CVP ANALYSIS

CVP Analysis

CVP Analysis

Q2. (a). First of all in order to calculate original or current Break even units following steps are required:

Selling price of the Cots $ 600

Annual Fixed Cost $ 150, 000

Variable Cost (per cot) $ 300

Now to find the number of units that Grace Inc must produce to achieve break even are as follow:

Selling Price (SP) = Fixed Cost + Variable Cost

So if we subtract variable cost from selling price we will get contribution margin i.e:

Selling Price - Variable Cost = Contribution

$ 600 - $ 300 = $ 300

Now calculate contribution to sales ratio (C/S ratio):

C/S Ratio = Contribution = 300 = 0.5

Selling Price 600

Now break even units are:

Break even units (original) = Fixed Cost = 150000 = 500 Units

Contribution 300

So Grace Inc has to produce and sell 500 units in order to achieve break even at the current stated budget.

Now by dividing fixed cost by C/S ratio we will get break even revenue i.e:

Break even Revenue = Fixed Cost = 150000 = $300000

C/S Ratio 0.5

Now we will calculate the desired income using same cost structure:

Net income after tax$ 650000

Net income before tax = 650000 = $ 928571

0.7 (as tax rate is 30%)

Fixed Cost $ 150000

So contribution is equal to = Net income before tax + Fixed Cost

= 928571 + 150000 = $ 1078571

Now we will divide contribution margin of budgeting and contribution of breakeven point to get the desired result.

1078751 = 3595

300

Q2(b). In order to maximize the net income of Grace Inc, we will evaluate various options to come up with a most preferable solution:

Option A

Reduce the selling price by $60. The sales organization forecasts that at this significantly reduced price, 4050 units can be sold during the remainder of the year. Total fixed costs and variable cost per unit will stay as budgeted.

First all we will evaluate option A:

Contribution

From current sales525*300 = 157500

From remaining sales4050* (selling price - new selling price) - Variable Cost = 972000

Total contribution157500 + 972000 = 1129500

Now subtract Fixed Cost from Contribution to have income before tax:

Income before tax = 1129500 - 150000 = 979500

Now add tax in this i.e :

979500*0.3 (as tax is 30%) = 293850

Net Income after tax = income before tax - tax = 979500 - 293850 = 685650 (from option A).

Option B

Lower variable cost per unit by $15 through the use of less expensive direct materials and slightly modified manufacturing techniques. The selling price will also be reduced by $45, and sales of 3300 units are expected for the remainder of the year.

Now we will evaluate the option B to calculate net income:

Contribution

From current sales525*300 = 157500

From remaining sales3300* (selling price - new selling price) - VC = 891000

Total contribution157500 + 891000 = 1048500

Now subtract Fixed Cost from Contribution to have income before tax:

Income before tax = 1048500 - 150000 = 898500

Now add tax in this i.e:

898500*0.3 (as tax is 30%) = 269550

Net Income after tax = income before tax - tax = 898500 - 269550 = 628950 ...