Applied Economics

Governor Pack Road, Baguio City, Philippines 2600

Tel. Nos.: (+6374) 442-3316, 442-8220; 444-2786;
442-2564; 442-8219; 442-8256; Fax No.: 442-6268 Grade Level/Section: Grade ___- ABM
Email: [email protected]; Website: www.uc-bcf.edu.ph

MODULE 7 – Applied Economics Subject Teacher:

COST-VOLUME-PROFIT (cvp) ANALYSIS

Learning Objectives:
At the end of the module, the students should be able to:
a. explain the concept of Cost and Profit;
b. explain the relationship of Cost, Profit, and Volume of production;
c. compute break-even-point in units and peso sales

CVP analysis examines the interaction of a firm’s sales volume, selling price, cost structure, and
profitability. It is a powerful tool in making managerial decisions including marketing, production,
investment, and financing decisions. Cost-volume-profit (CVP) analysis is a planning tool that looks at
the relationships among costs and volume and how they affect profits (or losses).

It can be used to seek the answer to the following sample questions:

 How many units of its products must a firm sell to break even?
 How many units of its products must a firm sell to earn a certain amount of profit?
 Should a firm advertise more to improve its sales?

Key assumptions of CVP model

• Selling price is constant
• Costs are linear and can be divided into variable and fixed elements.
• In multi-product companies, sales mix is constant
• In manufacturing companies, inventories do not change.

There are two different types of costs that are needed for the CVP Analysis which are the following:
1. Variable costs
- Variable costs remain constant per unit but change in total as volume changes.
-Variable Cost varies directly with profit and quantity. For a company to sell more products to
increase profit, it needs to use more direct materials and labor, which are under variable cost.
This will lead to a higher amount of Total Variable Cost.
Table no. 1:
Test Kits Produced in units(Q) Variable Cost Per Unit (VC/u) Total Variable Cost (TVC)
- ₱ 2,000.00 ₱ -
3,000 ₱ 2,000.00 ₱ 6,000,000.00
5,000 ₱ 2,000.00 ₱ 10,000,000.00
8,000 ₱ 2,000.00 ₱ 16,000,000.00
To graph the total variable cost, the line begins at the bottom-left corner. This point is called the
origin, and it represents zero volume and zero cost. The slope of the graph equals the variable cost
per unit. In this case, the slope of the variable cost line is ₱2,000 per test kit. The graph below shows
how the total variable cost varies directly with the number of products produced. But again, note
that the per unit cost remains constant, at ₱2,000 per test kit.
Graph no. 1: Total Variable Cost Function
Total Variable Cost (TVC)
₱20,000,000.00
₱15,000,000.00
₱10,000,000.00
₱5,000,000.00
₱-
0 2000 4000 6000 8000 10000
2. Fixed costs
- The total fixed cost remains constant, but the fixed cost per unit is inversely proportional to the
changes in the volume/quantity.

Page 1 of 5
 Applied Economics
Governor Pack Road, Baguio City, Philippines 2600
Tel. Nos.: (+6374) 442-3316, 442-8220; 444-2786;
442-2564; 442-8219; 442-8256; Fax No.: 442-6268 Grade Level/Section: Grade ___- ABM
Email: [email protected]; Website: www.uc-bcf.edu.ph

MODULE 7 – Applied Economics Subject Teacher:

-In contrast to variable costs, fixed costs are costs that do not change in total over wide ranges
of volume of activity. Some common fixed costs include rent, salaries, property taxes, and
depreciation
Table no. 2:
Test Kits Produced (Q) Fixed Cost Per Unit (FC/u) Total Fixed Cost (TFC)
0 ₱ 50,000.00 ₱ 50,000.00
3000 ₱ 16.67 ₱ 50,000.00
5000 ₱ 10.00 ₱ 50,000.00
8000 ₱ 6.25 ₱ 50,000.00

Fixed costs are graphed as a flat line that intersects the cost axis at ₱50,000 because the company
will incur the same amount of fixed costs regardless of the number of kits produced during the month.
Graph no. 2: Total Fixed Cost Function
Total Fixed Cost (TFC)
₱3,000,000.00
₱2,000,000.00
₱1,000,000.00
₱-
0 2000 4000 6000 8000 10000

CVP analysis can be used to estimate the amount of sales needed to achieve a target profit by using
three possible methods:
a) Equation approach
- An equation can be used to estimate the number of units a company needs to sell to
achieve target profit or total sales revenue.
b) Contribution margin approach
-A shortcut method of computing the required sales in units by using the contribution
margin per unit. This is used as a replacement for the equation approach as the can provide
you with the same answer.
c) Contribution margin ratio approach
-Computes required sales in terms of peso sales (revenue) rather than in units. Hence
the answer derived from this formula is in Pesos unlike methods 1 and 2 that provide number of
units.

Illustrative problem:
Gardo, Inc., manufactures and sells toy cars. A projected income values for the sales volume of
100,000 toy cars is as follows:
Sales ₱5,000,000
Variable expenses ₱ 500,000
Fixed expenses ₱2,000,000
How many units should Gardo produce and sell to earn a profit of ₱1,000,000?

a. Using the equation approach

Formula: *TR- TVC-TFC= Target Profit
(S₱/unit x Q) – (VC/u x Q)- TFC= Target Profit

In order to start with the solution proper, determine first the selling price per unit and variable cost per
unit. These costs are needed for future computations.
*Selling price= Total Revenue/ Quantity = ₱5,0000,000/ 100,000=₱50 per unit
*Variable cost per unit= Total Variable Cost/ Quantity= ₱500,000/ 100,000= ₱5 per unit

Solution:
Net Sales- TVC-TFC= Target Profit
(S₱/unit x Q) – (VC/u x Q)- TFC= Target Profit
Page 2 of 5
 Applied Economics
Governor Pack Road, Baguio City, Philippines 2600
Tel. Nos.: (+6374) 442-3316, 442-8220; 444-2786;
442-2564; 442-8219; 442-8256; Fax No.: 442-6268 Grade Level/Section: Grade ___- ABM
Email: [email protected]; Website: www.uc-bcf.edu.ph

MODULE 7 – Applied Economics Subject Teacher:

(₱50 x Q) – (₱5 x Q) - ₱2,000,000= ₱1,0000,000

₱50Q-₱5Q=₱1,000,000+₱2,000,000
₱45Q = ₱3,000,000
₱45Q/₱45 = ₱3,000,000/ ₱45
Q= 66,666,67 units = 66,667 units (always round up)

Hence, if Gardo Inc. aims to earn a profit of ₱1,000,000, they should be able to produce and sell
66,667 units of toy cars.

b. The contribution margin approach

Formula: Target sales in units = (Total Fixed Cost + Target Profit)/ contribution margin per unit*

*Contribution margin per unit= S₱/u – VC/u = ₱50-₱5 = ₱45 per unit

Solution:
Target sales in units = (Total Fixed Cost + Target Profit)/ contribution margin per unit*
Target sales in units = (₱2,000,000 + ₱1,000,000)/ ₱45 per unit
Target sales in units = 66,666,67 units = 66,667 units (always round up)

Notice that the answer for #1 and #2 are the same. It is because no matter what method you use,
both provide the same answer.

c. The contribution margin ratio approach

How much should be Gardo Inc.’s Sales or Revenue to earn a profit of ₱1,000,000?

Formula: Target dollar sales = (Total Fixed Cost + Target Profit)/ contribution margin ratio*

*Contribution margin ratio= CM/u divided by S₱/u = ₱45/₱50 = .90 or 90%

Solution:
Target dollar sales = (Total Fixed Cost + Target Profit)/ contribution margin ratio*
Target dollar sales = (₱2,000,000+₱1,000,000)/ 90%
Target dollar sales = ₱3,333,333.33

In order for Gardo Inc. to earn a profit of ₱1,000,000, there should be a total Sales of ₱3,333,333.33. To
check your answer, get the target sales in units and multiply it with the selling price per unit. (66,667
units x ₱50 per unit)= ₱3,333,350 (difference due to rounding up)

Break-even Point—A Variation of Target Profit

 The break-even point calculation is a variation of the target profit calculation.
 The break-even point is the point at which total revenues equal total costs.
 The same three approaches used for target profit can be used to determine the break-even
point.
 A variation of the target profit calculation is the break-even point calculation. The break-even
point is the sales level at which the company does not earn a profit or a loss but has an
operating income of zero. It is the point at which total revenues equal total costs. The same
three approaches can be used. The only difference is that the target profit is ₱0.
Using the problem on Gardo Inc. given above, answer the following questions on Break-even
Analysis.

1. Using the equation approach, how many should Gardo produce and sell in order to Break-even?
Formula: Net Sales- TVC-TFC= Target Profit

*Selling price= Total Revenue/ Quantity = ₱5,0000,000/ 100,000=₱50 per unit

Page 3 of 5
 Applied Economics
Governor Pack Road, Baguio City, Philippines 2600
Tel. Nos.: (+6374) 442-3316, 442-8220; 444-2786;
442-2564; 442-8219; 442-8256; Fax No.: 442-6268 Grade Level/Section: Grade ___- ABM
Email: [email protected]; Website: www.uc-bcf.edu.ph

MODULE 7 – Applied Economics Subject Teacher:

*Variable cost per unit= Total Variable Cost/ Quantity= ₱500,000/ 100,000= ₱5 per unit

Solution:
Net Sales- TVC-TFC= Target Profit
(S₱/unit x Q) – (VC/u x Q)- TFC= Target Profit
(₱50 x Q) – (₱5 x Q) - ₱2,000,000= ₱0
₱50Q-₱5Q=₱0+₱2,000,000
₱45Q = ₱2,000,000
₱45Q/₱45 = ₱2,000,000/ ₱45
Q= 44,444.44 units = 44,445 units (always round up)

Hence, if Gardo Inc aims to break-even, the company should be able to produce and sell 44,444
units of toy cars. This is to ensure that Gardo Inc. will have no losses but will have no profit as well.

2. Using the contribution margin approach, how many should Gardo Inc. produce and sell to Break-
even?
Formula: Target sales in units = (Total Fixed Cost + Target Profit)/ contribution margin per unit*

*Contribution margin per unit= S₱/u – VC/u = ₱50-₱5 = ₱45 per unit

Solution:
Target sales in units = (Total Fixed Cost + Target Profit)/ contribution margin per unit*
Target sales in units = (₱2,000,000 + ₱0)/ ₱45 per unit
Target sales in units (BEPQ) = 44,444.44 units = 44,445 units (always round up)

3. Using the contribution margin ratio approach, how much should be Gardo’s Sales or Revenue in
order to break-even?

Formula: Target dollar sales = (Total Fixed Cost + Target Profit)/ contribution margin ratio*

*Contribution margin ratio= CM/u divided by S₱/u = ₱45/₱50 = .90 or 90%

Solution:
Target dollar sales = (Total Fixed Cost + Target Profit)/ contribution margin ratio*
Target dollar sales = (₱2,000,000+₱0)/ 90%
Target dollar sales (BEP₱) = ₱2,222,222.22

In order for Gardo Inc. to break-even, there should be a total Sales of ₱2,222,222.22. To check your
answer, get the target sales in units and multiply it with the selling price per unit. (44,445 units x ₱50
per unit)= ₱2,222,250 (difference due to rounding up).

Another way to determine the Break-even point in units and in dollar sales is the graphing method.
4. Using the graphing method, determine the Break-even point in units and in dollar sales.
In using the graphing method, there should be at least two complete points in order to complete the
graph. For this problem, you are already provided with four points.
Table no. 3:
Qty. S₱/ unit Total Revenue VC/u Total Variable Cost Total Fixed Cost Total Cost
0 ₱ 50 ₱- ₱5 ₱- ₱ 2,000,000 ₱ 2,000,000
20,000 ₱ 50 ₱ 1,000,000 ₱5 ₱ 100,000 ₱ 2,000,000 ₱ 2,100,000
30,000 ₱ 50 ₱ 1,500,000 ₱5 ₱ 150,000 ₱ 2,000,000 ₱ 2,150,000
50,000 ₱ 50 ₱ 2,500,000 ₱5 ₱ 250,000 ₱ 2,000,000 ₱ 2,250,000
You only need to plot the TR, TC, and FC lines as shown below.

Page 4 of 5
 Applied Economics
Governor Pack Road, Baguio City, Philippines 2600
Tel. Nos.: (+6374) 442-3316, 442-8220; 444-2786;
442-2564; 442-8219; 442-8256; Fax No.: 442-6268 Grade Level/Section: Grade ___- ABM
Email: [email protected]; Website: www.uc-bcf.edu.ph

MODULE 7 – Applied Economics Subject Teacher:

Graph no. 3: Break-even Point (BEP)

₱27,500
₱25,000 BEP
₱22,500BEP₱
Peso Amount (hundreds)

₱20,000
₱17,500
₱15,000
Total Revenue
₱12,500
Total Fixed Cost
₱10,000
Total Cost
₱7,500
₱5,000
₱2,500
BEPQ
₱-
0 10000 20000 30000 40000 50000 60000
Quantity

Graphing Guide:
 The Total Cost (TC) line always starts where the Total Fixed Cost is.
 Fixed Cost is a horizontal line always as it does not change in amount regardless of the change
in quantity.
 Total Revenue starts at the point of origin since there is zero revenue when there are zero units
sold.

Analysis: The point where the TR and TC line intercepts is the Break-even point (approximately 44,445;
₱2,222,222.22). The X-axis point represents the Break-even point in units. On the other hand, the Y-axis
point represents the break-even point in peso sales.

References:
1. Azarcon, et al. (2008). Principles of Economics. Baguio City: Valencia Book team.
2. Caoile, P. V. (2017). Applied Economics. Quezon City: Phoenix Publishing House, Inc.
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Activity 7. Write your answers on a long bond paper or yellow paper (handwritten)
Part-I: Essay.
1. Explain the relationship of Variable Cost and Fixed Cost with Profit. (Relevance-3 points;
Cohesiveness-2 points)
2. Explain how Variable costs and Flexible costs are affected by the change in volume of
production. (Relevance-3 points; Cohesiveness-2 points)

Part-II: Problem Solving. Solve for the Break-Even Point of this business and provide the figures being
asked for below. (5 items, 25 points total)
A young mother is now exploring the option to start selling her mother’s recipe for cheesecakes. She
is trying to find out how many must she sell in order to start earning money. From an initial feasibility
study, she will incur a total of 17,000 pesos for the maintenance of the equipments. She is planning to
sell her cheesecakes at 500 pesos for each cake at 250 pesos cost per unit.
1. Derive the TOTAL REVENUE EQUATION? Clue: TR=S₱/u x Q
2. Derive the TOTAL COST EQUATION? Clue: TC=TVC +TFC
3. How many cakes must she sell in order to break even?
4. If she rents a small store for ₱3,000, how many cakes should she sell to break even?
5. How many cakes must she sell in order to have a profit of ₱20,000?

“Eighty percent of success is showing up.”

Woody Allen

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