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# Capital Budgeting Example Problem

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Company Data

Company's average selling price (SP) per unit = \$40
Product's variable cost per unit = \$28
Company's budgeted fixed costs for the upcoming year are expected to be \$1,000,000
You need to complete the following:

What is the difference between break-even analysis and CVP analysis?
In simple terms,
what is contribution margin?
Do managers want contribution margin to be a bigger or smaller figure? Why?
Below the break-even point, what does every dollar of contribution margin go toward?
Above the break-even point, what does every dollar of contribution margin go toward?
Include at least 1 page of calculations for the following scenario analyses:
What is the break-even point, in units and dollars, for the basic data?
The sales department thinks it could sell the product at a slightly higher price of \$45/unit, but if the price is raised, it may lose 10% of sales volume in units.
What would the expected profitability be if this higher selling price/unit in fact occurred?
Based on this, the price be raised? Why? Why not?
As an alternative increasing the sales price to \$45/unit, the CEO is thinking of hiring a new VP of operations to ease his own workload, at a total of \$100,000 compensation and benefit cost.
How much more volume, above the break-even unit volume determined in earlier, would have to be sold to cover this additional cost?
Obviously the CEO does not want everyone to work hard just to break even. Using just to the original data given:
What unit volume must be sold for the firm to earn \$150,000 of profit?

#### Solution Preview

Dear student,

What is the difference between break-even analysis and CVP analysis?
CVP analysis is a technique that examines changes in profits in response to changes in sales volumes, costs and prices. CVP analysis helps to make following decisions:
a. Make or buy the product
b. The volume of sales needed to achieve the targeted profit,
c. Whether to increase the fixed costs.
d. Whether fixed costs expose the organization to unacceptable level of risk.
Assumptions:
1. CVP analysis assumes that costs and revenues are linear throughout the relevant range of activities.
2. Changes in the activity are the only factor that affects costs.
3. All units ...

#### Solution Summary

This solution provides assistance with the capital budgeting problem.

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