Chapter (2)

Cost- Volume- Profit Relationships

Ch2: Cost- Volume- Profit Relationships Page 1

Introduction:
Cost- volume- profit (CVP) analysis is a powerful tool that helps managers
understanding the relationships among cost, volume and profit.

CPV analysis focuses on how profits affected by the following factors:

- Selling Prices
- Sales volume
- Unit variable costs
- Total fixed costs
- Mix of products sold

We will discuss the following points:

1- Main assumptions of CVP analysis.
2- The effect of the change in sales volume on contribution margin and net operating
income.
3- Break-even point in unit sales and sales dollars.
4- Target profit.
5- Margin of safety.
6- Compute the Break-even point for multiproduct company.
7- Compute the degree of operating leverage.

1- Main assumptions of CVP analysis:

1. Total costs can be divided into fixed and variable.
2. The unit selling price, unit variable costs, and fixed costs are known and
constant.
3. Unit produced = Unit sold. There is no change in inventory.
4. Company produces and sales a single product or mix products with no change in
the sales mix.

Basics of Cost-Volume-Profit Analysis

First of all you must know how to prepare income statement using Contribution format
as follows:
An income statement uses the contribution format

Total Per unit

Sales revenue xx xx
(-)
Variable cost (xx) (xx)
Contribution margin xx xx
(-)
Fixed cost (xx)
Net operating income(loss) xx

Ch2: Cost- Volume- Profit Relationships Page 2

Example (1): The following data for "ABC" company
Units of sales 10,000 units
Unit Sales price $ 20
Unit variable cost $ 12
Total fixed cost $ 45,000
Required: Prepare Income statement using Contribution format (variable approach).
Answer
Income statement using Contribution format

Total Per unit

Sales revenue (10,000X$20) 200,000 20
(-)
Variable cost(10,000X$12) (120,000) (12)
Contribution margin 80,000 8
(-)
Fixed cost (45,000)
Net operating income 35,000
Notes:
 Contribution Margin (CM) is the amount remaining from sales revenue after
variable expenses have been deducted.
 CM is used first to cover fixed expenses. Any remaining CM contributes to net
operating income.
 Contribution margin per unit = $8 means that any additional unit sales will add to
net operating income $8.
 Contribution margin % = Total Contribution margin ÷ Sales revenue

$80,000 ÷ $200,000 = 40%

OR

= Contribution margin per unit ÷ selling price per unit

$8 ÷ $20 = 40%

 Contribution margin % = 40% means that any additional sales dollar will add to
net operating income 40 cents.
 Variable cost % = Total variable cost ÷ Sales revenue

$120,000 ÷ $200,000 = 60%

OR

= Variable cost per unit ÷ Selling price per unit

$12 ÷ $20 = 60%

Ch2: Cost- Volume- Profit Relationships Page 3

  Contribution margin % + Variable cost % = 1

40% + 60% =1

2- The effect of the change in sales volume on contribution margin and net
operating income.

Example (2): The following data for "Adham" company

Units of sales 20,000 units

Unit variable cost $ 35
Unit Sales price $ 50
Total fixed cost $ 200,000

Required:
1- Prepare Income statement using Contribution format.
2- Assume that sales units are expected to increase by 2,000 units. What will be the
increase in net operating income? (Do not prepare an income statement).
Answer

1- Income statement using Contribution format:

Total Per unit
Sales revenue = 20,000 X $50 = 1,000,000 50
(-)
Variable cost = 20,000 X $35= (700,000) (35)
Contribution Margin 300,000 15
(-)
Fixed cost (200,000)
Net Operating Income 100,000

Notes: Contribution margin per unit = $15 means that any additional unit sales
will add to net operating income $15.

2- Change in net operating income =

Change in C.M= Increase in unit sales X Unit C.M= 2,000 X 15= $30,000
(-)
Change in fixed cost Zero
Increase in net operating income + $30,000

Ch2: Cost- Volume- Profit Relationships Page 4

 Note: You can check your answer by preparing income statement with sales units
22,000 (20,000 + 2,000) as follow:

Total Per unit

Sales revenue = 22,000 X $50 = 1,100,000 50
(-)Variable cost = 22,000 X $35= (770,000) (35)
Contribution Margin 330,000 15
(-)Fixed cost (200,000)

Net Operating Income 130,000

Notes: The net operating income increased by $30,000 (130,000 – 100,000)

Example (3):
The following is the income statement under C.M approach:

Total Percent
Sales revenue 800,000 100%
(-)
Variable cost (600,000) 75%
Contribution Margin 200,000 25%
(-)
Fixed cost (50,000)
Net Operating Income 150,000
Required:
Assume that sales revenues are expected to increase by $100,000. What will be the
increase in net operating income? (Do not prepare an income statement).
Answer
Notes: Contribution margin ratio (C.M.R) =25% means that any additional sales
dollar will add to net operating income $ 0.25

Change in net operating income =

Change in C.M= Increase in sales revenue X C.M.R = $100,000 X 25% =$25,000

(-)
Change in fixed cost Zero
Increase in net operating income + $25,000

Ch2: Cost- Volume- Profit Relationships Page 5

 Example (4): The following is the income statement under C.M approach:

Total Per unit

Sales revenue (10 000 X $100) 1,000,000 100
(-)
Variable cost (600,000) (60)
Contribution Margin 400,000 40
(-)
Fixed cost (300,000)
Net Operating Income 100,000

- Assume the increase in advertising by $59,000 is expected to increase sales volume by

2,000 units.
Required:
1. What will be the effect on C.M and Net operating income? (Do not prepare an
income statement).
2. Should the advertising budget be increased?

Answer
(1)

Change in C.M= increase in unit sales X Unit C.M= 2,000 X 40= 80,000
(-)
Change in fixed cost (Advertising) 59,000
Increase in net operating income + $21,000

(2) Advertising budget should be increased due to increase in net operating

income.
=============================================

To sum up:

1-Change in total C.M=

Change in total C.M= Change in unit sales X Unit C.M

OR
Change in sales revenue X C.M.R

2- Change in net operating income =Change in C.M - Change in fixed cost

Ch2: Cost- Volume- Profit Relationships Page 6

 3- Break-even analysis

Break- even point: it is a point at which:

- Total Revenue = Total Cost

- Profit = Zero
- Total Contribution Margin = Total Fixed Cost

There are 2 methods to determine the break-even point in units:

1. Graph method.
2. Formula method.

Example (1):
ABC Company has a single product, whose selling price is $500 and whose variable
cost is $300 per unit. The company's fixed cost $80,000.
Required:

How many units must be sold to break-even? Using:

• Graph method.
• Formula method.
Answer

The break-even point is where the total revenue and total expenses lines intersect. In
the case of ABC Company, break-even is 400 units sold, or sales revenue of $200,000.
The profit or loss at any given sales level is measured by the vertical distance between
the total revenue and the total expenses lines.

Ch2: Cost- Volume- Profit Relationships Page 7

 - If sales units > Break-even The company will achieve profit
- If sales units < Break-even The company will achieve loss

Formula method
- The Formula method has two key equations
1- Break-even in Sales Units

Fixed Cost
Break-even- point (in Sales unit) =
Unit Contribution Margin

2- Break-even in Sales dollars

Fixed Cost
Break- even point (in Sales Dollar) =
Contribution Margin Ratio
OR
= ( Break- even point in Units X Selling Price )

In the above example:

- Unit contribution margin = Unit sales price – Unit variable cost
= $500 – $300 = $200

$80,000
Break-even- point (in Sales unit) = = 400 units
$200

$80,000
Break-even- point (in Sales dollars) = =$200,000
40%

$200
- Contribution Margin Ratio = = 40%
$500
OR
- Break- even point (in Sales Dollar) =
= Break- even point in units X Selling Price

= 400 units X $500 = $200,000

Ch2: Cost- Volume- Profit Relationships Page 8

 4- Target Profit Analysis
Sometimes Management desires to achieve a target profit and know in advance how
many sales units or sales dollars to achieve this target profit.

1-Target Profit in Sales Units

Fixed Cost + Target Profit

- Target Profit - point in Sales unit =
Unit Contribution Margin

2-Target Profit in Sales Dollars

Fixed Cost + Target Profit

- Target Profit - point in Sales Dollar =
Contribution Margin Ratio
OR
= (Target Profit - point in units X Selling Price)
Example (2):
Nouran Company has a single product whose selling price is $120 and whose variable
cost is $90 per unit. The company's monthly fixed cost is $90,000.
Required:
1. How many units would have to be sold to earn a target profit of $60,000?
2. What will be sales dollars to achieve this target profit?
Answer
- Unit contribution margin = Unit sales price – Unit variable cost
= $ 120 – $ 90 = $30

(1)
Fixed Cost + Target Profit
- Target Profit - point in Sales unit =
Unit Contribution Margin

90,000 + 60,000
= = 5,000 units
$30

Fixed Cost + Target Profit

- Target Profit - point in Sales Dollar =
Contribution Margin Ratio

Ch2: Cost- Volume- Profit Relationships Page 9

 $30
- Contribution Margin Ratio = = 25%
$120

90,000 + 60,000
- Target Profit - point in Sales Dollar = = $600,000
25%
OR
- Target Profit - point in Sales Dollar
= Target Profit - point in units X Selling Price

= 5,000 units X $120 = $600,000

==================================================
5-Margin of safety
- The margin of safety is the excess of sales over the break-even volume of sales.

- It represents the amount in which expected sales to decrease before making loss.

Margin of Safety = Sales Units - break-even point in Sales Units

OR
= Sales Dollars - break-even point in Sales Dollars

Margin of Safety Ratio = Margin of Safety ÷ Sales

Example (3): Assume in Example (1) the Expected Sales next year 500 units.
What will be the margin of safety in Sales units and the margin of safety Ratio?

Answer
Margin of Safety in Sales Units = Sales Units - break-even point in Sales Units

= 500 – 400 = 100 Units

Margin of Safety Ratio = Margin of Safety in sales units ÷ Sales units

=100 ÷ 500 = 20%

This means that the sales can decrease by 100 units or 20% before achieving
losses.

Ch2: Cost- Volume- Profit Relationships Page 10

Exercise: The following is the income statement under C.M approach:
Total Per unit
Sales Revenue (20,000 Units) 1,000,000 50
(-)
Variable cost (600,000) (30)
Contribution Margin 400,000 20
(-)
Fixed cost (200,000)
Net Operating Income 200,000

Required:
1. What is the break-even point in units sold and in sales dollars?
2. Without resorting to computations, what is the total contribution margin at
the break-even point?
3. How many units would have to be sold to earn a target profit of $80,000 ?
4. Refer to the original data. Compute the company's margin of safety in both
dollar and ratio terms.
5. If sales revenue are expected to increase by $100,000. What will be the
increase in net operating income?
Answer
(1)
- Unit contribution margin = $20

$200,000
- Break- even point in units = = 10,000 units
$ 20

- Break- even point (in Sales Dollar)

= Break- even point in Units X Sales Price

= 10,000 units X $50 = $500,000

(2)
Total contribution margin at the break-even point = Fixed cost=$200,000

(3)
200,000 + 80,000
- Target Profit - point in Sales unit = =14,000 units
20

(4)
- Margin of Safety = Sales Dollars - break-even point in Sales Dollars

= $1,000,000 – $500,000 = $500,000

Ch2: Cost- Volume- Profit Relationships Page 11

 Margin of Safety 500,000
- Margin of Safety Ratio = = = 50%
Sales 1,000,000

(5)
20
- Contribution Margin Ratio (C.M.R) = = 40 %
50

Change in net operating income =

Change in C.M= Increase in sales revenue X C.M.R = $100,000 X 40% =$40,000

(-)
Change in fixed cost Zero
Increase in net operating income + $40,000

Ch2: Cost- Volume- Profit Relationships Page 12

6-Compute the Break-even point for multiproduct company (sales mix)
- Sales mix is the relative proportion in which a company’s products are sold.
- Different products have different selling prices, cost structures, and
contribution margins.
- When a company sells more than one product, break-even analysis becomes more
complex as the following example illustrates.

Example:
ABC Co. produces two products “A" and "B". A contribution format income statement
for a recent month for the two products appears below:
Product A B Total
Sales Revenues 600,000 100% 400,000 100% 1,000,000 100%
(-)
Variable cost (360,000) 60% (320,000) 80% (680,000) 68%
C.M 240,000 40% 80,000 20% 320,000 32%
(-)
Fixed cost (256,000)
Net.O. Income 66,000
Sales Mix 60 % 40 % 100%
Required:
1- Compute the overall break-even point for the company in sales dollars
2- Compute the overall break-even point for each product.
Answer

Total Fixed Cost

1. Overall break- even point in Mix sales Dollars =
Overall C.M %

$256,000
= = $800,000
32%

2. Break- even point for each product = Overall break- even point X Sales Mix

Break- even point (Product A) = $800,000 X 60% = $ 480,000

Break- even point (Product B) = $800,000 X 40% = $ 320,000

Ch2: Cost- Volume- Profit Relationships Page 13

 Cost Structure and Profit Stability
A company’s cost structure refers to the relative proportion of fixed and variable
costs in an organization. Some companies have high fixed expenses relative to variable
expenses. It is like utility companies. Because of the heavy investment in property,
plant, and equipment, many utility companies have a high proportion of fixed costs.
Managers often have some latitude in determining their organization’s cost structure.
There are advantages and disadvantages to high fixed cost (or low variable cost) and
low fixed cost (or high variable cost) structures.
High fixed cost structure Low fixed cost structure

Low variable cost high variable cost

High contribution margin ratio low contribution margin ratio

Any increase in sales (good years) will Any increase in sales (good years) will
lead to a greater increase in net lead to a smaller increase in net
operating income operating income

Any decrease in sales (bad years) will Any decrease in sales (bad years) will
lead to a greater decrease in net lead to a smaller decrease in net
operating income operating income

Therefore a high fixed cost structure is Therefore a lower fixed cost structure
preferred in in good years (sales are is preferred in bad years (sales are
expected to be increased) expected to be decreased)
- An advantage of a high fixed cost structure is that income will be higher in good
years compared to companies with lower proportion of fixed costs.
- A disadvantage of a high fixed cost structure is that income will be lower in bad
years compared to companies with lower proportion of fixed costs.
- Companies with low fixed cost structures enjoy greater stability in income
across good and bad years.
Example: The following is the income statement for Co. A and Co.B
Product A B
Sales 100,000 100% 100,000 100%
(-)
variable cost (70,000) 70% (30,000) 30%
C.M 30,000 30% 70,000 70%
(-)
Fixed cost 20,000 60,000
Net Operating Income 10,000 10,000
If sales are expected to increase by 10% in both Co. A and Co. B
Required: What will be the Net operating income for both firms?

Ch2: Cost- Volume- Profit Relationships Page 14

 Answer
Product A B
Sales 110,000 100% 110,000 100%
(-)
variable cost (77,000) 70% (33,000) 30%
C.M 33,000 30% 77,000 70%
(-)
Fixed cost 20,000 60,000
Net Operating Income 13,000 17,000
Company “B” has experienced a greater increase in net operating income due to its
higher CM ratio even though the increase in sales was the same for both farms.

7- Operating Leverage
Operating Leverage is a measure of how sensitive net operating income is to
percentage changes in sales.

Contribution margin
Operating leverage =
Net operating income

Example: The following is the income statement for Co. A and Co.B
Product A B
Sales 100,000 100% 100,000 100%
(-)
variable cost (70,000) 70% (30,000) 30%
C.M 30,000 30% 70,000 70%
(-)
Fixed cost 20,000 60,000
Net Operating Income 10,000 10,000
If sales are expected to increase by 10% in both Co. A and Co. B
Required:
1. Compute the operating leverage for each company
2. What will be the Net operating income for both firms using the operating leverage?
Answer

1- Operating leverage = contribution margin ÷ net operating income

Company “A” = $30,000 ÷ $10,000 = 3

Company “B” = $70,000 ÷ $10,000 = 7

Ch2: Cost- Volume- Profit Relationships Page 15

 2- The Net operating income for both firms

Company “A”

With an operating leverage of 3, if the Company increases its sales by 10%, net
operating income would increase by 30%

How
Change in net operating leverage = Change in sales% X operating leverage.

= 10% X 3 = 30%
New net operating income = $10,000 + (10,000 X 30%) = $13,000

Company “B”

With an operating leverage of 7, if the Company increases its sales by 10%, net
operating income would increase by (10% X 7)= 70%

New net operating income = $10,000 + (10,000 X 70%) = $17,000

(Same result when we prepare income statement in previous example page 16)

Ch2: Cost- Volume- Profit Relationships Page 16

Exercise:
The following is information about JSY Company:
Variable per unit Fixed cost
Manufacturing expense $7 $100,000
Selling expense $2 $45,000
While the administrative expense at level 15,000 units is $20,000 and at level 25,000
units is $30,000. The selling price is $15 per unit.
Required:
1. Calculate the break-even point in sales units and sales dollars.
2. How much is sales units that achieve a target profit of $300,000?
3. Prepare the income statement assuming that the company produces and sells
45,000 units.
4. Based on the income statement prepared in no.3, answer the following questions:
a) Determine the margin of safety in units and the margin of safety ratio.
What does this mean?
b) Determine the operating leverage.
c) What happen to net income if sales increase by 10% (use three different
ways to prove your answer).
Answer
First, we need to split the fixed and variable components of administrative expenses
using the high-low method:

Variable admin. Expenses per unit (b) = Change in Cost ÷ Change in Units
= ($30,000 -$20,000) ÷ (25,000 – 15,000) = $1 per unit

Fixed admin. Expenses

Y = a + bx
At high level
$30,000 = a + ($1 X 25,000)
a = $30,000 - $25,000 = $5,000

So, total variable cost per unit = $7 + 2 +1 = 10

Total fixed costs = $100,000 + 45,000 + 5,000 = $150,000

Contribution margin per unit = $ 15 – 10 =$ 5 per unit

Contribution margin ratio = $5 ÷ 15 = 33.3%

1. Break-even point in sales units = Total Fixed costs ÷ Contribution margin per unit
= $150,000 ÷ $5 = 30,000 units
Break-even point in sales dollars = Total fixed costs ÷ Contribution margin ratio
= $150,000 ÷ 33.3% = $450,000

Ch2: Cost- Volume- Profit Relationships Page 17

 2. Target profit point in sales units =
(Total Fixed costs + Target profit) ÷ Contribution margin per unit
($150,000 + $300,000) ÷ $5 = 90,000 units

3. Income statement at 45,000 units

Total
Sales revenue (45,000 X $15) 675,000
(-)
Variable cost (45,000 X $10) (450,000)
Contribution Margin 225,000
(-)
Fixed cost (150,000)
Net Operating Income 75,000

4.
A) Margin of safety in units = Sales units – Break-Even in sales units
= 45,000– 30,000 = 15,000 units

Margin of safety ratio = Margin of safety in units ÷ Sales

= 15,000 ÷ 45,000 = 33.3%

Sales can drop by 15,000 units or by33.3% before the company will generate losses.

B) Operating leverage = Contribution margin ÷ Net Operating Income

= $225,000 ÷ $75,000 = 3

C) If sales increased by 10% (an increase of 4,500 units to become 49,500 units)

1- Using operating leverage:

Increase in NOI = change in sales % X operating leverage = 10% x 3 = 30%
Increase in NOI = $75,000 x 30% = $22,500

2- Using CVP relationships:

Change in net operating income
Change in C.M= Increase in sales units X C.M per unit= 4,500 X 5 = 22,500
(-)
Change in fixed cost Zero
Increase in net operating income + $22,500

Ch2: Cost- Volume- Profit Relationships Page 18

3- Preparing an income statement:

Total
Sales revenue (49,500 X $15) 742,000
(-)
Variable cost (49,500 X $10) (495,000)
Contribution Margin 247,500
(-)
Fixed cost (150,000)
Net Operating Income 97,500

Increase in NOI = New NOI – Current NOI = $97,500 – 75,000 = $ 22,500

Ch2: Cost- Volume- Profit Relationships Page 19

Assignment (3)
Question (1):Multiple Choice Questions

1. Contribution margin can be defined as:

A) the amount of sales revenue necessary to cover variable expenses.
B) sales revenue minus fixed expenses.
C) the amount of sales revenue necessary to cover fixed and variable expenses.
D) sales revenue minus variable expenses.

2. Which of the following statements is correct with regard to a CVP graph?

A) A CVP graph shows the maximum possible profit.
B) A CVP graph shows the break-even point as the intersection of the total sales
revenue line and the total expense line.
C) A CVP graph assumes that total expense varies in direct proportion to unit
sales.
D) A CVP graph shows the operating leverage as the gap between total sales
revenue and total expense at the actual level of sales.

3. Which of the following is true regarding the contribution margin ratio of a single product
company?
A) As fixed expenses decrease, the contribution margin ratio increases.
B) The contribution margin ratio multiplied by the selling price per unit equals the
contribution margin per unit.
C) The contribution margin ratio will decline as unit sales decline.
D) The contribution margin ratio equals the selling price per unit less the variable
expense ratio.

4. If a company is operating at the break-even point:

A) its contribution margin will be equal to its variable expenses.
B) its margin of safety will be equal to zero.
C) its fixed expenses will be equal to its variable expenses.
D) its selling price will be equal to its variable expense per unit.

5. Target profit analysis is used to answer which of the following questions?

A) What sales volume is needed to cover all expenses?
B) What sales volume is needed to cover fixed expenses?
C) What sales volume is needed to earn a specific amount of net operating
income?
D) What sales volume is needed to avoid a loss?

6. The margin of safety can be calculated by:

A) Sales − (Fixed expenses/Contribution margin ratio).
B) Sales − (Fixed expenses/Variable expense per unit).
C) Sales − (Fixed expenses + Variable expenses).
D) Sales − Net operating income.

Ch2: Cost- Volume- Profit Relationships Page 20

7. Which of the following is the correct calculation for the degree of operating leverage?
A) net operating income divided by total expenses.
B) net operating income divided by total contribution margin.
C) total contribution margin divided by net operating income.
D) variable expense divided by total contribution margin.

8.Which of the following is an assumption underlying standard CVP analysis?

A) In multiproduct companies, the sales mix is constant.
B) In manufacturing companies, inventories always change.
C) The price of a product or service is expected to change as volume changes.
D) Fixed expenses will change as volume increases.

9. Rovinsky Corporation, a company that produces and sells a single product, has provided
its contribution format income statement for November.

Sales (5,700 units) ............. $319,200

Variable expenses .............. 188,100
Contribution margin .......... 131,100
Fixed expenses .................. 106,500
Net operating income ........ $ 24,600
If the company sells 5,300 units, its net operating income should be closest to:
A) $24,600
B) $2,200
C) $22,874
D) $15,400

10. Dodero Company produces a single product which sells for $100 per unit. Fixed expenses
total $12,000 per month, and variable expenses are $60 per unit. The company's sales
average 500 units per month. Which of the following statements is correct?
A) The company's break-even point is $12,000 per month.
B) The fixed expenses remain constant at $24 per unit for any activity level within
the relevant range.
C) The company's contribution margin ratio is 40%.
D) Responses A, B, and C are all correct.

11. A company makes a single product that it sells for $16 per unit. Fixed costs are $76,800
per month and the product has a contribution margin ratio of 40%. If the company's actual
sales are $224,000, its margin of safety is:
A) $32,000
B) $96,000
C) $128,000
D) $192,000

Ch2: Cost- Volume- Profit Relationships Page 21

12. Borich Corporation produces and sells a single product. Data concerning that product
appear below:

Selling price per unit .................... $150.00

Variable expense per unit ............. $73.50
Fixed expense per month .............. $308,295

The break-even in monthly unit sales is closest to:

A) 2,055
B) 4,030
C) 4,194
D) 3,426

13. Wenstrom Corporation produces and sells a single product. Data concerning that product
appear below:

Selling price per unit .................... $130.00

Variable expense per unit ............. $41.60
Fixed expense per month .............. $109,616

The break-even in monthly dollar sales is closest to:

A) $342,550
B) $204,455
C) $109,616
D) $161,200

14. The Saginaw Ice Company had sales of $400,000, with variable expenses of $162,000
and fixed expenses of $98,175. Which of the following is closest to Saginaw's break-even
point?
A) $260,000
B) $165,000
C) $140,000
D) $238,000

15. Product Y sells for $15 per unit, and has related variable expenses of $9 per unit. Fixed
expenses total $300,000 per year. How many units of Product Y must be sold each year to
yield an annual profit of $90,000:
A) 50,000 units
B) 65,000 units
C) 15,000 units
D) 43,333 units

16. Logsdon Corporation produces and sells a single product whose contribution margin ratio
is 63%. The company's monthly fixed expense is $720,720 and the company's monthly target
profit is $28,000. The dollar sales to attain that target profit is closest to:
A) $471,694
B) $454,054
C) $1,188,444
D) $1,144,000

Ch2: Cost- Volume- Profit Relationships Page 22

17. Majid Corporation sells a product for $240 per unit. The product's current sales are
41,300 units and its break-even sales are 36,757 units.
What is the margin of safety in dollars?
A) $8,821,680
B) $6,608,000
C) $9,912,000
D) $1,090,320

18. Mcmurtry Corporation sells a product for $100 per unit. The product's current sales are
10,000 units and its break-even sales are 8,000 units. The margin of safety as a
percentage of sales is closest to:
A) 23%
B) 81%
C) 20%
D) 77%

19.Ostler Company's net operating income last year was $20,000 and its contribution margin
was $50,000. Using the operating leverage concept, if the company's sales increase next year
by 10 percent, net operating income can be expected to increase by:
A) 20%
B) 16%
C) 160%
D) 25%

20. Serfass Corporation's contribution format income statement for July appears below:

Sales .................................. $260,000

Variable expenses .............. 176,000
Contribution margin .......... 84,000
Fixed expenses .................. 71,800
Net operating income ........ $ 12,200

The degree of operating leverage is closest to:

A) 0.05
B) 0.15
C) 21.31
D) 6.89

Ch2: Cost- Volume- Profit Relationships Page 23

 Question (2)
Feather Friends, Inc., distributes a high-quality wooden birdhouse that sells for $20 per unit.
Variable costs are $8 per unit, and fixed costs total $180,000 per year.
Required:
Answer the following independent questions:
1. What is the product’s CM ratio?
2. Use the CM ratio to determine the break-even point in sales dollars.
3. Due to an increase in demand, the company estimates that sales will increase by
$75,000 during the next year. By how much should net operating income increase (or
net loss decrease) assuming that fixed costs do not change?
4. Assume that the operating results for last year were:

a. Compute the degree of operating leverage at the current level of sales.

b. The president expects sales to increase by 20% next year. By what percentage should
net operating income increase?

Question (3)
Lido Products markets two computer games: Claimjumper and Makeover. A contribution
format income statement for a recent month for the two games appears as follow:

Claimjumper Makeover Total

Sales Revenue 30,000 $70,000 $100,000
(-)
Variable cost (20,000) (50,000) (70,000)

Contribution Margin 10,000 20,000 30,000

(-)
Fixed cost 24,000
Net Operating Income 6,000
Required:
1- Compute the overall contribution margin (CM) ratio for the company.
2- Compute the overall break-even point for the company in sales dollars.
3- Compute the overall break-even point for each product in sales dollars.

Ch2: Cost- Volume- Profit Relationships Page 24