1. Vince's Pizza delivers pizzas to dormitories near a major state university.

The company's annual fixed costs are

$48,000. The sales price averages $9, and it costs the firm $3 to make and deliver each pizza.
A. How many pizzas must Vince's sell to break even?
B. How many pizzas must the company sell to earn a target net profit of $54,000?
C. If budgeted sales total 9,900 pizzas, how much is the company's safety margin?
D. Vince's assistant manager, an accounting major, has suggested that the firm should try to increase the
contribution margin per pizza. Explain the meaning of "contribution margin" in layman's terms.

A. Break even = 8,000 units

B. Pizzas to earn $54,000: ($48,000 + $54,000) $6 = 17,000
C. Safety margin: (9,900 $9) - (8,000 $9) = $17,100
D. The contribution margin is the amount that each unit (pizza) contributes toward covering fixed cost and
producing a profit. Once a company's fixed costs are covered, operating income will increase by the amount of
the contribution margin. Mathematically, it is computed as the difference between selling price and the variable
cost per unit.

2. Seventh Heaven takes tourists on helicopter tours of Hawaii. Each tourist buys a $150 ticket; the variable
costs average $60 per person. Seventh Heaven has annual fixed costs of $702,000.
Required:
A. How many tours must the company conduct in a month to break even?
B. Compute the sales revenue needed to produce a target net profit of $36,000 per month.
C. Calculate the contribution margin ratio.
D. Determine whether the actions that follow will increase, decrease, or not affect the break-even point.
1. A decrease in tour prices.
2. The termination of a salaried clerk (no replacement is planned).
3. A decrease in the number of tours sold.

A. Break-even tours in year = 7,800 tours

Break even tours in month = 7,800 / 12 = 650 tours
B. Tours to earn $36,000: [($702,000 12 months) + $36,000] $90 = 1,050 tours/ month
C. Contribution margin ratio: $90 $150 = 0.6 = Contribution margin / Sales
D. 1. Increase
2. Decrease
3. No effect

3. The information that follows was obtained from the accounting records of Gladstone Manufacturing during a
period when the company sold 100,000 units.

A. Compute the company's per-unit contribution margin and break-even point.

B. How many units must Gladstone sell to produce a target net profit of $550,400?
C. Assume that Gladstone was able to reduce the variable cost per unit by $4. What selling price could
management charge if it desired to maintain the current break-even point?
D. Depreciation charges of $640,000 are included in the firm's fixed costs of $6,016,000. If these charges were to
increase by 10%, what effect, if any, would this cost increase have on the company's contribution margin?

A. Contribution margin per unit = (8,800,000 – 2,400,000)/100,000 = 64$

Break even point = 6,016,000 / 64 = 94,000 units
B. Unit sales to earn $550,400: ($6,016,000 + $550,400) $64 = 102,600
C. The current selling price is $88 per unit ($8,800,000 100,000 units). Gladstone must maintain the same
per-unit contribution margin to achieve a break-even point of 94,000 units. Thus, the $4 reduction in variable
cost must be matched by a $4-per-unit reduction in revenue, yielding a selling price of $84 ($88 - $4).
D. No effect. A change in fixed costs does not impact the contribution margin (sales price - variable cost).

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4. Thompson Company is considering the development of two products: no. 65 or no. 66. Manufacturing cost
information follows.

Regardless of which product is introduced, the anticipated selling price will be $50 and the company will pay a
10% sales commission on gross dollar sales. Thompson will not carry an inventory of these items.
Required:
A. What is the break-even sales volume (in dollars) on product no. 66?
B. Which of the two products will be more profitable at a sales level of 25,000 units?
C. At what unit-volume level will the profit/loss on product no. 65 equal the profit/loss on product no. 66?

A. Break even in units = 340,000 / (50-25-5) = 17,000 units

Break even in sales = 17,000 * 50 = 850,000$.
B. No. 65 No. 66
Sales 1,250,000 1,250,000 (25,000 * 50)
Less: VC 950,000 750,000 [=25,000 * (33+50*10%)] ; [=25,000*(25+50*10%)]
Contribution margin 300,000 500,000
Less: FC 220,000 340,000
Operating income 80,000 160,000 No. 66 is more profitable than No. 65

C. ($50 - $38)X - $220,000 = ($50 - $30)X - $340,000

X = 15,000 units

5. The Bruggs & Strutton Company manufactures an engine for carpet cleaners called the "Snooper." Budgeted
cost and revenue data for the "Snooper" are given below, based on sales of 40,000 units.

Cost of goods sold consists of $810,000 of variable costs and $310,000 of fixed costs. Operating expenses
consist of $30,000 of variable costs and $70,000 of fixed costs.
A. Calculate the break-even point in units and sales dollars.
B. Calculate the safety margin.
C. Bruggs & Strutton received an order for 6,000 units at a price of $25.00. There will be no increase in fixed
costs, but variable costs will be reduced by $0.54 per unit because of cheaper packaging. Determine the
projected increase or decrease in profit from the order.

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6. Oakmark recently sold 70,000 units, generating sales revenue of $4,900,000. The company's variable cost per
unit and total fixed cost amounted to $20 and $2,800,000, respectively. Management is in the process of studying
the dollar impact of various transactions and events, and desires answers to the following independent cases:
Case no. 1: Management wants to lower the firm's break-even point to 52,000 units. All other things being
equal, what must happen to fixed costs to achieve this objective?
Case no. 2:The company anticipates a $2 hike in the variable cost per unit. All other things being equal, if
management desires to keep the firm's current break-even point, what must happen to Oakmark's selling price? If
selling price remains constant, what must happen to the firm's total fixed costs?
A. Answer the two cases raised by management.
B. Determine the impact (increase, decrease, or no effect) of the following operating changes on the items cited:
1. An increase in variable selling costs on net income.
2. A decrease in direct material cost on the unit contribution margin.
3. A decrease in the number of units sold on the break-even point.
A. Case no. 1:
Selling price per unit: $4,900,000 70,000 units = $70
Unit contribution margin: $70 - $20 = $50
Current break-even point: $2,800,000 $50 = 56,000 units
New level of fixed cost: X $50 = 52,000 units; X = $2,600,000
Fixed costs must decrease by $200,000 ($2,800,000 - $2,600,000).
Case no. 2:
To keep the same break-even point, the contribution margin must remain at $50. Thus, the selling price must
increase to $72 to offset the $2 hike in variable cost.
Break-even: Fixed cost $48 = 56,000 units; fixed cost = $2,688,000
Fixed costs must fall by $112,000 ($2,800,000 - $2,688,000) if the selling price remains constant.
B. 1. Decrease
2. Increase
3. No effect

7. Wilcox Company is studying the impact of the following:

1. An increase in sales price.
2. An increase in the variable cost per unit.
3. An increase in the number of units sold (note: each unit produces a $6 contribution margin).
4. A decrease in fixed costs.
5. A proposed change in the method of compensation for salespeople, away from commissions based on gross
sales dollars and toward higher monthly salaries.
Determine the impact of each of these operating changes on Wilcox's per-unit contribution margin and break-
even point by completing the chart that follows. Your responses should be Increase (INC), Decrease (DEC), No
Effect (NE), or Insufficient Information to Judge (II).

8. Gladstone Company is studying the impact of the following:

1. An increase in sales price on the break-even point.  Decrease
2. A decrease in fixed costs on the contribution margin.  No effect
3. An increase in the contribution margin on the break-even point.  Decrease
4. A decrease in the variable cost per unit on the sales volume needed to achieve Gladstone's $68,000 target net
profit.  Decrease
5. An increase in sales commissions on the contribution margin and the break-even point.  decre and increase.
6. A decrease in anticipated advertising outlays on fixed cost and the break-even point.  decre and decrease.
Determine the impact of these operating changes (increase, decrease, no effect) on the item(s) noted.

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9. Boise Company manufactures and sells three products: Good, Better, and Best. Annual fixed costs are
$3,315,000, and data about the three products follow.

A. Determine the weighted-average unit contribution margin.

B. Determine the break-even volume in units for each product.
C. Determine the total number of units that must be sold to obtain a profit for the company of $234,000.
D. Assume that the sales mix for Good, Better, and Best is changed to 50%, 30%, and 20%, respectively. Will the
number of units required to break-even increase or decrease? Explain. Hint: Detailed calculations are not needed
to obtain the proper solution.
A) Good Better Best
Selling price 250 350 500
Less: VC 100 150 250
Contribution margin 150 200 250
Percent 30% 50% 20%
Weighted-ave CM 45 100 50  Total weighted average CM = 195
B. Break-even volume: $3,315,000 $195 = 17,000 units
Good: 17,000 30% = 5,100 units, Better: 17,000 50% = 8,500 units, Best: 17,000 20% = 3,400 units
C. Volume to earn $234,000: ($3,315,000 + $234,000) $195 = 18,200 units
D. The number of units required would increase since a greater proportion of lower-contribution-margin units
(specifically, Good) would be sold.

10. Alphabet Corporation sells three products: J, K, and L. The information was taken from a recent budget:

Total fixed costs are anticipated to be $2,450,000.

A. Determine Alphabet's sales mix.
B. Determine the weighted-average contribution margin.
C. Calculate the number of units of J, K, and L that must be sold to break even.
D. If Alphabet desires to increase company profitability, should it attempt to increase or decrease the sales of
product K relative to those of J and L? Briefly explain.

A. Sales mix: 40,000 + 130,000 + 30,000 = 200,000 units

J: 40,000 200,000 = 20%
K: 130,000 200,000 = 65%
L: 30,000 200,000 = 15%

B. Unit contribution margins:

J K L
Selling price 60 80 75
Less: VC 40 65 50
Contribution margin 20 15 25
Percent 20% 65% 15%
Weighted-ave CM 4 9.75 3.75  Total weighted average CM = 17.50
C. Break-even volume: $2,450,000 $17.50 = 140,000 units
J: 140,000 20% = 28,000 units, K: 140,000 65% = 91,000 units, L: 140,000 15% = 21,000 units

D. As measured in units, K has 65% of the company's sales mix. Unfortunately, though, K is Alphabet's least
profitable product ($15 contribution margin vs. $20 and $25). To increase overall profitability, the firm should
strive to decrease sales of K relative to those of J and L.

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11. Price Publications, Inc., produces and sells business books. The results of the company's operations for the
year ended December 31, 20x1, are given below.

A. Prepare a traditional income statement for the company.

B. Prepare a contribution income statement for the company.
C. Which income statement (traditional or contribution) would an operating manager most likely use to study
changes in operating income that are caused by changes in sales? Why?

A. Sales 400,000
COGS 300,000
Gross margin 100,000
Less: Selling expense 30,000
Admin expense 30,000
Net income 40,000
B. Sales 400,000
Less VC: MOH 200,000
Selling 20,000
Admin 6,000
Contribution margin 174,000
Less FC: MOH 100,000
Selling 10,000
Admin 24,000
Net income 40,000
C. The contribution statement would be used because the fixed and variable costs must be separated in order to
measure the effect of a volume change on total costs. Unfortunately, a traditional income statement does not
provide the necessary information.

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12. High Point reported sales revenues of $1,850,000 for the period just ended. Cost of goods sold, selling
expenses, and administrative expenses totaled $1,200,000, $280,000, and $170,000, respectively. A detailed
analysis of the latter three amounts revealed fixed cost components of $780,000, $60,000, and $130,000.
A. Determine the amounts, if any, that High Point would report on a traditional income statement for (1) gross
margin, (2) contribution margin, and (3) net income.
B. Determine the amounts, if any, that High Point would report on a contribution income statement for (1) gross
margin, (2) contribution margin, and (3) net income.
C. Which of the two income statements (traditional or contribution) is more useful for studying a company's
cost-volume-profit relationships.

A. 1. Sales ($1,850,000) - cost of goods sold ($1,200,000) = gross margin ($650,000)

2. $0. The contribution margin is not disclosed on a traditional income statement.
3. Gross margin ($650,000) - selling expenses ($280,000) - administrative expenses ($170,000) = net income
($200,000)
B. 1. $0. Gross margin is not disclosed on a contribution income statement.
2.

3. Contribution margin ($1,170,000) - fixed expenses ($780,000 + $60,000 + $130,000 = $970,000) = net
income ($200,000)
C. Contribution income statement because the fixed and variable costs must be separated in order to measure
the effect of a volume change on total costs.

13. Cortez Enterprises is studying the addition of a new product that would have an expected selling price of
$180 and expected variable cost of $120. Anticipated demand is 9,000 units.
A new salesperson must be hired because the company's current sales force is working at capacity. Two
compensation plans are under consideration:
Plan 1: An annual salary of $38,000 plus 10% commission based on gross sales dollars
Plan 2: An annual salary of $180,000 and no commission
A. What is meant by the term "operating leverage"?
B. Calculate the contribution margin and net income of the two plans at 9,000 units.
C. Compute the operating leverage factor of the two plans at 9,000 units. Which of the two plans is more highly
leveraged? Why?
D. Assume that a general economic downturn occurred during year no. 2, with product demand falling from
9,000 to 7,200 units. By using the operating leverage factors, determine and show which plan would produce a
larger percentage decrease in net income.
A. Operating leverage refers to the use of fixed costs in an organization's overall cost structure. An organization
that has a relatively high proportion of fixed costs and low proportion of variable costs has a high degree of
operating leverage.

C. Plan 1: $378,000 $340,000 = 1.11 ; Plan 2: $540,000 $360,000 = 1.5

Plan 2 has the higher degree of operating leverage because it has the higher operating leverage factor.
D. Plan 1 = 20% * 1.11 = 22.2% ; Plan 2 = 20% * 1.5 = 30%  (9.000 units to 7,200 units = 20% decre)

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14. Once upon a time, two brothers (Barry and Larry) dreamt about owning and operating companies in the same
line of business. Barry believed in maintaining a very large, highly efficient manual labor force; Larry, on the
other hand, favored automated-production processes. One business was located in Madison and the other was
located in Austin. Recent data follow.

A. Which of the two businesses, Madison or Austin, has the highest level of (1) variable cost and (2) highest
level of fixed cost? Explain how you determined your answer.
B. Determine the probable owner of the firm located in (1) Madison and (2) Austin. Briefly explain your logic.
C. Compute the operating leverage factor for Madison and Austin.
D. Suppose that both Madison and Austin had the opportunity to increase sales by 10%. Which of the two
locations would experience a larger percentage change in net income? Why?

A. Given that both locations have identical sales, Austin has a higher level of variable cost ($1,600,000 vs.
$300,000) as indicated by a smaller contribution margin. Madison, in contrast, has a higher amount of fixed cost
($1,550,000 vs. $250,000) because of the larger contribution margin and a net income equal to that of Austin.
B. Operations with sizable labor forces have high variable costs; conversely, automated facilities give rise to
high fixed costs (e.g., depreciation, lease payments, maintenance). Thus, Barry's philosophy is most closely
associated with the Austin facility, and Larry's seems consistent with the cost structure in Madison.
C. Madison: $1,700,000 $150,000 = 11.33
Austin: $400,000 $150,000 = 2.67
D. Madison would experience a larger percentage change in net income because it is more highly leveraged than
Austin. Mathematically, the percentage change in income can be computed by multiplying the operating leverage
factor by the percentage change in sales revenue.

15. Maddox Corporation's product no. H647 has a negative contribution margin. How can such a situation arise?
Should the company continue to stock and sell product no. H647? Explain.
A negative contribution arises because selling price is less than variable cost. Several reasons may create this
situation: (1) inefficient operations and, thus, higher costs; (2) a very competitive marketplace, which has forced
the firm to lower its price; and (3) a loss leader whereby Maddox is purposely taking a loss on product no. H647
with the intent of stimulating customer demand for other, more profitable products.
Each unit sold will lower overall profitability so, technically, Maddox should not continue to sell product no.
H647. However, for reasons (2) and (3) above, the firm might decide otherwise and stick with this "loser."

16. Operating leverage is an important concept for many companies.

A. Define operating leverage.
B. Assume that a firm pays no income taxes and is planning to increase its selling price. If sales volume in units
does not change, what will be the effect on the operating leverage factor? Explain.
C. Assume that another firm that pays no income taxes is planning to increase total fixed manufacturing costs
and decrease variable manufacturing costs per unit. At the present volume of production, the total manufacturing
costs will be unchanged. What will this change do to the operating leverage factor? Explain.

A. Mathematically, operating leverage is contribution margin divided by net income. The degree of operating
leverage indicates a company's ability to operate with a given amount of fixed cost relative to variable cost.
B. The increase in selling price with no change in units sold will increase both contribution margin and net
income by the same dollar amount. The percentage change in net income will be greater than the percentage
change in contribution margin and, thus, the operating leverage factor will decrease.
C. The decrease in variable costs will increase the contribution margin, but net income will not change because
total costs remain the same. The operating leverage factor will therefore increase.

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17. Many firms are moving toward flexible manufacturing systems and adopting the just-in-time (JIT)
philosophy.
A. How is cost behavior altered in the typical flexible manufacturing environment as compared to a traditional
manufacturing system? What is the impact on the break-even point? Explain.
B. One of the assumptions underlying cost-volume profit analysis is that sales volume and production volume
are equal. Stated another way, inventories are assumed to remain constant. Is this assumption likely to be
violated under an ongoing JIT philosophy? Explain.

A. Variable manufacturing costs typically decrease in a flexible manufacturing environment and total fixed costs
increase. Automation (along with accompanying depreciation, lease, and maintenance costs) and fewer people
normally account for this change. The break-even point, as a result, often increases.

B. When a company first changes to JIT, there is likely to be a drop-off in inventories. However, the assumption
of no significant change in inventories will probably not be violated for an ongoing JIT user. Any accompanying
level changes are not likely to be significant relative to the volume of production and sales.

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