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Sensitivity Analysis CVP Provides structure to answer a variety of “what- if” scenarios “What” happens to profit “if”: Selling price changes Volume changes Cost structure changes Variable cost per unit changes Fixed cost changes See Page 95-96

© 2009 Pearson Prentice Hall. All rights reserved. Margin of Safety One indicator of risk, the Margin of Safety (MOS) measures the distance between budgeted sales and breakeven sales: MOS = Budgeted Sales – BE Sales The MOS Ratio removes the firm’s size from the output, and expresses itself in the form of a percentage: MOS Ratio = MOS ÷ Budgeted Sales See Page 97-98

© 2009 Pearson Prentice Hall. All rights reserved. Operating Leverage Operating Leverage (OL) is the effect that fixed costs have on changes in operating income as changes occur in units sold, expressed as changes in contribution margin OL = Contribution Margin Operating Income Notice these two items are identical, except for fixed costs See Page 98-99

© 2009 Pearson Prentice Hall. All rights reserved. Effects of Sales-Mix on CVP The formulae presented to this point have assumed a single product is produced and sold A more realistic scenario involves multiple products sold, in different volumes, with different costs The same formulae are used, but instead use average contribution margins for bundles of products. See Page 101-102

© 2009 Pearson Prentice Hall. All rights reserved. Effects of Sales-Mix on CVP Q: The following information is for Mohammad Corporation: Product X: Revenue \$10.00 Variable Cost \$2.50 Product Y: Revenue \$15.00 Variable Cost \$5.00 Total fixed costs \$50,000 1-What is the breakeven point assuming the sales mix consists of two units of Product X and one unit of Product Y? 2-What is the operating income, assuming actual sales total 150,000 units, and the sales mix is two units of Product X and one unit of Product Y?

© 2009 Pearson Prentice Hall. All rights reserved. Effects of Sales-Mix on CVP (1): Bundle = 1Nunit of product Y& 2 units of product X. Breakeven point in Bundle (Units) = Fixed Costs / C.M u * C.M u (bundle) = CM(X)*2 + CM(Ys)*1 7.5*2+10*1 = 25 So, Breakeven point in Bundle (Units) = 50,000/25 = 2000 Every Bundle has :1 Product Y = 1*2000= 2,000 units 2 Product X = 2*2000=4,000 units

© 2009 Pearson Prentice Hall. All rights reserved. Effects of Sales-Mix on CVP (2): Product X Product Y Total Sales units 100,000 50,000 150,000 Revenue\$1,000,000 \$750,000 \$1,750,000 Var. costs 250,000 250,000 500,000 CM \$750,000 \$500,000 \$1,250,000 Fixed costs 50,000 Operating Income \$1,200,000

© 2009 Pearson Prentice Hall. All rights reserved. Multiple Cost Drivers Variable costs may arise from multiple cost drivers or activities. A separate variable cost needs to be calculated for each driver. Examples include: Customer or patient count Passenger miles Patient days Student credit-hours See Page 102-104