3

Fundamentals of Cost-Volume-Profit Analysis

Solutions to Review Questions

3-1.
Profit = TR – TC
= PX – VX – F
= (P – V)X – F
where
Profit = operating profit,
TR = total revenue,
TC = total costs,
P = average unit selling price,
V = average unit variable cost,
X = quantity of units,
F = total fixed costs for the period.

3-2.
Total costs = Total variable costs plus total fixed costs.

3-3.
Total contribution margin: Total selling price – Variable manufacturing costs expensed –
Variable nonmanufacturing costs expensed = Total contribution margin.
Gross margin: Total selling price – Variable manufacturing costs expensed – Fixed
manufacturing costs expensed = Gross margin.

3-4.
Profit-volume analysis plots only the contribution margin line against volume, while cost-
volume-profit analysis plots total revenue and total costs against volume. Profit-volume
analysis is a simpler, but less complete, method of presentation.

3-5.
Costs that are ―fixed in the short run‖ are usually not fixed in the long run. In fact few, if
any, costs are fixed over a very long time horizon, because managers can make decisions
that change a firm’s cost structure.

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Solutions Manual, Chapter 3 83
3-6.
Operating leverage is the proportion of fixed costs in an organization’s cost structure. It is
important for managers because it determines how an increase in volume affects the
change in profits.

3-7.
The margin of safety is the excess of sales over the break-even volume. Managers can
use the margin of safety to understand how far sales can fall before the firm is operating at
a loss.

3-8.
Goal Seek is the function in Microsoft Excel that can be used for CVP analysis.

3-9.

Fixed costs + [Target profit/(1-t)]

Target volume (units) =
Unit contribution margin

3-10.
Income taxes do not affect the break-even equation because with zero income
(breakeven), there are no income taxes to pay.

3-11.
It is common to assume a fixed sales mix when solving for break-even volumes with
multiple products because the contribution margin depends on the relative quantities of
the individual products sold. If the sales mix is not fixed, the break-even volume is
indeterminate.

3-12.
Two common assumptions in CVP analysis are that unit prices and unit variable costs are
constant. It is also common to assume that fixed costs are constant over relatively large
volume ranges. Although these assumptions are common, they are not a necessary part
of CVP analysis. CVP analysis can accept many forms of price and cost relations with
volume. However, when more general relations are used, the common break-even
formulas will no longer hold.

©The McGraw-Hill Companies, Inc., 2017

84 Fundamentals of Cost Accounting
Solutions to Critical Analysis and Discussion Questions

3-13.
There may be a difference between costs used in cost-volume-profit analysis and costs
expensed in financial statements. A common example is fixed manufacturing costs. Cost-
volume-profit analysis assumes fixed manufacturing costs are period costs, while they are
treated as product costs for financial reporting. If part of current production is inventoried,
some fixed manufacturing costs would not be expensed for financial reporting. On the
other hand, if current sales include all of current production plus some from inventory, all
fixed costs from this period plus some from previous periods would be expensed for
financial reporting.

3-14.
The accountant makes use of a linear representation to simplify the analysis of costs and
revenues. These simplifying assumptions are generally reasonable within a relevant range
of activity. Within this range, it is generally believed that the additional costs required to
employ nonlinear analysis cannot be justified in terms of the benefits obtained. Thus,
within this range, the linear model is considered the ―best‖ in a cost-benefit sense.

3-15.
As volume rises, it is likely that product markets will be saturated, leading to a need to cut
prices to maintain or increase volume. This price-cutting would result in a nonlinear
revenue function with a slope that becomes less steep (though still positive) as volume
increases. Moreover, as activity increases and approaches capacity constraints, costs
tend to rise more than proportionately. Overtime premiums and shift pay differentials
increase the unit labor costs. Similar costs may be incurred in terms of excess
maintenance costs for running machines beyond their optimal performance levels, higher
materials costs for any input commodity that is in short supply, and similar factors. These
factors tend to cause costs to rise more than proportionately with an increase in activity.

3-16.
Although the assumptions of CVP analysis appear relatively simplistic, CVP analysis is a
useful tool for understanding the relations among costs, volumes, and the resulting profit.
Clearly, the more important the decision, the more time that should be spent developing
good assumptions. However, CVP analysis is useful for developing intuition about the cost
structure of the firm.

3-17.
Although there are no ―profits‖ in a not-for-profit organization, these organizations are still
very concerned about the difference between inflows (from fees, grants, sales, or other
sources) and costs. Often the term ―surplus‖ will be used in place of profit and the
methods of CVP analysis can be applied in the same way that it is in a for-profit firm.

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Solutions Manual, Chapter 3 85
3-18.
Most business schools have relatively high fixed costs when volume is measured by the
number of students. Examples of these costs would be plant (buildings and grounds),
faculty and staff, and support (for example, computer resources). Variable costs are
relatively low. Therefore, most business schools would be characterized by high operating
leverage.

3-19.
High (or low) operating leverage is not a good (or bad) thing. It is the result of managerial
decisions about the resources to be used (and the structure of the costs that result).
Therefore, if it is better to use resources, which are more flexible, it might be preferable to
rent (lease). As a result, the operating leverage would be lower than a similar business
where a manager decided that is was better not to bear the risks of rising rents.

3-20.
The ―product‖ or ―service‖ for an airline consists of a flight between two city-pairs (for
example, Los Angeles to San Francisco). As you can imagine, the number of ―products‖
for any airline is very large. (In fact, it is even larger, if time-of-day is considered to be
another product.) Airlines often fly a mix of aircraft as well, further complicating the
analysis. Therefore, when you read statements such as this, be aware that the numbers
are given assuming a current mix of flights and aircraft. It does not mean that if an
individual flight has 63% of seats filled, the flight will break even.

3-21.
Because the price Luxe pays for the leased parking space is fixed (it does not depend on
how many times it is used), the cost per use falls as the number of times it is used
increases. This is the same phenomenon we saw in Chapter 2 when considering fixed
manufacturing overhead and fixed administrative costs.

3-22.
The per-unit lease cost is not appropriate to decide where to park the cars, because the
lease costs will not be affected by that decision.

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86 Fundamentals of Cost Accounting
Solutions to Exercises

3-23. (15 min.) Profit Equation Components.

b. Total revenue line

g. The profit area

f. The break-even point

Dollars

d. Slope = Variable cost per unit

a. Total cost line

c. The variable costs area

h. The loss area

h. Loss volume g. Profit volume

e. The fixed costs area

Volume

3-24. (15 min.) Profit Equation Components.

a. Total fixed costs (loss at zero volume)
b. Break-even point
c. Slope = contribution margin per unit
d. Profit line
e. Profit area
f. Net loss area
g. Zero profit line

©The McGraw-Hill Companies, Inc., 2017

Solutions Manual, Chapter 3 87
3-25. (20 min.) Basic Decision Analysis Using CVP: Anu’s Amusement Center.
a. $2,400,000  75,000 tickets = $32 per ticket
b. $1,350,000  75,000 tickets = $18 per ticket
c. ($32.00 – $18.00) = $14 per ticket
d. Profit = ($32 – $18)X – $656,250
Let Profit = 0
0 = ($32.00 – $18.00)X – $656,250

$656,250
X=
$14
X = 46,875 tickets

e. Let Profit = $131,250

$131,250 = ($32 – $18)X – $656,250

$656,250 + $131,250
X=
$14
X = 56,250 tickets

3-26. (20 min.) Basic CVP Analysis: Dukey’s Shoe Station.

a. Break-even point is sales dollars = Fixed costs ÷ Contribution margin ratio
= $450,000 ÷ 0.40 = $1,125,000

b. Break-even point is sales dollars = Fixed costs ÷ Contribution margin ratio

= $450,000 ÷ 0.25 = $1,800,000

c. Sales dollars required = (Fixed costs + Desired profit) ÷ Contribution margin ratio
= ($450,000 + $100,000) ÷ 0.40 = $1,375,000

©The McGraw-Hill Companies, Inc., 2017

88 Fundamentals of Cost Accounting
3-27. (25 min.) CVP Analysis—Ethical Issues: Mark Ting.
This problem is based on the experience of the authors at several companies.
The problem in this example, which is common, is that the guidelines the company has
established (for example, a high break-even point) lead to projects that would be valuable
in some way, but cannot meet the standard established by the company.
Mark believes, perhaps honestly, that the new product is valuable for the company.
However, the approach he has taken to support the product is unethical.
Mark should persuade the management of the company that the break-even requirement
is inappropriate.

3-28. (55 min.) Basic Decision Analysis Using CVP: Derby Phones.
a.

Profit = (P – V)X – F
$0 = ($270 – $120)X – $300,000
$150X = $300,000

$300,000
X=
$150
X = 2,000 units

b.
Profit = (P – V)X – F
$180,000 = ($270 – $120)X – $300,000
$150X = $480,000

$480,000
X=
$150
X= 3,200 units

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Solutions Manual, Chapter 3 89
3-29. (55 min.) Basic Decision Analysis Using CVP: Derby Phones.

a. Profit = ($270 – $120)  5,000 – $300,000

= $450,000

b. 10% price decrease. Now P = $243

Profit = ($243 – $120) x 5,000 – $300,000
= $315,000 Profit decreases by $135,000

20% price increase. Now P = $324

Profit = ($324 – $120) x 5,000 – $300,000
= $720,000 Profit increases by $270,000

c. 10% variable cost decrease. Now V = $108

Profit = ($270 – $108) x 5,000 – $300,000
= $510,000 Profit increases by $60,000
20% variable cost increase. Now V = $144
Profit = ($270 – $144) x 5,000 – $300,000
= $330,000 Profit decreases by $120,000

d. Profit = ($270 – $132) x 5,000 – $240,000

= $450,000 Profit remains the same.

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90 Fundamentals of Cost Accounting
3-30. (25 min.) Basic Decision Analysis Using CVP: Warner Clothing.
a.

Profit = (P – V)X – F
$0 = ($15 – $3)X – $42,000
$12X = $42,000

$42,000
X=
$12
X = 3,500 units

b.
Profit = (P – V)X – F
$30,000 = ($15 – $3)X – $42,000
$12X = $72,000

$72,000
X=
$12
X= 6,000 units

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Solutions Manual, Chapter 3 91
3-31. (30 min.) Basic Decision Analysis Using CVP: Warner Clothing.

a. Profit = ($15 – $3)  5,000 – $42,000
= $18,000

b. 10% price decrease. Now P = $13.50

Profit = ($13.50 – $3.00) x 5,000 – $42,000
= $10,500 Profit decreases by $7,500

20% price increase. Now P = $18

Profit = ($18 – $3) x 5,000 – $42,000
= $33,000 Profit increases by $15,000

c. 10% variable cost decrease. Now V = $2.70

Profit = ($15.00 – $2.70) x 5,000 – $42,000
= $19,500 Profit increases by $1,500
20% variable cost increase. Now V = $3.60
Profit = ($15.00 – $3.60) x 5,000 – $42,000
= $15,000 Profit decreases by $3,000

d. Profit = ($15.00 – $3.30) x 5,000 – $37,800

= $20,700 Profit increases by $2,700

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92 Fundamentals of Cost Accounting
3-32. (30 min.) Basic CVP Analysis: Pacific Parts.

$23 per unit.

Using the profit equation:

Profit = (P – V) x X – FC
$1,000,000 = ($30 – V) x 270,000 – $890,000
V = $6,210,000 ÷ 270,000
V = $23 per unit.

Using an income statement format (based on 270,000 units):

Amount Unit
Sales ............................................... $8,100,000 (a) $30
Variable cost .................................... 6,210,000 23 (c)
Contribution margin ......................... $1,890,000 (b) $7
Fixed costs ....................................... 890,000
Operating profit before taxes ............ $1,000,000

(a) $30 x 270,000 units = $8,100,000 (Sales)

(b) $1,000,000 + $890,000 = $1,890,000 (Contribution margin)
(c) $8,100,000 - $1,890,000 = $6,210,000 / 270,000 units = $23 (Unit variable cost)

3-33. (30 min.) Analysis of Cost Structure: The Greenback Store vs. One-Mart.

a. Greenback Store One-Mart

Amount Percentage Amount Percentage
Sales ..................................$800,000 100% $800,000 100%
Variable cost ....................... 600,000 75 200,000 25
Contribution margin ............$200,000 25% $600,000 75%
Fixed costs .......................... 40,000 5 440,000 55
Operating profit ...................$160,000 20% $160,000 20%

b. Greenback Store’s profits increase by $30,000 [= .25 x ($800,000 x .15)] and One
Mart’s profits increase by $90,000 [= .75 x ($800,000 x .15)].

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Solutions Manual, Chapter 3 93
3-34. (30 min.) Analysis of Cost Structure: Spring Company vs. Winters Company.

a. Spring Company Winters Company

Amount Percentage Amount Percentage
Sales ..................................$500,000 100% $500,000 100%
Variable cost ....................... 400,000 80 150,000 30
Contribution margin ............$100,000 20% $350,000 70%
Fixed costs .......................... 60,000 12 310,000 62
Operating profit ...................$ 40,000 8% $40,000 8%

b. Spring Company’s profits increase by $8,000 [= .20 x ($500,000 x .08)] and Winter
Company’s profits increase by $28,000 [= .70 x ($500,000 x .08)].

3-35. (15 min.) CVP and Margin of Safety: Bristol Car Service.
a.

Profit = (P – V)X – F
$0 = ($50 – $12)X – $2,736
$38X = $2,736

$2,736
X=
$38
X = 72 trips

b.
Margin of safety = 90 – 72
= 18 trips (25%)

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94 Fundamentals of Cost Accounting
3-36. (15 min.) CVP and Margin of Safety: Casey’s Cases.
a.

Profit = (P – V)X – F
$0 = ($30 – $26)X – $2,480
$4X = $2,480

$2,480
X=
$4
X = 620 cases

b.
Margin of safety = 700 – 620
= 80 cases (12.9%)

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Solutions Manual, Chapter 3 95
3-37. (20 min.) Using Microsoft Excel to Perform CVP Analysis: Derby Phones.
a. 2,000 units.
The following two screenshots show the setup and solution.

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96 Fundamentals of Cost Accounting
3-37 (continued).
b. 2,040 units.
The following two screenshots show the setup and solution.

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Solutions Manual, Chapter 3 97
3-38. (20 min.) Using Microsoft Excel to Perform CVP Analysis: Warner Clothing.
a. 3,500 units.
The following two screenshots show the setup and solution.

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98 Fundamentals of Cost Accounting
 3-38(continued).
b. 4,250 units.
The following two screenshots show the setup and solution.

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Solutions Manual, Chapter 3 99
3-39. (20 min.) CVP With Income Taxes: Hunter & Sons.
a.

Profit = (P – V)X – F
$0 = ($550 – $330)X – $143,000

$143,000
X=
$220
X = 650 units

b. In order to achieve a profit of $39,600 after tax, Hunter & Sons must earn:
$66,000 = [$39,600 ÷ (1.00 – 0.40)] before taxes.
The number of units to earn $66,000 in operating profits is:
X = ($143,000 + $66,000) ÷ ($550 – $330) = 950 units

3-40. (20 min.) CVP With Income Taxes: Hammerhead Charters.

a.

Profit = (P – V)X – F
$0 = ($50 – $20)X – $6,000

$6,000
X=
$30
X = 200 trips

b. In order to achieve a profit of $9,000 after tax, Hammerhead Charters must earn:
$12,000 = [$9,000 ÷ (1.00 – 0.25)] before taxes.
The number of units to earn $75,000 in operating profits is:
X = ($6,000 + $12,000) ÷ ($50 – $20) = 600 trips

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100 Fundamentals of Cost Accounting
3-41. (20 min.) Multiproduct CVP Analysis: Rio Coffee Shoppe.’
First, compute the weighted-average contribution margin per unit:
= $0.96 = 60% x ($1.50 – $0.70) + 40% x ($2.50 – $1.30)
The total number of cups of regular coffee and lattes (X) to break even is:

Profit = (P – V)X – F
$0 = $0.96 X – $6,720
X = 7,000 cups
4,200 (= 60% x 7,000) cups of regular coffee
= and
2,800 (= 40% x 7,000) lattes

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Solutions Manual, Chapter 3 101
3-42. (20 min.) Multiproduct CVP Analysis: Mission Foods.

a. Profit = ($3.00 – $1.50) x 200,000 + ($4.50 – $2.25) x 300,000 – $117,000

= $858,000

b. First, compute the weighted-average contribution margin per unit:

= $1.95 = 40% x ($3.00 – $1.50) + 60% x ($4.50 – $2.25)
The total number of chicken and fish tacos (X) to break even is:

Profit = (P – V)X – F
$0 = $1.95 X – $117,000
X = 60,000 tacos
= 24,000 (= 40% x 60,000) chicken tacos and
36,000 (= 60% x 60,000) fish tacos

c. First, compute the weighted-average contribution margin per unit:

= $1.65 = 80% x ($3.00 – $1.50) + 20% x ($4.50 – $2.25)
The total number of chicken and fish tacos (X) to break even is:

Profit = (P – V)X – F
$0 = $1.65 X – $117,000
X = 70,910 tacos (rounding up)
= 56,728 (= 80% x 70,910) chicken tacos and
14,182 (= 20% x 70,910) fish tacos

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102 Fundamentals of Cost Accounting
Solutions to Problems

3-43. (35 min.) CVP Analysis and Price Changes: Argentina Partners.
a. Current profit = 60,000 units x ($30 – $15) – $700,000 = $200,000
Variable costs. New variable cost per unit:
Labor + Materials + Overhead
115%  50%  $15 + 110%  25%  $15 + 120%  25%  $15 = $17.25

Price: New price = 110%  $30 = $33.00

Fixed costs: New fixed costs = 105%  $700,000 = $735,000
Sales: Profit target = $200,000
Profit = (P – V)X – F
$200,000 = ($33.00 – $17.25)X – $735,000
X = $935,000 ÷ ($33.00 – $17.25)
= 59,365 units (rounded)

or sales of 59,365  $33 = $1,959,045

b.
Profit target = $200,000  106% = $212,000
 Profit = (P – V)X – F
$212,000 = ($33.00 – $17.25)X – $735,000
X = $947,000 ÷ ($33.00 – $17.25)
= 60,127 units (rounded)

or sales of 60,127  $33.00 = $1,984,191

c.
Profit = PX – VX – F
$212,000 = P(60,000) – ($17.25  60,000) – $735,000
P = $1,982,000 ÷ 60,000
P = $33.03 (rounded) or a 10.1% increase

©The McGraw-Hill Companies, Inc., 2017

Solutions Manual, Chapter 3 103
3-44. (35 min.) CVP Analysis and Price Changes: Scholes Systems.
a. Current profit = 80,000 units x ($60 – $30) – $1,400,000 = $1,000,000
Variable costs. New variable cost per unit:
Labor + Materials + Overhead
115%  50%  $30 + 110%  25%  $30 + 120%  25%  $30 = $34.50

Price: New price = 110%  $60 = $66.00

Fixed costs: New fixed costs = 105%  $1,400,000 = $1,470,000
Sales: Profit target = $1,000,000
Profit = (P – V)X – F
$1,000,000 = ($66.00 – $34.50)X – $1,470,000
X = $2,470,000 ÷ ($66.00 – $34.50)
= 78,413 units (rounded)

or sales of 78,413  $66 = $5,175,258

b.
Profit target = $1,000,000  106% = $1,060,000
 Profit = (P – V)X – F
$1,060,000 = ($66.00 – $34.50)X – $1,470,000
X = $2,530,000 ÷ ($66.00 – $34.50)
= 80,318 units (rounded up)

or sales of 80,318  $66.00 = $5,300,988

c.
Profit = PX – VX – F
$1,060,000 = P(80,000) – ($34.50  80,000) – $1,470,000
Rearranging,
$1,060,000 + ($34.50  80,000) + $1,470,000 = P(80,000)
P = $5,290,000 ÷ 80,000
P = $66.13 (rounded) or a 10.2% increase

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104 Fundamentals of Cost Accounting
3-45. (20 min.) CVP Analysis―Missing Data: Breed Products.
a. $8.20
Because the volume is given, it is not necessary to know the fixed and variable costs
separately.

Profit = Revenues – Costs

Profit = 150,000 x Price – Costs
$600,000 = 150,000 P – $630,000
$1,230,000 = 150,000 P
P = $8.20
b. $1,125,000

Profit = Revenues – Costs

0.20 Revenues = (P – V)X – F
0.20 Revenues = Revenues – 0.6 Revenues – $225,000
0.20 Revenues = $225,000
Revenues = $1,125,000
c. 125,000 units (= $1,125,000 ÷ $9)

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Solutions Manual, Chapter 3 105
3-46. (20 min.) CVP Analysis―Missing Data: Remington Inc.
P = $20
There are several ways to approach this problem. Note that although we do not know
the fixed costs, they are irrelevant to the solution as we will see.
(1) Set this up as two equations with two unknowns (Price and the breakeven point).
Let P = Current price, BE the breakeven point at the current price, and FC fixed cost.
Then
BE = FC ÷ (P – $5) at the current price.
If the price is cut by 50 percent, we know that the breakeven point is tripled, so
(3 x BE) = FC ÷ [(0.5 x P) – $5].
Substituting the first equation in the second, we have:
[(3 x FC)/(P – $5)] = FC ÷ [(0.5 x P) – $5].
Solving for P yields P = $20.
(2) For the same fixed cost, if the new breakeven point is three times the old
breakeven point, the contribution margin at the current price must be three times the
contribution margin at 50 percent of the current price:
(P – $5) = 3 x [(0.5 x P) – $5]
Solving for P yields P = $20.

3-47. (20 min.) CVP Analysis With Subsidies: Suburban Bus Lines.
a.

Surplus = (P – V)X – F + Subsidy

$0 = ($1.00 – $1.50)X – $200,000 + $250,000
$0.50X = $50,000

$50,000
X=
$0.50
X = 100,000 riders

b. With 75,000 riders, Suburban will operate at a surplus because the subsidy more than
offsets the negative contribution margin plus fixed costs. It is ―below‖ break-even, but
because Suburban loses money on each rider ($1.00 revenue less the $1.50 variable
costs), it operates with a surplus below break-even and at a deficit above break-even.

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106 Fundamentals of Cost Accounting
3-48. (35 min.) CVP Analysis―Sensitivity Analysis: Alameda Tile.

a. Profit = (P – V) X – F
Profit = ($800 – $480) X – $160,000
0 = ($800 – $480) X – $160,000
X = $160,000 ÷ $320
= 500 students

b. Profit = ($800 – $480) X – $160,000

$80,000 = ($800 – $480) X – $160,000
X = $240,000 ÷ $320
= 750 students

c. (1) Profit = ($800 – $480) x 800 students – $160,000

= $96,000

c. (2) 10% price decrease. Now P = $720

Profit = ($720 – $480) x 800 students – $160,000
= $32,000 Profit decreases by $64,000

20% price increase. Now P = $960

Profit = ($960 – $480) x 800 students – $160,000
= $224,000 Profit increases by $128,000

c. (3) 10% variable cost decrease. Now V = $432

Profit = ($800 – $432) x 800 students – $160,000
= $134,400 Profit increases by $38,400

20% variable cost increase. Now V = $576

Profit = ($800 – $576) x 800 students – $160,000
= $19,200 Profit decreases by $76,800

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Solutions Manual, Chapter 3 107
3-48 (continued).

c. (4) 10% fixed cost decrease, 10% variable cost increase.

Now F = $144,000 and V = $528
Profit = ($800 – $528) x 800 students – $144,000
= $73,600 Profit decreases by $22,400

3-49. (35 min.) Extensions of the CVP Model―Semifixed (Step) Costs: Sam's
Sushi.

a. There are three possible break-even points (one with each additional lane):

1 lane: X = $33,000 ÷ ($10 – $4) = 5,500 meals

2 lanes: X = $39,000 ÷ ($10 – $4) = 6,500 meals
3 lanes: X = $52,500 ÷ ($10 – $4) = 8,750 meals
The break-even point with one lane is not feasible because it exceeds the maximum
number of meals for one lane.
Therefore, there are two break-even points: 6,500 meals and 8,750 meals.
b. To answer this question, we just need to check at the three maximum levels for each
lane alternative:

Alternative Profit (Loss)

1 lane [($10 — $4) x 5,000 meals – $33,000] = ($3,000)
2 lanes [($10 — $4) x 8,000 meals – $39,000] = $9,000
3 lanes [($10 — $4) x 10,000 meals – $52,500] = $7,500

Sam should operate 2 lanes.

©The McGraw-Hill Companies, Inc., 2017

108 Fundamentals of Cost Accounting
3-50. (35 min.) Extensions of the CVP Model―Semifixed (Step) Costs: Cesar's
Bottlers.
a. There are three possible break-even points (one with each additional shift):

1 shift: X = $1,980 ÷ ($2.00 – $0.90) = 1,800 cases

2 shifts: X = $3,740 ÷ ($2.00 – $0.90) = 3,400 cases
3 shifts: X = $5,170 ÷ ($2.00 – $0.90) = 4,700 cases
Each of the three break-even points is feasible.
b. To answer this question, we just need to check at the three maximum levels for each
lane alternative:

Alternative Profit
1 shift [($2.00 - $0.90) x 2,000 cases – $1,980] = $220
2 shifts [($2.00 - $0.90) x 3,600 cases – $3,740] = $220
3 shifts [($2.00 - $0.90) x 5,000 cases – $5,170] = $330

Cesar should operate 3 shifts.

3-51. (15 min.) Extensions of the CVP Model—Taxes: Odd Wallow Drinks.
a.
X = $12,168,000 ÷ ($75 – $36) = 312,000 cases

b. In order to achieve a profit of $1,872,000 after tax, Odd Wallow must earn:
$3,120,000 = [$1,872,000 ÷ (100% – 40%)] before taxes.
The number of cases to earn $3,120,000 in operating profits is:
X = ($12,168,000 + $3,120,000) ÷ ($75 – $36) = 392,000 cases

©The McGraw-Hill Companies, Inc., 2017

Solutions Manual, Chapter 3 109
3-52. (20 min.) Extensions of the CVP Model—Taxes: Frightproof Commuter
Airlines.

a.
0 = (P – V)X – F
0 = ($240 – $60)X – $8,640
$8,640 = ($240 – $60)X
X = $8,640 ÷ $180
= 48 passengers

b.
After-tax profits = [(P – V)X – F](1 – t)
$3,510 = [($240 – $60)X – $8,640](1 – .25)
$3,510 = ($180X – $8,640)(.75)
($3,510 ÷ .75) = $180X – $8,640
$4,680 + $8,640 = $180X
$180X = $13,320
X = $13,320 ÷ $180
X = 74 passengers

c. With a capacity of 70 passengers, Frightproof can break even (48 < 70), but will not be
able to earn $3,510 per flight after taxes (74 > 70).

3-53. (20 min.) Extensions of the CVP Model—Taxes: Central Co.

After tax profits = [(P – V)X – F](1 – t)

$187,200 = [($13 – $4) x 100,000 – $540,000](1 – t)
$187,200 = $360,000 – $360,000t
$360,000t = $172,800
t = $172,800 ÷ $360,000
= 0.48 or 48%

©The McGraw-Hill Companies, Inc., 2017

110 Fundamentals of Cost Accounting
3-54. (20 min.) Extensions of the CVP Model—Taxes: Toys 4 Us.

a.
0 = (P – V)X – F
0 = ($1,200 – $750)X – $900,000
$900,000 = ($1,200 – $750)X
X = $900,000 ÷ $450
= 2,000 units

b.
After tax profits = [(P – V)X – F](1 – t)
$135,000 = [($1,200 – $750)X – $900,000](1 – .40)
$135,000 = ($450X – $900,000)(.60)
($135,000 ÷ .60) = $450X – $900,000
$225,000 + $900,000 = $450X
$450X = $1,125,000
X = $1,125,000 ÷ $450
X = 2,500 units

3-55. (40 min.) Extensions of the CVP Model—Taxes: Eagle Company.

a.
Sales ................................ $10,000,000 (= $400 x 25,000)
Variable costs .................. 4,125,000 (= $165 x 25,000)
Contribution margin .......... $5,875,000
Fixed costs ....................... 1,500,000
Before-tax profit ............... $ 4,375,000
Taxes (35% rate) ............. 1,531,250
After-tax profit .................. $ 2,843,750

©The McGraw-Hill Companies, Inc., 2017

Solutions Manual, Chapter 3 111
3-55 (continued).

b.
Profit = (P – V)X – F
$0 = ($400 – $165)X – $1,500,000
$235X = $1,500,000

$1,500,000
X=
$235
X = 6,383 Units (rounded)

c.
Sales ................................ $11,200,000 (= $400 x 28,000)
Variable costs ................... 4,620,000 (= $165 x 28,000)
Contribution margin .......... $ 6,580,000
Fixed costs ....................... 1,800,000 (= $1,500,000 + $300,000)
Before-tax profit ................ $ 4,780,000
Taxes (35% rate) .............. 1,673,000
After-tax profit ................... $3,107,000

d.
Profit = (P – V)X – F
$0 = ($400 – $165)X – $1,800,000
$235X = $1,800,000

$1,800,000
X= = 7,660 units (rounded)
$235
Sales $ = $400 x 7,660 = $3,064,000

©The McGraw-Hill Companies, Inc., 2017

112 Fundamentals of Cost Accounting
3-55 (continued).

e. $10,510,800

Fixed costs + [Target profit ÷ (1 − t)]

Target profit in units =
Unit contribution margin
$1,800,000 + [$2,843,750 ÷ (1 − .35)]
=
$235
$1,800,000 + $4,375,000
=
$235
= 26,277 units (rounded)

Sales dollars = $10,510,800 (= 26,277 x $400)

f. $3,926,154
Sales ................................ $11,200,000 (= $400 x 28,000)
Variable costs .................. 4,620,000 (= $165 x 28,000)
Contribution margin .......... $6,580,000
Advertising costs .............. ?
Other fixed costs .............. 1,500,000
Before-tax profit ............... $ 1,153,846 (= $750,000 ÷ [1 − 0.35]
Taxes (35% rate) ............. 403,846
After-tax profit .................. $ 750,000

To find the maximum advertising cost to maintain after-tax profit of $750,000, solve as
follows:
Contribution Margin ($6,580,000) – Advertising Costs – Other Fixed Costs
($1,500,000)
= Before-Tax Profits ($1,153,846)
$6,580,000 – $1,500,000 – $1,153,846 = Advertising Costs
Maximum Advertising Costs = $3,926,154

©The McGraw-Hill Companies, Inc., 2017

Solutions Manual, Chapter 3 113
3-56. (30 min.) Extensions of the CVP Model—Multiple Products: On-the Go, Inc.

a. Programmer + Executive
8,000  $70 + 12,000  $100 = $1,760,000 PX
8,000  $30 + 12,000  $40 = 720,000 VX
8,000  $40 + 12,000  $60 = $ 1,040,000 (P – V)X
819,000 F
$ 221,000 Profit

b.

Compute the weighted-average contribution margin.

Weights:
Programmer = 8,000 ÷ (8,000 + 12,000) = .40
Executive = 12,000 ÷ (8,000 + 12,000) = .60

Weighted-average CM = 0.4  $40 + 0.6  $60

= $16 + $36
Weighted-average CM = $52

Compute break-even:
Profit = (P – V)X – F
$0 = $52X – $819,000
$52X = $819,000
X = $819,000 ÷ $52
X = 15,750 total units

Programmer: produce 0.4  15,750 = 6,300 units

Executive: produce 0.6  15,750 = 9,450 units
Alternative approach:
Define a package containing 4 Programmer and 6 Executive models:
Price 4  $70 + 6  $100 = $880
Variable cost 4  $30 + 6  $40 = 360
Contribution margin $520
Break-even $819,000 ÷ $520 = 1,575 packages
Programmer model: 4  1,575 packages = 6,300 units
Executive model: 6  1,575 packages = 9,450 units

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114 Fundamentals of Cost Accounting
3-56. (continued).
c. New weights:

Weights:
Programmer = .90
Executive = .10

Weighted-average CM = 0.9  $40 + 0.1  $60

= $36 + $6
Weighted-average CM = $42

Compute break-even:
Profit = (P – V)X – F
$0 = $42X – $819,000
$42X = $819,000
X = $819,000 ÷ $42
X = 19,500 total units
Programmer: produce 0.9  19,500 = 17,550 units
Executive: produce 0.1  19,500 = 1,950 units

Alternative approach:
Define a package containing 9 Programmer and 1 Executive models:
Price 9  $70 + 1  $100 = $730
Variable cost 9  $30 + 1  $40 = 310
Contribution margin $420
Break-even $819,000 ÷ $420 = 1,950 packages
Programmer model: 9  1,950 packages = 17,550 units
Executive model: 1  1,950 packages = 1,950 units

©The McGraw-Hill Companies, Inc., 2017

Solutions Manual, Chapter 3 115
3-57. (30 min.) Extensions of the CVP Model—Multiple Products: Sundial, Inc.

a. AU + NZ
60,000  $160 + 40,000  $160 = $16,000,000 PX
60,000  $60 + 40,000  $80 = 6,800,000 VX
60,000  $100 + 40,000  $80 = $ 9,200,000 (P – V)X
2,208,000 F
$6,992,000 Profit

b.

Compute the weighted-average contribution margin.

Weights:
AU = 60,000 ÷ (60,000 + 40,000) = .60
NZ = 40,000 ÷ (60,000 + 40,000) = .40

Weighted-average CM = 0.6  $100 + 0.4  $80

= $60 + $32
Weighted-average CM = $92

Compute break-even:
Profit = (P – V)X – F
$0 = $92X – $2,208,000
$92X = $2,208,000
X = $2,208,000 ÷ $92
X = 24,000 total units

AU: produce 0.6  24,000 = 14,400 units

NZ: produce 0.4  24,000 = 9,600 units
Alternative approach:
Define a package containing 6 AU and 4 NZ models:
Price 6  $160 + 4  $160 = $1,600
Variable cost 6  $60 + 4  $80 = 680
Contribution margin $920
Break-even $2,208,000 ÷ $920 = 2,400 packages
AU model: 6  2,400 packages = 14,400 units
NZ model: 4  2,400 packages = 9,600 units

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116 Fundamentals of Cost Accounting
3-57. (continued).
c. New weights:

Weights:
AU = .80
NZ = .20

Weighted-average CM = 0.8  $100 + 0.2  $80

= $80 + $16
Weighted-average CM = $96

Compute break-even:
Profit = (P – V)X – F
$0 = $96X – $2,208,000
$96X = $2,208,000
X = $2,208,000 ÷ $96
X = 23,000 total units
AU: produce 0.8  23,000 = 18,400 units
NZ: produce 0.2  23,000 = 4,600 units

Alternative approach:
Define a package containing 8 AU and 2 NZ models:
Price 8  $160 + 2  $160 = $1,600
Variable cost 8  $60 + 2  $80 = 640
Contribution margin $960
Break-even $2,208,000 ÷ $960 = 2,300 packages
AU model: 8  2,300 packages = 18,400 units
NZ model: 2  2,300 packages = 4,600 units

©The McGraw-Hill Companies, Inc., 2017

Solutions Manual, Chapter 3 117
3-58. (30 min.) Extensions of the CVP Model—Multiple Products: Sell Block.

a. Individuals + Partnerships + Corporations

60,000  $200 + 4,000  $1,000 + 16,000  $2,000 = $48,000,000 PX
60,000  $180 + 4,000  $900 + 16,000  $1,800 = 43,200,000 VX
60,000  $20 + 4,000  $100 + 16,000  $200 = $ 4,800,000 (P – V)X
3,690,000 F
$ 1,110,000 Profit

b. Compute the weighted-average contribution margin.

Weights:
Individuals = 60,000 ÷ (60,000 + 4,000 + 16,000) = .75
Partnerships = 4,000 ÷ (60,000 + 4,000 + 16,000) = .05
Corporations = 16,000 ÷ (60,000 + 4,000 + 16,000) = .20

Weighted-average CM = 0.75  $20 + 0.05  $100 + 0.20 x $200

= $15 + $5 + $40
Weighted-average CM = $60

Compute break-even:
Profit = (P – V)X – F
$0 = $60X – $3,690,000
$60X = $3,690,000
X = $3,690,000 ÷ $60
X = 61,500 total returns

Individuals: prepare 0.75  61,500 = 46,125 returns

Partnerships: prepare 0.05  61,500 = 3,075 returns
Corporations: prepare 0.20  61,500 = 12,300 returns

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118 Fundamentals of Cost Accounting
3-58. (continued).
c. New weights:

Weights:
Individuals = .60
Partnerships = .10
Corporations = .30

Weighted-average CM = 0.6  $20 + 0.1  $100 + 0.3 x $200

= $12+ $10 + $60
Weighted-average CM = $82

Compute breakeven:
Profit = (P – V)X – F
$0 = $82X – $3,690,000
$82X = $3,690,000
X = $3,690,000 ÷ $82
X = 45,000 total units
Individuals: prepare 0.60  45,000 = 27,000 returns
Partnerships: prepare 0.10  45,000 = 4,500 returns
Corporations: prepare 0.30  45,000 = 13,500 returns

©The McGraw-Hill Companies, Inc., 2017

Solutions Manual, Chapter 3 119
3-59. (20 min.) Extensions of CVP Analysis—Multiple Products: Minot Furniture.
At the break-even point of 750 total units, the total contribution margin will equal the fixed
costs. Let X = the number of basic desks sold at the break-even point. Then (750 − X) will
equal the number of adjustable desks sold at the break-even point. Therefore,
($600 − $360) X + ($900 − $450) (750 − X) = $243,000
$240 X + $450 (750 − X) = $243,000
$210 X = $94,500
X = 450 basic desks
So, (750 − X) = 300 adjustable desks

The assumed sales mix is 450/750 or 60 percent basic desks and 40 percent adjustable
desks.

©The McGraw-Hill Companies, Inc., 2017

120 Fundamentals of Cost Accounting
3-60. (30 min.) Extensions of the CVP Basic Model—Multiple Products and Taxes:
Ocean King Products.

a. Compute weighted-average contribution margins for each product.

Selling Variable Contribution
Price per Cost per Margin per
Weights case Case Case
Variety 1 .40 $ 3 $ 2 $1
Variety 2 .35 5 3 2
Variety 3 .25 10 6 4

Weighted-average Revenue = .4 x $3 + .35 x $5 + .25 x $10

= $5.45
Weighted-average CM = .4 x $1 + .35 x $2 + .25 x $4
= $2.10
Weighted-average CM% = $2.10 ÷ $5.45 = 38.5321% (rounded)

Compute break-even revenue:

Break-even revenue = F ÷ Weighted-average CM%
= $46,200 ÷ 38.5321%
= $119,900 (rounded)

b.

After-tax income: = $40,950

Before-tax income = [$40,950 ÷ (1 – .35)]
= ($40,950 ÷ .65)
= $63,000
Compute required revenue:
Revenue = (F + Required profit) ÷ Weighted-average CM%
= ($46,200 + $63,000) ÷ 38.5321%
= $109,200 ÷ 38.5321%
= $283,400 (rounded)

©The McGraw-Hill Companies, Inc., 2017

Solutions Manual, Chapter 3 121
3-61. (30 min.) Extensions of the CVP Model—Multiple Products and Taxes:
Limitless Labs, Inc.
a. Basic + Retest + Vital Total
Revenue 850  $500 + 100  $800 + 50  $4,000 = $705,000
Variable costs 850  $120 + 100  $400 + 50  $2,800 = 282,000
Contribution margin 850  $380 + 100  $400 + 50  $1,200 = $ 423,000
Fixed cost 390,000
Profit before taxes $ 33,000
Income tax (@ 40%) 13,200
Profit $19,800

b. Compute weighted-average contribution margin percentages for each product.

Selling Price Variable Cost Contribution
Weights per Test per Test Margin per Test
Basic .85 $ 500 $ 120 $380
Retest .10 800 400 400
Vital .05 4,000 2,800 1,200

Weighted-average Revenue = .85 x $500 + .10 x $800 + .05 x $4,000

= $705
Weighted-average CM = .85 x $380 + .10 x $400 + .05 x $1,200
= $423
Weighted-average CM% = $423 ÷ $705 = 60%

Compute break-even revenue:

Break-even revenue = F ÷ Weighted-average CM%
= $390,000 ÷ 60%
= $650,000

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122 Fundamentals of Cost Accounting
3-61. (continued).

c.
After-tax income: = $180,000
Before-tax income = [$180,000 ÷ (1 – .40)]
= ($180,000 ÷ .60)
= $300,000
Compute required revenue:
Revenue = (F + Required profit) ÷ Weighted-average CM%
= ($390,000 + $300,000) ÷ 60%
= $690,000 ÷ 60%
= $1,150,000

d. Basic + Retests + Vital Total

Revenue 100  $500 + 400  $800 + 200  $4,000 = $1,170,000
Variable costs 100  $120 + 400  $400 + 200  $2,800 = 732,000
Contribution margin 100  $380 + 400  $400 + 200  $1,200 = $ 438,000
Fixed cost 420,000
Profit before taxes $ 18,000
Income tax (@ 40%) 7,200
Profit $10,800

Based on after-tax profit, Limitless Labs should not change the product mix.

©The McGraw-Hill Companies, Inc., 2017

Solutions Manual, Chapter 3 123
3-62. (30 min.) Extensions of the CVP Model—Multiple Products and Taxes:
Painless Dental Clinics, Inc.
a. Cleaning + Filling + Capping Total
Revenue 9,000  $120 + 900  $400 + 100  $1,200 = $1,560,000
Variable costs 9,000  $80 + 900  $300 + 100  $500 = 1,040,000
Contribution margin 9,000  $40 + 900  $100 + 100  $700 = $ 520,000
Fixed cost 400,000
Profit before taxes $ 120,000
Income tax (@ 30%) 36,000
Profit $84,000

b. Compute weighted-average contribution margin percentages for each product.

Selling Price Variable Cost Contribution Margin
Weights per Service per Service per Service
Cleaning .90 $ 120 $ 80 $ 40
Filling .09 400 300 100
Capping .01 1,200 500 700

Weighted-average Revenue = .90 x $120 + .09 x $400 + .01 x $1,200

= $156
Weighted-average CM = .90 x $40 + .09 x $100 + .01 x $700
= $52
Weighted-average CM% = $52 ÷ $156 = 33.33% (rounded)

Compute break-even revenue:

Break-even revenue = F ÷ Weighted-average CM%
= $400,000 ÷ 33.33%
= $1,200,000 (rounded)
c.
After tax income: = $140,000
Before tax income = [$140,000 ÷ (1 – .30)]
= ($140,000 ÷ .70)
= $200,000
Compute required revenue:
Revenue = (F + Required profit) ÷ Weighted-average CM%
= ($400,000 + $200,000) ÷ 33.33%
= $600,000 ÷ 33.33%
= $1,800,000 (rounded)

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124 Fundamentals of Cost Accounting
3-62. (continued).

d. Cleaning + Filling + Capping Total

Revenue 12,000  $120 + 1,000  $400 + 0  $1,200 = $1,840,000
Variable costs 12,000  $80 + 1,000  $300 + 0  $500 = 1,260,000
Contribution margin 12,000  $40 + 1,000  $100 + 0  $700 = $ 580,000
Fixed cost 450,000
Profit before taxes $ 130,000
Income tax (@ 30%) 39,000
Profit $91,000

Based on after-tax profit, Painless Dental Clinics should change the product mix.

3-63. (20 min.) Extensions of the CVP Model—Taxes With Graduated Rates:
Hastings & Daughters.

a.
Profit = (P – V)X – F
$0 = ($25 – $17)X – $112,000
$8X = $112,000

$112,000
X=
$8
X = 14,000 Units

©The McGraw-Hill Companies, Inc., 2017

Solutions Manual, Chapter 3 125
3-63. (continued).

b.

First, determine the pre-tax income necessary to earn $90,000 after-tax. The first
$100,000 of income is taxed at 25 percent, so the after-tax income is $75,000:

= [100,000 x (1.0 – 0.25).

To earn an additional $15,000 (= $90,000 – $75,000) after tax requires pre-tax income of
$25,000 [= $15,000 ÷ (1.0 – 0.40)]. Therefore, to earn $90,000 after tax requires pre-tax
income of $125,000 (= $100,000 + $25,000).

Substitute $125,000 in the breakeven equation:

Profit = (P – V)X – F
$125,000 = ($25 – $17)X – $112,000
$8X = $112,000

$237,000
X=
$8
X = 29,625 Units

©The McGraw-Hill Companies, Inc., 2017

126 Fundamentals of Cost Accounting
Solutions to Integrative Case

3-64. (60 min.) Financial Modeling: Roseville Brewing Company.

a. Potential investors and bankers were concerned about the accuracy of the income
statement projections. They wanted to know what would happen if the projections
were overly optimistic. Operating profit was heavily influenced by projected sales
dollars and product mix. The concern was over the impact changes in sales and
product mix (among other things) might have on operating profit.
b. The first income statement was in the traditional format. In the traditional format, costs
are not shown according to cost behavior. Thus, it is difficult to predict what will
happen with costs as changes are made in sales volume. For example, if sales
volume decreases by 10 percent, it is difficult to predict what will happen with cost of
sales and marketing and administrative expenses. Will they decrease by the same
percentage? (Unlikely unless all costs are variable!)
c. The best way to quickly check for reasonableness is to compare the operating profit as
a percentage of sales to other similar businesses. In addition, the dollar amount of
operating profit can be compared to other similar businesses of roughly the same size.
(In fact, the banks and investors who were approached by RBC often looked at these
two items as a starting point to ensure the projected income statement was
reasonable.)
d. The cost of a pint of beer can range from $0.15 to $1.40 depending on what is included
in the cost. Should we include only the materials? Should we include direct labor?
Indirect labor? Manufacturing overhead? The point is to understand what is included
in the cost of a product, particularly when this information is used for pricing and other
forms of decision-making.
e. (1) The break-even point in sales dollars is $1,235,154, calculated as follows:

Breakeven point = Total fixed costs ÷ contribution margin ratio

= $520,000 ÷ ($822,212 ÷ $1,953,000)
= $520,000 ÷ .421
= $1,235,154.
(2) The margin of safety is $717,846, calculated as follows:

Margin of safety = $1,953,000 – $1,235,154

= $717,846.

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Solutions Manual, Chapter 3 127
3-64 (continued).
(3) RBC is selling many different products that change daily. It is difficult if not
impossible, to measure units of product for a brew pub. This same argument holds
true for most service companies as well. Service companies do not sell ―units‖ of
service. Thus, for these types of companies, break-even points and target profit points
are calculated using sales dollars.

(4) The sales dollars required to achieve $200,000 in operating profit is $1,710,214,
calculated as follows:

Total fixed costs + Target profit

Target profit =
Contribution margin ratio

= ($520,000 + $200,000) ÷ .421

= $720,000 ÷ .421
= $1,710,214.

The sales dollars required to achieve $500,000 in operating profit is $2,422,803,

calculated as follows:
= ($520,000 + $500,000) ÷ .421
= $1,020,000 ÷ .421
= $2,422,803.

These calculations assume that the product mix is constant. The contribution margin
ratio is dependent on the product mix, and will change as the product mix changes.

©The McGraw-Hill Companies, Inc., 2017

128 Fundamentals of Cost Accounting