QUESTIONS

7-1 The underlying relationship in cost-volume-profit analysis is that costs, revenues, and profits all change in a predictable way as the volume of activity changes. 7-2 It is more practical to find the breakeven point in sales dollars for companies having thousands of individual items. Finding the breakeven point for each item would be laborious and meaningless.

7-3 The contribution margin ratio is: price - variable costs price

The contribution margin ratio (CMR) represents the net contribution per sales dollar. The CMR tells us the change in profit associated with a given change in sales dollars. It is a useful measure of the relative contribution to profit of different products, divisions, or sales units. The use of this ratio can give a retail store a good approximation of the sales dollars necessary for the store to break even. A higher CMR is associated with higher risk. A higher CMR can have a more favorable impact on profit. However, if sales fall below breakeven, then a high CMR will yield a relatively more negative impact on profits. 7-4 The basic assumption of the CVP model is that the behavior of revenues and total costs is assumed to be linear over the relevant range of activity. Managers must be careful to remember that the calculations done within the context of a given CVP model cannot be interpreted safely outside of the relevant range of output for that particular model. Other assumptions include: fixed costs are measured by all fixed costs if a long-term perspective (i.e., breakeven over a longer period of time) is to be taken, while only incremental fixed costs for the project or activity are included if a short- term perspective (i.e., to determine when the firm will achieve breakeven on a new product) is taken. Also, allocated fixed costs are not included if a short-term perspective is taken, since these costs will not change in the short term.

7-5 If part of the costs are fixed, they will remain constant even when the activity level declines. Therefore, the variable costs will need to fall by the entire amount of the budget cut. Fixed costs are sticky; the expected savings from reducing activity levels will be less than the effect on the activity itself. 7-6 Only include fixed costs that are relevant for a short-term analysis to determine when the new product will reach breakeven. Relevant costs are those additional, new, or incremental fixed costs which will influence the profitability of the newBlocher,Stout,Cokins,Chen:Cost Management, 4e 7-2 ©The McGraw-Hill Companies, Inc., 2008 venture. If a new product does not require any new fixed cost, then the breakeven point is zero.

7-7 Sensitivity analysis is used for two important purposes: 1. To determine which factors have the greatest influence on profit, and to assess the magnitude of that influence

2. To examine the sensitivity of profit to a given forecast or estimate for any one of the factors

7-8 The issue of taxes does not affect the calculation of the breakeven point because the breakeven point is determined at the level of zero profit. 7-9 Technologically advanced firms usually have high fixed costs. Therefore, profits are strongly affected by the level of activity. High profits are earned beyond the breakeven point, but high losses can result from falling below breakeven. 7-10 Sensitivity analysis deals with the risk that sales may fall short of expectations or that costs will be higher than expected.

7-11 The breakeven point can be calculated using:

1. The equation method for sales in units

2. The equation method for sales dollars

3. The contribution margin method for sales in units

4. The contribution margin method for sales dollars

7-12 Margin of safety = expected sales - breakeven sales

The margin of safety is measured in either dollars or units. It measures the potential effect of the...