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CVP Analysis

Assumptions :

1. Number of output units are the only revenue driver and cost driver.2. Total costs can be separated into fixed (both direct and indirect) and variable

component (both direct and indirect)

3. When represented graphically TR and TC have a linear relationship with outputfor a given range and time period.

4. SPU, VCU and TC are known and constant(within a relevant range and time period)

5. The analysis covers a single product.Mariam is thinking of selling Business SW at a two day computer convention

VCU = 120 per copy ( Variable cost per unit )

SPU = 200 per copy ( Selling price per unit )

Booth Rental (Fixed) Rs 2000/- for two days.

CMU = SPU VCU = 80/- ( Contribution margin per unit i.e it

contributes to the recovery of fixed costs)

BEP = Point where TR = TC i.e No profit no loss basis.

Approaches to calculating BEP.

1. Algebraic approach2. Graph method1. Algebraic approach or Equation method

BEP ( no. of units) = FC / CMU

No. of copies Mariam needs to sell to breakeven = 2000 / 80 = 25.

BEP ( in amount ) = FC / CMU %

Total revenue which mariam needs to generate to breakeven = 2000 / (80 / 200)

= 2000 / 0.4 = Rs.5000 / -

Target Operating Income (TOI) If mariam desires to earn an income of Rs 1,200/-

from the two day convention then the number of copies she needs to

sell = ( FC + TOI) / CMU

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= (2000 + 1200) / 80 = 3200 / 80 = 40 copies.

Target Net income (TNI) with a given rate of Income Tax. If Mariam falls in

a tax bracket of 40% and then she desires a net income of 960 /- post tax then

= ( FC + ( TNI / (1-Tax Rate)) / CMU

= ( 2000 + ( 960 / (1-0.40))) / 80

= ( 2000 + (960 / 0.60)) / 80

= ( 2000 + (1600)) / 80

= ( 3600 / 80 )

= 45 copies.

Proof :

Revenue (200 * 45) 9000

Less TVC (200 * 120) 5400

= TCM 3600

Less Fixed Cost 2000

= Operating Income 1600

Less Taxes @ 40% 640

= TNI 960/-

Decision to advertise Under normal circumstances Mariam is expecting a sale of

40 copies. So Operating Income will be Rs 1,200/- (assume no taxes).

She has a proposal of putting an ad in the convention brochure which will cost

another 500/-. As a result she expects an increase of additional 4 copies. Should

she go for it?

Whether to reduce the selling price - Mariam is thinking of reducing the selling price

to 175/- she thinks she will be able to sell 50 copies?

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Sensitivity Analysis and Uncertainty

Alternative Fixed cost and variable cost structures.

Substituting fixed cost with variable cost Risk return profile Operating Leverage.

Option !

2000/- fixed fee.

Option 2 800/- fixed + 15% of revenue

Option 3 No fixed fee but 25% of revenue.

She anticipates selling 40 copies. Which option she should choose.