BUS 108 Midterm

Operating Income

Total CM - fixed expenses

Total Contribution Margin: (Units x CM P/Unit)

Contribution Margin

• When each sale contributes

• CM= Units x (selling price-Variable Cost)

CM Per Unit

Selling Price - Variable Cost P/Unit

CM Ratio

CM P/Unit / Selling Price

CM Example

donut

1.30 selling price

0.91 variable cost

donut

1.30 selling price

0.91 variable cost

P/Unit- .39

CM Ratio- 30%

Break even Analysis

-find the sales level where profit is zero

Break even Units

Fixed cost / CM P/Unit

Break even Sales

Fixed cost / CM P/Unit

Break even unit/sales Example

Hat Fixed Cost: $240,000

Break even P/Unit: 240,000 / (80/20) =60,000 4,000 hats

Break even Sales: 240,000 / ((80-20)/80) = 320,000 sales

Target Profit and Taxes

• Adding the desired profit to fixed costs

• Required Units = (Fixed costs +Target Operating Income) / CM P/Unit

• If target is after-tax Net Income: Pretax Target = Net Income / (1-tax rate)

Sales Mix and Pricing

• Multiple Products require separate contribution margins

• Operating Income = Sum of (Units for each product x its CM/Unit) - Fixed Cost

• Keep the specified sales mix constant

• Markup: Price= Cost x (1+markup rate)’

Sales Mix and Pricing Example

253 queen beds

759 king beds

Fixed cost- $1,956,508

What is CM/Unit and operating income?

Beds: 253 queen x $1626 + 759 King x ($2,070) - $1,956,508= $26,000

What If Analysis

• Recalculate when assumptions change

New CM/Unit

New CM/Unit = New Price - New Variable Cost

then find new profit or break even

Margin of Safety

Margin of Safety: Current Sales - Breakeven Sales

Change in Operating Income (Extra Operating Income)

• Change in Operating Income = Change in Sales x CM Ratio

• EX. 200,000 extra sales * 60% CM Ratio

What does it mean to break even?

2. If a product’s variable cost per unit increases while the selling

price and fixed costs remain constant, what will happen to the

breakeven point?

3. How do you calculate the breakeven point in units? In dollars?

4. What actions can a company take to reduce its breakeven point?

5. What is the margin of safety? How is it calculated?

break even point

Total revenues = total expenses

profit = 0

Solve for Break even point

Operating income= Sales revenue - variable expenses- fixed expenses

or (Selling price for each unit units sold) - (Variable cost * Units sold) - FC = $0

or (CM/Unit * Units sold) - FC = $0

Solve for units sold= which equals breakeven point

Why is operating income set to zero? total sales revenue is exactly equal to its total expenses

In-class Practice

Assume a sales price per unit of $25, variable cost per

unit $15, and total fixed costs of $18,000. What is the

breakeven point in dollars?

	a. $30,000
	b. $45,000
	c. $26,999
	d. $37,500

B

(25-15) ÷ 25 = 0.4

18,000 ÷ 0.4 = 45,000

In-class Practice

A breakeven graph illustrates the relationship between

a. volume and sales price.

b. volume and total costs.

c. breakeven and operating income.

d. sales and costs.

D sales and costs

In-class Practice

Assume a sales volume of 6,000 units, unit selling price

of $20, unit variable cost of $12, and total fixed costs of

$20,000. What is the margin of safety in sales dollars?

a.	$25,000
b.	$50,000
	c. $70,000
	d. $120,000

C

20,000 ÷ (20-12) = 2,500

(6,000-2,500) x 20 = 70,000

Exercise 3.2

Exercise 3.2 solution

a. $0.80 – $0.45 = $0.35

b Contribution margin ratio =

$0.35

$0.80

= 0.4375 or 43.75%

c. $0.80x – $0.45x – $175,000 = $0

$0.35x = $175,000

x = 500,000 bars to breakeven

500,000 bars ÷ $0.80 per bar = $400,000 breakeven sales $

d The breakeven point will increase to

$175,00

=700,000 bars; 700,000 bars × $0.80 = $560,000