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
4,000 8,000 12,000 16,000 20,000Number of Computers Processed
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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Cost Behavior Basics
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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Cost Behavior Basics
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
4,000 8,000 12,000 16,000 20,000Number of Computers Processed
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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Operating Income Approach
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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Operating Income Approach
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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Operating Income Approach
Example:
Variable Cost per Unit = P 17,400,000
72,500
= P 240
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Operating Income Approach
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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Operating Income Approach
Example:
To double check:
Sales (50,000 units x P 400/unit) P 20,000,000
Less Variable Expenses (P 12,000,000)
Contribution Margin P 8,000,000Less Fixed Expenses (P 8,000,000)
Operating Income P 0
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Contribution Margin Approach
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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Contribution Margin Approach
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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Contribution Margin Approach
Example:
Method 2
Contribution Margin per Unit = Price per unitVariable
Cost per unit
= P 400P 240= P 160 per unit
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Contribution Margin Approach
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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Targeted Operating Income Approach
Example:
Mercury Tool Corporation has set a targeted operating
income of P 4,240,000. How many units should be sold?
Operating Income = (Price per Unit x No. of Units)
(Variable Cost per Unit No. of Units)Total Fixed Costs
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Targeted Operating Income Approach
Solution:
Operating Income = (Price per Unit x No. of Units)
(Variable Cost per Unit No. of Units)Total Fixed Costs
P 4,240,000 = (P 400 x Units)(P 24 x Units)P 8,000,000
= 76,500 units
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Targeted Operating Income Approach
Example:
To double check:
Sales (76,500 units x P 400/unit) P 30,600,000
Less Variable Expenses (P 18,360,000)
Contribution Margin P 12,240,000
Less Fixed Expenses (P 8,000,000)
Operating Income P 4,240,000
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Targeted Operating Income Approach
Example:
Mercury Tool Corporation has set a targeted operating
income of 15% of sales. How many units should be sold?
Operating Income = (Price per Unit x No. of Units)
(Variable Cost per Unit No. of Units)Total Fixed Costs
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Targeted Operating Income Approach
Solution:
Operating Income = (Price per Unit x No. of Units)
(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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Impact of Fixed Costs on Profit
Revenues
Units
Total Variable Cost
Contribution
Margin
Fixed
Costs
Fixed Costs < Contribution Margin; Profit > 0
Profit
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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
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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Multi Product Operating Income Analysis
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)
Operating Income P 8,000,000
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Multi Product Operating Income Analysis
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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Multi Product Breakeven Point Analysis
Solution:
Breakeven Volume = Fixed Costs
Contribution Margin
= Fixed Costs
(Price - Unit Variable Cost)
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Multi Product Breakeven Point Analysis
Solution:
Regular Drillers Breakeven Units
Breakeven Volume = Fixed Costs
(Price - Unit Variable Cost)
= P 2,500,000
(P 400 - P 240)
= 15,625 units
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Multi Product Breakeven Point Analysis
Solution:
Mini Drillers Breakeven Units
Breakeven Volume = Fixed Costs
(Price - Unit Variable Cost)
= 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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Using Sales Mix in Cost Volume Analysis
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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Using Sales Mix in Cost Volume Analysis
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
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Using Sales Mix in Cost Volume Analysis
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
Less Variable Expenses (P 27,000,000)
Contribution Margin P 21,000,000
Less Fixed Expenses (P 13,000,000)
Operating Income P 8,000,000
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
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Profit Analysis if CVP Variables Change
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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Profit Analysis if CVP Variables Change
Solution (Choice 1):
Before the Proposed
Advertising Increase
After the Proposed
Advertising Increase
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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Profit Analysis if CVP Variables Change
Solution (Choice 1):
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
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Profit Analysis if CVP Variables Change
Solution (Choice 2):
Before the Proposed
Advertising Increase
After the Proposed
Advertising Increase
Units Sold 72,500 80,000
Unit Contribution Margin X P 160 X P 140**
Total Contribution Margin P 11,600,000 P 11,200,000
Less Fixed Expenses (P 8,000,000) (P8,000,000)
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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Profit Analysis if CVP Variables Change
Solution (Choice 2):
Difference in Profit
Change in Contribution Margin
(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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Profit Analysis if CVP Variables Change
Solution (Choice 3):
Before the Proposed
Advertising Increase
After the Proposed
Advertising Increase
Units Sold 72,500 90,000
Unit Contribution Margin X P 160 X P 140
Total Contribution Margin P 11,600,000 P 12,600,000
Less Fixed Expenses (P 8,000,000) (P8,480,000)
Profit P 3,600,000 P 4,120,000
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Profit Analysis if CVP Variables Change
Solution (Choice 3):
Difference in Profit
Change in Contribution Margin
(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
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Operating Leverage
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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.
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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
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Operating Leverage
Solution:
Automated System
***Unit Contribution Margin = Contribution Margin
No. of Units Sold
= P 500,000
10,000= P 50
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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
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Operating Leverage
Solution:
Automated System
cUnit Contribution Margin = Contribution Margin
No. of Units Sold
= P 200,000
10,000= P 20
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Operating Leverage
Solution:
Automated System
Degree of Operating Leverage = Contribution Margin
Operating Income
= P 500,000
P 125,000= 4 x
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Operating Leverage
Solution:
Manual System
Degree of Operating Leverage = Contribution Margin
Operating Income
= P 200,000
P 100,000= 2 x
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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
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Operating Leverage
Solution:
Automated System
*Unit Selling Price = Total Annual Sales
No. of Units Sold
= P 1,400,000
14,000= P 100
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Operating Leverage
Solution:
Automated System
**Unit Variable Cost = Variable Expenses
No. of Units Sold
= P 700,000
14,000= P 50
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8/14/2019 De La Salle - CB - FINMAN 1 - Breakeven.pdf
76/80
Operating Leverage
Solution:
Automated System
***Unit Contribution Margin = Contribution Margin
No. of Units Sold
= P 700,000
14,000= P 50
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8/14/2019 De La Salle - CB - FINMAN 1 - Breakeven.pdf
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
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8/14/2019 De La Salle - CB - FINMAN 1 - Breakeven.pdf
78/80
Operating Leverage
Solution:
Manual System
bUnit Variable Cost = Variable Expenses
No. of Units Sold
= P 1,120,000
14,000= P 80
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8/14/2019 De La Salle - CB - FINMAN 1 - Breakeven.pdf
79/80
Operating Leverage
Solution:
Automated System
cUnit Contribution Margin = Contribution Margin
No. of Units Sold
= P 280,000
14,000= P 20
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8/14/2019 De La Salle - CB - FINMAN 1 - Breakeven.pdf
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.