ 4,000
Labor 4,500
Power 200
Other 450
Opportunity cost of special order $ 3,350
(d) The sunk costs are the costs that do not change as a result of choosing one order or the other:
Depreciation $1,800 Power 200 Rent 500 Heat and light__50
2. On the basis of the data in the question, it would pay Mr. Jackson to accept the order.
New sales $35,000
Less: Standard sales 12,500
$22,500
Incremental costs [from l.(a)] 21,050
117
Cash advantage to special units $ 1,450

Direct materials $ 5,000

Direct labor 8,000
Overhead 2,000
$15,000
Other Plus 20% 3,000 factors
must also be
considered, such as the
Selling price $18,000
long-run
consequences of failing to satisfy standard parts customers, the reliability of the cost estimates, and the
importance of this valued customer.
5.5 E. Berg and Sons build custom-made pleasure boats that range in price from $10,000 to $250,000.
For the past 30 years, Mr. Berg, Sr., has determined the selling price of each boat by estimating the cost
of material, labor, and a pro-rated portion of overhead, and adding 20 percent to their estimated costs.
For example, a recent price quotation was determined as follows:
The overhead figure was determined by estimating total overhead costs for the year and allocating them
at 25 percent of direct labor.
If a customer rejected the price and business was slack, Mr. Berg, Sr., would often be willing to reduce
his markup to as little as 5 percent over estimated costs. Thus, average markup for the year is estimated
at 15 percent.
Mr. Ed Berg, Jr., has just completed a course on pricing, and believes the firm could use some of the
techniques discussed in the course. The course emphasized the contribution margin approach to pricing,
and Mr. Berg, Jr., feels that such an approach would be helpful in determining the selling prices of their
custom-made pleasure boats.
Total overhead, which includes selling and administrative expenses for the year, has been estimated at
$150,000, of which $90,000 is fixed and the remainder is variable in direct proportion to direct labor.
1. Assume that the customer in the example rejected the $18,000 quotation and also rejected a $15,750
quotation (5 percent markup) during a slack period. The customer countered with a $15,000 offer.
(a) What is the minimum selling price Mr. Berg, Jr., could have quoted without reducing or increasing
company net income?
(b) What is the difference in company net income for the year between accepting and rejecting the
customer's offer?

118
2. What advantages does the contribution margin approach to pricing have over the approach used by Mr.
Berg, Sr.?
3. What pitfalls are there, if any, to contribution margin pricing?
(CMA, adapted)
SOLUTION
1. (a) The minimum price needed to have no effects is $13,800, which is computed as follows:
Variable cost of quoted boat: Direct material $ 5,000
Direct labor 8,000
Variable overhead (10% x 8,000)* 800
$13,800
»Total overhead was $150,000, which is 25% of direct labor. Therefore, $150 000
0.25
Variable overhead ($150,000 - $90,000)
Direct labor $600,000
(b) An increase in income of $1,200 (before taxes) would result from accepting the $15,000 offer.
Customer's offer $15,000
Variable costs 13,800
Contribution to profit $ 1,200
2. The contribution margin approach focuses on the relationship between future costs incurred as a
result of taking an order and the revenue the order will produce. The impact of a specific order on
profits can be estimated and the lower limits on price can be observed.
3. The major pitfall to the contribution margin approach to pricing is its failure to recognize the fixed
costs explicitly. Although they can be overlooked in the short run, the fixed costs must be covered in the
long run if the business is to continue.
JFK Manufacturing Corp. is using 10,000 units of part no. 300 as a component to assemble one of its
products. It costs the company $18 per unit to produce it internally, computed as follows:
Direct materials $ 45,000
Direct labor 50,000
Variable overhead 40,000
Fixed overhead 45,000
Total cost $180,000
An outside vendor has just offered to supply the part for $16 per unit. If the company stops producing
this part, one-third of the fixed overhead would be avoided. Should the company make or buy?
SOLUTION
10,000 Units
Make Buy
Outside purchase price $160,000 ($16 x 10,000 units)
Direct materials $ 45,000
Direct labor 50,000
Variable overhead 40,000
Fixed overhead avoided 15,000
$150,000 $160,000
As indicated above, the company is better off making the part.
119
As indicated above, the company is better off making the part.
5.7 The Vernom Corporation, which produces and sells to wholesalers a highly successful line of summer
lotions and insect repellents, has decided to diversify in order to stabilize sales throughout the year. A
natural area for the company to consider is the production of winter lotions and creams to prevent dry
and chapped skin.
After considerable research, a winter products line has been developed. However, because of the
conservative nature of the company management, Vernom's president has decided to introduce only one
of the new products for this coming winter. If the product is a success, further expansion in future
years will be initiated.
The product selected (called "Chap-off') is a lip balm that will be sold in a lipstick-type tube. The product
will be sold to wholesalers in boxes of 24 tubes for $8 per box. Because of available capacity, no
additional fixed charges will be incurred to produce the product. However, a $100,000 fixed charge will
be absorbed by the product to allocate a fair share of the company's present fixed costs to the new
product.
Using the estimated sales and production of 100,000 boxes of Chap-off as the standard volume, the
accounting department has developed the following costs:
Direct labor $2.00 per box
Direct materials 3.00 per box
Total overhead 1.50 per box
Total $6.50 per box
Vernom has approached a cosmetics manufacturer to discuss the possibility of purchasing the tubes for
Chap-off. The purchase price of the empty tubes from the cosmetics manufacturer would be $0.90 per
24 tubes. If the Vernom Corporation accepts the purchase proposal, it is estimated that direct labor and
variable overhead costs would be reduced by 10 percent and direct material costs would be reduced by
20 percent.
1. Should the Vernom Corporation make or buy the tubes? Show calculations to support your answer.
2. What would be the minimum purchase price acceptable to the Vernom Corporation for the tubes?
Support your answer with an appropriate explanation.
3. Instead of sales of 100,000 boxes, revised estimates show sales volume at 125,000 boxes. At this new
volume, additional equipment, at an annual rental of $10,000, must be acquired to manufacture the tubes.
However, this incremental cost would be the only additional fixed cost required even if sales increased to
300,000 boxes. (The 300,000 level is the goal for the third year of production.) Under these
circumstances, should the Vernom Corporation make or buy the tubes? Show calculations to support your
answer.
4. The company has the option of making and buying at the same time. What would be your answer to
question 3 if this alternative was considered? Show calculations to support your answer.
5. What nonquantifiable factors should the Vernom Corporation consider in determining whether they
should make or buy the lipstick tubes?
(CMA, adapted)
SOLUTION
1. Vernom Corporation should make the tubes:
Cost saved by purchasing tubes:
Total $0.85
120
Cost to buy $0.90
♦Total overhead $1.50 per unit
Allocated overhead $1.00 per unit ($100,000 h- 100,000) Variable overhead $0.50 per unit.
2. The problem asks for the minimum purchase price. The contcxt of the problem implies that the
maximum purchase price is what was really required. Vernom Corporation would not pay more than $0.85
each because that is the cost to make the product internally. Obviously, the company would be willing to
pay any amount which was less than $0.85.
3. At a volume of 125,000 units, Vernom should buy the tubes. The cost of buying 125,000 tubes is
$112,500 (125,000 x $0.90). The cost of making 125,000 tubes is
125,000 x $0.85 $106,250 Added fixed cost 10,000 $116,250
Buying the tubes will save $3,750.
4. Vernom Corporation needs 125,000 tubes. The cost to buy 125,000 tubes is $112,500. The cost to
make 125,000 tubes is $116,250. The cost to make 100,000 (standard volume) and buy 25,000 is
Therefore, to supply its needs, Vernom should choose this latter course of action.
5. There are many nonquantifiable factors which Vernom should consider in addition to the economic
factors calculated above. Among such factors are:
(a) The quality of the purchased tubes as compared to Vernom-produced tubes
(b) The reliability of delivery to meet production schedules
(c) The financial stability of the supplier
(.d) Development of an alternate source of supply (ie) Alternate uses of tube-manufacturing capacity (/)
The long-run character and size of the market
5.8 Answer the following four multiple-choice questions:
1. Buck Company manufactures part no. 1700 for use in its production cycle. The costs per unit for a
5,000-unit quantity follows:
Direct materials $2
Direct labor 12
Variable overhead 5
Fixed overhead applied _J7
Hollow Company has offered to sell Buck 5,000 units of part no. 1700 for $27 per unit. If Buck accepts
the offer, some of the facilities presently used to manufacture part no. 1700 could be used to help with
the manufacture of part no. 1211. This would save $40,000 in relevant costs in the manufacture of part
no. 1211, and $3 per unit of the fixed overhead applied to part no. 1700 would be totally eliminated. By
what amount would net relevant costs be increased or decreased if Buck accepts Hollow's offer?
(a) $35,000 decrease
(c) $15,000 decrease
(d) $5,000 increase
2. Relay Corporation manufactures batons. Relay can manufacture 300,000 batons a year at a variable
cost of $750,000 and a fixed cost of $450,000. Based on Relay's predictions, 240,000 batons will be
sold at the regular price of $5 each. In addition, a special order was placed for 60,000 batons to be sold
at a 40 percent discount off the regular price. By what amount would income be increased or decreased
as a result of the special order?
(a) $60,000 decrease
(b) $30,000 increase
121
(c) $36,000 increase
(d) $180,000 increase
3. Cardinal Company needs 20,000 units of a certain part to use in its production cycle. The following
information is available:
Cost to Cardinal to make the part:
Direct materials $ 4
Direct labor 16
Variable overhead 8
Fixed overhead applied 10
Cost to buy the part from the Oriole Company $36
If Cardinal buys the part from Oriole instead of making it, Cardinal could not use the released facilities
in another manufacturing activity. Sixty percent of the fixed overhead applied will continue, regardless
of what decision is made.
In deciding whether to make or buy the part, the total relevant costs to make the part are
4. The Reno Company manufactures part no. 498 for use in its production cycle. The cost per unit for
20,000 units of part no. 498 is as follows:
Direct materials $6
Direct labor 30
Variable overhead 12
Fixed overhead applied _ 16
The Tray Company has offered to sell 20,000 units of part no. 498 to Reno for $60 per unit. Reno will
make the decision to buy the part from Tray if there is a savings of $25,000 for Reno. If Reno accepts
Tray's offer, $9 per unit of the fixed overhead applied would be totally eliminated. Furthermore, Reno
has determined that the released facilities could be used to save relevant costs in the manufacture of
part no. 575. In order to have a savings of $25,000, the amount of relevant costs that would be saved by
using the released facilities in the manufacture of part no. 575 would have to be
(AICPA, adapted)
SOLUTION
1. (c) Relevant unit costs = $26 - $7 + $3 = $22
Total relevant costs:
Savings on part no. 1211 $ 40,000
Savings on part no. 1700: 5,000 x $22 110,000
Subtotal $150,000
Cost to purchase: 5,000 x $27 135,000
Decrease in net relevant costs $ 15,000
2. (b) Variable cost per unit = $750,000 - 300,000 = $2.50
Contribution margin per unit on special order = $5.00 - (0.40) ($5.00) - $2.50 = $0.50 Therefore, income
will increase: 60,000 x $0.50 = $30,000.
3. (b) In any make-or-buy decision, the relevant costs are those present and future costs that will be
either incurred or avoided. Based on the facts given, costs that could be avoided would be the relevant
costs.
Avoidable costs per unit:
Direct material $4
122
Direct labor 16
Variable overhead 8
Relevant costs: $32 x 20,000 = $640,000. Note also that only 40 percent of the fixed overhead is a
relevant cost, since 60 percent would continue in any event.
4. (b) On a per-unit basis, the avoidable costs for part no. 498, as given, are:
Avoidable costs per unit:
Direct material $6
Direct labor 30
Variable overhead 12
Fixed avoidable overhead _9
Total $57
Only $9 of fixed overhead is avoidable, because that is the amount which would be eliminated; the
remainder would continue.
It appears that Reno would lose $3 per unit ($60 - $57) by purchasing the part from TVay. An additional
factor, however, is that Reno may be able to compensate for this loss by saving enough relevant costs on
the manufacture of part no. 575 to recoup the $3 loss per unit and still have a savings of $25,000
besides. Reno would have to save $60,000 ($3 X 20,000) and another $25,000 for a total of $85,000 in
the manufacture of part no. 575.
5.9 Products A and B are produced jointly in Department Z. Each product can be sold as is at the split-off
point or processed further. During January, Department Z recorded a joint cost of $150,000. The
following data for January are available:
Product Quantity
10,000 units 20,000
At Split-Off $5 1.50
Selling Prices per Unit
If Processed Further $8 2
Costs after Split-Off $40,000 5,000
Analyze whether individual products should be processed beyond the split-off point, using:
(a) The total project approach (or comparative statement approach)
(b) The incremental (differential) approach
(c) The opportunity cost approach
SOLUTION
For product A:
Sales Costs
Net revenue
At Split-Off $50,000
$50,000
At Completion $80,000 40,000 $40,000

123