Question

CVP Analysis and Cost Structure (Single Product). Fallon Company produces road bikes. The company has annual fixed costs totaling $10,000,000 and variable costs of $600 per unit. Each unit of product is sold for $1,000. Fallon expects to sell 70,000 units this year.

Required:

1. Find the break-even point in units.

2. How many units must be sold to earn an annual profit of $2,000,000?

3. Find the break-even point in sales dollars.

4. What amount of sales dollars is required to earn an annual profit of $500,000?

5. Find the margin of safety in units.

6. Find the margin of safety in sales dollars.

7. How much will operating profit change if fixed costs are 15 percent lower than anticipated? Would this decrease in fixed costs result in higher or lower operating leverage? Explain.

Answer 1

	Sale price per unit	$1,000
	Variable cost per unit	$600
	Contribution per unit	$400
	GP ratio	40%
	Fixed Cost	$10,000,000
	Breakeven point in units=	Fixed Cost/Contribution per unit
		10,000,000/400
	Breakeven point in units=	25000
	Units required for target profit=	(Fixed cost + target profit)/contribution per unit
	Units required for target profit=	(10,000,000+2,000,000)/400
	Units required for target profit=	30,000
	Break even point in sales dollars=	Fixed Cost/GP ratio
	Break even point in sales dollars=	10,000,000/40%
	Break even point in sales dollars=	$25,000,000
	Target sales for for profit of $500,000	(10,000,000+500,000)/40%
	Target sales for for profit of $500,000	$26,250,000
	Margin of safety in units =	Expected sales - Breakeven sales
		70,000-25,000
		45,000
	Margin of safety in Dollars =	Expected sales value - Breakeven dollar sales
		70,000,000 - 25,000,000
	Margin of safety in Dollars =	$45,000,000
	New fixed cost after decrease of 15%	$8,500,000
	Contribution	$28,000,000	(400*70,000)
	New operating profit	$19,500,000
	Old operating profit	$18,000,000	(28,000,0000-10,000,000)
	INCREASE in operating profit	$1,500,000
	Operating profit will increase by	8.33%	(1,500,000/18,000,000)
	Operating leverage without reduction in fixed cost	28,000,000/(28,000,000-10,000,000)
		1.56
	Operating leverage after reduction in fixed cost	28,000,000/(28,000,000-8,500,000)
		1.44
	This decrease in fixed cost reduces the operating leverage.