De La Salle - CB - FINMAN 1 - Breakeven.pdf

8/14/2019 De La Salle - CB - FINMAN 1 - Breakeven.pdf

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Cost Determinants of Price

Variable Cost

Cost that varies with changes

in the level of output Fixed Cost

Cost that does not change as

output is increased ordecreased


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Cost Behavior Basics

Example:

PC Corporation has a plant that produces PCs. One thedepartments of the plant inserts a CD-ROM disk driveinto each computer. The activity is drive insertion and theactivity driver is the number of computers processed.

The production workers are supervised by a productionmanager who is paid P 540,000 annually.

For production of up to 10,000 units, only one manager isneeded. For production between 10,001 and 20,000units, two managers are needed.


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Fixed Costs

Example:

Cost of supervision for several levels of production for the

plant

Supervision Computers Processed Unit Cost

P 540,000 4,000 P 135

P 540,000 8,000 P 675

P 540,000 10,000 P 540

P 1,080,000 12,000 P 900

P 1,080,000 16,000 P 675

P 1,080,000 20,000 P 540


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Fixed Cost Behavior

P 1,080,000

P 540,000

Supervision

Cost

4,000 8,000 12,000 16,000 20,000Number of Computers Processed

10,000 units

Fixed Cost

= P 1,080,000


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Variable Costs

Costs that in total varyin

direct proportionto

changes in an activity

driver


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Variable Costs

Example:

Total cost of disk drives for various levels of production

Total Cost of Disk Drivers Number of Computers Produced Unit Cost of Disk Drives

P 1,200,000 4,000 P 300

P 2,400,000 8,000 P 300

P 3,600,000 12,000 P 300

P 4,800,000 16,000 P 300

P 6,000,000 20,000 P 300

Total Variable Costs = Variable Cost per Unit x Number of Units of the Driver


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Variable Cost Behavior

P 1,200,000

Cost


Fixed Cost

= P 1,080,000

P 2,400,000

P 3,600,000

P 4,800,000

P 6,000,000

Y = P 300 X

Y = total variable costs

V = variable cost per unit

X = no. of units of the

driver

Y = VX


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Mixed Costs

Costs that have both a

fixed and a variable

component

Example:

Sales representative are

often paid with a salaryplus a commission on

commission


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Mixed Costs

Y = Fixed Cost + Variable

Cost

Y = F + VX

Where:

Y = Total Cost


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Example:

PC Corporation has 10 salesrepresentatives each earning asalary of P 300,000 annually plus acommission of P 500 per computersold.

The activity is selling and theactivity driver is units sold.

10,000 computers were sold.

What would be the total sellingcost?


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Example:

Total selling cost = Sum of fixed

salary cost + commission cost

Y = Fixed Cost + Variable Cost

= (P 300,000 x 10 salesmen)

+ (P 500 x 10,000 units)

= P 3,000,000 + P 5,000,000

= P 8,000,000


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Mixed Costs Behavior

Example:

Selling cost for different levels of sales activity

Total Fixed Cost

of Selling

Total Variable

Cost of Selling

Total Cost Computers Sold Selling Cost per

Unit

P 3,000,000 P 2,000,000 P 5,000,000 4,000 P 1,250.00

P 3,000,000 P 4,000,000 P 7,000,000 8,000 P 875.00

P 3,000,000 P 6,000,000 P 9,000,000 12,000 P 750.00

P 3,000,000 P 8,000,00 P 11,000,000 16,000 P 687.50

P 3,000,000 P 10,000,000 P 13,000,000 20,000 P 650.00


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Mixed Cost Behavior

P 7,000,000

Cost


P 9,000,000

P 11,000,000

P 13,000,000P 15,000,000

Variable Costs

Y = total variable costs

V = variable cost per unit

X = no. of units of the

driver

Y = P 3,000,000 + (P 500 x no. of units sold)

P 5,000,000

P 3,000,000

Fixed Costs


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Cost Determinants of Price

Break-Even Pricing

Method of determining

what sales volumemust be reached

before total revenue

equals total costs


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Break-Even Pricing

Exercise:

Patricia de la Cruz, Product Manager of SunDetergents Inc., has a fixed costs of P 200,000.The cost of labor and materials for each unitproduced is P 50.00. It can sell up to 60,000 ofits product at P 100.00 without having to lower

its price.

What should be its break-even volume?


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Break-Even Pricing

Solution:

Break-Even Volume = Fixed Costs

Selling Price - Variable Costs

= P 200,000

P 100.00 - P 50.00

= 4,000 units


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Breakeven Analysis


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Breakeven Point

Point of zero profit

Starting point of cost volume profit

analysis Has two approaches namely:

Operating Income Approach

Contribution Margin Approach


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Focuses on the income statement as a

useful tool in organizing the companys

costs into fixed and variable categories

Operating Income = Sales RevenuesVariable Expenses

Fixed Expenses

Operating Income = (Price per Unit x No. of Units)

(Variable Cost per Unit No. of Units)Total Fixed Costs


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Example:

Mercury Tool Corporation produces one type of power

tool called drillers. It has the following projected operatingincome:

Sales (72,500 units at P 400) P 29,000,000

Less Variable Expenses (P 17,400,000)

Contribution Margin P 11,600,000

Less Fixed Expenses (P 8,000,000)

Operating Income P 3,600,000


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Example:

Variable Cost per Unit = P 17,400,000

72,500

= P 240


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Example:

To get breakeven point, set operating income to zero

Operating Income = SalesVariable CostsFixed Costs

P 0 = (P 400 x Units)(P 240 x Units)P 8,000,000P 0 = (P 160 x Units)P 8,000,000

Units = 50,000


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Example:

To double check:

Sales (50,000 units x P 400/unit) P 20,000,000


Contribution Margin P 8,000,000Less Fixed Expenses (P 8,000,000)

Operating Income P 0


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Recognizes that at breakeven point, total contribution

margin equals the fixed expenses

Contribution Margin = Sales RevenuesTotal Variable Costs

Breakeven No. of Units = Fixed Costs

Unit Contribution Margin


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Example:

Method 1

Contribution Margin per Unit = Total Contribution

Units Sold

= P 11,600,00072,500 units

= P 160 per unit


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Example:

Method 2

Contribution Margin per Unit = Price per unitVariable

Cost per unit

= P 400P 240= P 160 per unit


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Example:

Breakeven No. of Units = Fixed Costs

Unit Contribution Margin

= P 8,000,000

P 160 per unit

= 50,000 units


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Targeted Operating Income Approach

Gives company a method to determine how many units to

be sold to earn a particular set targeted income

Methodology Use the operating income formula

Instead of setting operating income at zero, use targeted operating

income to get required no. of units to be sold


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Example:

Mercury Tool Corporation has set a targeted operating

income of P 4,240,000. How many units should be sold?




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Solution:



P 4,240,000 = (P 400 x Units)(P 24 x Units)P 8,000,000

= 76,500 units


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Example:

To double check:

Sales (76,500 units x P 400/unit) P 30,600,000






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Example:

Mercury Tool Corporation has set a targeted operating

income of 15% of sales. How many units should be sold?




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Solution:


(Variable Cost per Unit No. of Units)Total Fixed Cos

Operating Income = 15% x Sales = 15% x (P 400 x Units)

0.15 x (P 400 x Units) = (P 400 x Units)(P 240 x Units)

P 8,000,000

Targeted No. of Units = 80,000 units


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Revenue = Variable Cost + Contribution Margin

Revenues

Units

Variable Cost

Contribution

Margin


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Impact of Fixed Costs on Profit

Revenues

Units

Total Variable Cost

Contribution

Margin

Fixed

Costs

Fixed Costs = Contribution Margin; Profit = 0


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Revenues

Units

Total Variable Cost

Contribution

Margin

Fixed

Costs

Fixed Costs < Contribution Margin; Profit > 0

Profit


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Revenues

Units

Total Variable Cost

Contribution

Margin

Fixed

Costs

Fixed Costs > Contribution Margin; Profit < 0

Loss


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Multi Product Operating Income Analysis

Example:

Mercury Tool Corporation has decided to offer two models

of drillers - (a) a regular driller selling for P 400 and a minidriller selling for P 600.

Its marketing department thinks it can sell 75,000 regular

drillers and 30,000 mini drillers annually.


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Example:

It prepared a projected income statement based on the

sales forecast:

Regular Drillers Mini Drillers Total

Sales P 30,000,000 P 18,000,000 P 48,000,000

Less Variable Expenses (P 18,000,000) (P 9,000,000) (P 27,000,000)

Contribution Margin P 12,000,000 P 9,000,000 P 21,000,000

Less Direct Fixed

Expenses*

(P 2,500,000) (P 4,500,000) (P 7,000,000)

Product Margin P 9,500,000 P 4,500,000 P 14,000,000

Less Common Fixed

Expenses**

(P 6,000,000)



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Example:

*Direct Fixed Expenses - fixed costs that can be tracedto

each segment and that would be avoided if the segmentdid not exist.

** Common Fixed Expenses - fixed costs that cannot be

tracedto the segments and that would remain even if oneof those segments was eliminated.


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Cost Volume Profit Analysis


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Multi Product Breakeven Point Analysis

Example:

Mercury Tool Corporation wants to know how many of its

two product lines of drillers must be sold to break even.

How should it derive it?


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Solution:

Breakeven Volume = Fixed Costs

Contribution Margin

= Fixed Costs

(Price - Unit Variable Cost)


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Solution:

Regular Drillers Breakeven Units



= P 2,500,000

(P 400 - P 240)

= 15,625 units


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Solution:

Mini Drillers Breakeven Units



= P 4,500,000

(P 600 - P 300)

= 15,000 units


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Using Sales Mix in Cost Volume Analysis

Example:

Mercury Tool Corporation plans on selling 75,000 regular

drillers and 30,000 mini drillers.

The sales mix in unit terms is:

75,000:30,000 or 75:30 or 5:2

Translation: For every five regular drillers sold, two mini

drillers are sold

What should be its breakeven if the two products are sold

as packages?


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Solution:

Product Price Unit Variable

Cost

Unit

Contribution

Margin

Sales Mix Package Unit

Contribution

Margin

Regular Driller P 400 (P 240) P 160 5 P 8001

Mini Driller P 600 (P 300) P 300 2 P 6002

Package Total P 1400

1No. of driller units in package (5) x unit contribution margin (P 160) = P 8002No. of mini driller units in package (2) x unit contribution margin (P 300) = P 600


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Solution:

Breakeven Point Volume = Fixed Cost

Package Contribution Margin

= P 13,000,000

P 1400

= 9,285.71 packages

Translation:

Mercury must sell 5 x 9,285.71 = 46,429 regular drillers and 2 x

9,285.71 = 18,571 mini drillers to break even


50/80


Double Check:

Regular Driller Mini Driller Total

Sales P 18,571,600 P 11,142,600 P 29,714,200

Less VariableExpenses

(P 11,142,960) (P 5,571,300) (P 16,714,260)

Contribution Margin P 7,428,640 P 5,571,300 P 12,999,940

Less Direct Fixed

Expenses

(P 2,500,000) (P 4,500,000) (P 7,000,000)

Product Margin P 4,928,640 P 1,071,300 P 5,999,940

Less Common Fixed

Expenses

P 6,000,000

Operating Income (P 6)*

*Operating income is not exactly zero due to rounding


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Shortcut: Using Sales to Derive Breakeven Point

Example:

Below is the projected income statement of Mercury Tool

Corporation.

Sales P 48,000,000





Compute for the breakeven sales needed?


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Shortcut: Using Sales to Derive Breakeven Point

Solution:

Breakeven Sales Volume = Fixed Costs

Contribution Margin Ratio

= Fixed Costs

Contribution Margin/Sales

= P 13,000,000

P 21,000,000/P 48,000,000= P 13,000,000

0.4375

= P 29,714,290


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Profit Analysis if CVP Variables Change

Example:

The Sales Department of Mercury Tool Corporation

conducted a market study for drillers that revealed thefollowing choices:

Choice 1 - If advertising expense increase by P

480,000, sales will increase from 72,500 unitsto 75,000 units


54/80


Example:

Choice 2 - A price decrease of P 20 from P 400 per unit to

P 380 per unit would increase sales from

72,500 units to 80,000 units

Choice 3 - By decreasing prices to P 380 per unit and

increasing advertising expense by P 480,000

will increase sales from 72,500 units to 90,000units

What should Mercury do? Maintain status quo or pick one

of the 3 choices?


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Solution (Choice 1):

Before the Proposed

Advertising Increase

After the Proposed


Units Sold 72,500 75,000

Unit Contribution Margin X P 160* X P 160*

Total Contribution Margin P 11,600,000 P 12,000,000

Less Fixed Expenses (P 8,000,000) (P8,480,000)

Profit P 3,600,000 P 3,520,000

*Unit Contribution Margin = Unit Price - Variable Cost per Unit

= P 400 per unit - P 240 per unit

= P 160 per unit


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Decrease in Profit

Change in Sales Volume 2,500

Unit Contribution Margin X P 160

Change in Contribution Margin

(from P 11,600,000 to P 12,000,000)

P 400,000

Less Increase in Fixed Expenses

(from P 8,000,000 to P 8,480,000)

(P 480,000)

Decrease in Profit P 80,000


57/80



Before the Proposed


After the Proposed


Units Sold 72,500 80,000

Unit Contribution Margin X P 160 X P 140**



Profit P 3,600,000 P 3,200,000

**Unit Contribution Margin = Lower Unit Price - Variable Cost per Unit

= P 380 per unit - P 240 per unit

= P 140 per unit


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Difference in Profit


(from P 11,600,000 to P 11,200,000)

( P 400,000)

Less Change in Fixed Expenses

(from P 8,000,000 to P 8,000,000)

-

Decrease in Profit (P 400,000)


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Before the Proposed


After the Proposed


Units Sold 72,500 90,000

Unit Contribution Margin X P 160 X P 140



Profit P 3,600,000 P 4,120,000


60/80



Difference in Profit


(from P 11,600,000 to P 12,600,000)

P 1,000,000

Less Change in Fixed Expenses

(from P 8,000,000 to P 8,480,000)

(P 480,000)

Decrease in Profit P 520,000


61/80

Operating Leverage


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63/80

Operating Leverage

Example:

Adamson Corporation plans to add a new product line.

In adding the new product line, the company can

choose to depend on automation or manual labor.

If the company chooses automation, fixed costs will be

higher, but unit variable costs will be lower.

Projected annual sales is 10,000 units.


64/80

Operating Leverage

Example:

What would happen if sales increase by 40%?

Automated System Manual System

Sales P 1,000,000 P 1,000,000

Less Variable Expenses (P 500,000) (P 800,000)

Contribution Margin P 500,000 P 200,000

Less Fixed Expenses (P 375,000) (P 100,000)

Operating Income P 125,000 P 100,000

Unit Selling Price P 100* P 100a

Unit Variable Cost P 50** P 50b

Unit Contribution Margin P 50*** P 20c


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Operating Leverage

Solution:

Automated System

*Unit Selling Price = Total Annual Sales

No. of Units Sold

= P 1,000,000

10,000= P 100


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Operating Leverage

Solution:

Automated System

**Unit Variable Cost = Variable Expenses

No. of Units Sold

= P 500,000

10,000= P 50


67/80

Operating Leverage

Solution:

Automated System

***Unit Contribution Margin = Contribution Margin

No. of Units Sold

= P 500,000

10,000= P 50


68/80

Operating Leverage

Solution:

Manual System

aUnit Selling Price = Total Annual Sales

No. of Units Sold

= P 1,000,000

10,000= P 100


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Operating Leverage

Solution:

Manual System

bUnit Variable Cost = Variable Expenses

No. of Units Sold

= P 800,000

10,000= P 80


70/80

Operating Leverage

Solution:

Automated System

cUnit Contribution Margin = Contribution Margin

No. of Units Sold

= P 200,000

10,000= P 20


71/80

Operating Leverage

Solution:

Automated System

Degree of Operating Leverage = Contribution Margin

Operating Income

= P 500,000

P 125,000= 4 x


72/80

Operating Leverage

Solution:

Manual System

Degree of Operating Leverage = Contribution Margin

Operating Income

= P 200,000

P 100,000= 2 x


73/80

Operating Leverage

Solution:

After 40% increase in sales

Automated System Manual System

Sales P 1,400,000 P 1,400,000

Less Variable Expenses (P 700,000) (P 1,120,000)

Contribution Margin P 700,000 P 280,000

Less Fixed Expenses (P 375,000) (P 100,000)

Operating Income P 325,000 P 180,000

Unit Selling Price P 100 P 100

Unit Variable Cost P 50 P 80

Unit Contribution Margin P 50 P 20


74/80

Operating Leverage

Solution:

Automated System

*Unit Selling Price = Total Annual Sales

No. of Units Sold

= P 1,400,000

14,000= P 100


75/80

Operating Leverage

Solution:

Automated System

**Unit Variable Cost = Variable Expenses

No. of Units Sold

= P 700,000

14,000= P 50


76/80

Operating Leverage

Solution:

Automated System

***Unit Contribution Margin = Contribution Margin

No. of Units Sold

= P 700,000

14,000= P 50


77/80

Operating Leverage

Solution:

Manual System

aUnit Selling Price = Total Annual Sales

No. of Units Sold

= P 1,400,000

14,000= P 100


78/80

Operating Leverage

Solution:

Manual System

bUnit Variable Cost = Variable Expenses

No. of Units Sold

= P 1,120,000

14,000= P 80


79/80

Operating Leverage

Solution:

Automated System

cUnit Contribution Margin = Contribution Margin

No. of Units Sold

= P 280,000

14,000= P 20


80/80

Operating Leverage

Analysis:

Automated System

Profits would increase from P 125,000 to P 325,000 or anincrease of P 200,000 or a 160% increase.

Manual System

Profits would increase from P 100,000 to P 180,000 or an

increase of only P 80,000 or an 80% increase.

Reason is the automated system has a higher degree

of operating leverage.

De La Salle - CB - FINMAN 1 - Breakeven.pdf

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