1. Presentation
Chapter 4
Profit Planning

2. Marginal Analysis Income Statement
To reach earnings before interest and taxes (Operating Income) Revenues Variable costs 60% 6000 Marginal contribution 4000 Fixed costs 1200 EBIT 4800

3. Break-even Analysis
The minimum position that allows continued operations. Key terms:
Break-even Point. The level of operations with neither a profit or loss.
Variable Cost. The cost of producing goods or delivering services.
Fixed Cost. Cost that does not vary with the level of activity.

4. Marginal Contribution
The direct profit from operations.
In Dollars. Revenues – variable costs.
As a Percent.
Revenues – variable costs
Revenues
or (Rev – VC)/Rev

5. B/E Dollars or Units
The break-even point may be calculated in dollars or units:
B/E_$ = level of revenues needed to cover fixed costs.
B/E_units = number of units sold needed to cover fixed costs

6. Break-even Formula -- Dollars
The break-even point in dollars is calculated by the formula:
B/E_$ = FC/(MC%)
where
B/E_$ = Revenues at the break-even point.
MC% = marginal contribution as a percent [(Rev-VC)/Rev]

7. Break-even Formula -- Units
The break-even point in units sold is calculated:
B/E_units = FC/(MC$)
where MC$ = Rev-VC

8. Profit-volume Analysis
This is a modification of break-even analysis. Profits are added to fixed costs.
B/E_Revs = (FC + Profit)/MC%
B/E_Revs equals the dollars of sales needed to achieve a desired profit.

9. Marginal Analysis This is the application of profit-volume analysis:
Varying the Level of Revenues. Forecasting profits at different sales levels while holding selling price and costs constant.
Varying Price. Forecasting profits at different prices.
Varying Fixed and Variable Costs. Trading one category of cost for another.

10. Profit Planning and Stock Price
Investors link a firm’s profits to the market price of its stock. Key terms:
Earnings per Share (EPS). Net income divided by outstanding shares of stock.
Price-earnings Ratio (P/E). Market price divided by EPS.

11. Normal P/E Multiple
A normal P/E multiple exists when EPS meets two conditions:
A firm has a satisfactory return on its capital.
Investors are not disturbed by unusual psychological or economic factors.

12. Estimating Normal P/E
The normal P/E for a company or industry is estimated by analyzing:
Historical data.
Similar firms.
Industry norms.
National markets
Common sense.

13. Question
How do know when we have found the normal P/E?

14. Answer
Nobody knows.