Question

Anya is the marketing manager at Education Plus, an Internet retail company that sells children's educational books and supplies. Anya believes that the company could increase sales by $5 million next year if the company spends a fixed $2 million on advertisements with Google and other popular search engines. Using CVP analysis, she estimated that her proposal would increase pretax income by $0.5 million. a. Discuss possible reasons why Anya might be biased in her revenue and cost estimates. b. Discuss how uncertainties and biases affect interpretation of CVP results. c. Assume that Anya is not biased in her analysis. How could sensitivity analysis help her analyze the reasonableness of her estimates? d. Discuss how consideration of the company's degree of operating leverage could affect whether the top managers accept Anya's proposal.

Answer 1

a. When making adjustments to revenue and cost estimates they will engage in target pricing a process in which a company uses market analysis and production information to determine the maximum price customers are willing to pay for a good or service in addition to the markup percentage .If the good can be produced at a cost that allows both the desired profit percentage as well as deliver the good at a price acceptable to the customer.,then the company should processed with the product ,otherwise the company will not achieve its desired profit goals.

b. As sales price increases - break even point decreases I.e contribution margin is higher ,need fewer sales to break even

As sales price decreases - break even increases I.e contribution margin is lower,need more sales to break even

Variable costs increase - break even increases I.e contribution margin is lower ,need more sales to break even

Variable costs decrease - break even point decreases I.e contribution margin is higher ,need fewer sales to break even

Fixed costs increase - Break even point increases I.e contribution margin doesn't change but need more sales to meet fixed cost

Fixed costs decrease - Break even point decreases I.e contribution margin doesnot change ,but need fewer sales to meet fixed cost

C. Cost volume profit analysis can be used to conduct a sensitivity analysis that shows what will happen if there are changes in any of the variable sales price,unit sold,variable cost per unit,or fixed costs.The break even point may or may not be impacted by changes in costs depending on the type of cost affected.

d. The benefits of high operating leverage can be immense .Companies with high operating leverage can make more money from each additional sale if they dont have to increase costs to produce more sales.The minute business pick up ,fixed assets such as property,plant and equipment as well as existing workers can do a whole lot more without additional expenses.