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Do managers want contribution margin to be a bigger or smaller figure? Why?

Your CEO has limited knowledge of management accounting but of course, is vitally interested in forecasting profitability under different scenarios. He asked you, the management accountant, to begin your report by answering a few basic questions he's always wondered about. He has also given you some data to review and has asked you to report on the expected profitability under some given scenarios.

Company Data

Company's average selling price (SP) per unit = $20
Product's variable cost per unit = $10
Company's budgeted fixed costs for the upcoming year are expected to be $500,000

Write a report including the following:
- What are two situations when the CEO would use CVP analysis?
- In simple terms, what is contribution margin?
- Do managers want contribution margin to be a bigger or smaller figure? Why?
- What kind of firm needs to have a large contribution margin to be profitable: a firm with low or high SG&A expenses? Why?
- Give an example of such a firm.
- 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 $25/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, should they raise the price? Why? Why not?
- As an alternative, increasing the sales price to $25/unit, the CEO is thinking of hiring a new VP of Marketing to ease his own workload at a total of $80,000 compensation and benefit cost.
- How much more volume, above the break-even unit volume determined 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 $250,000 of profit?

Solution Preview

Your CEO has limited knowledge of management accounting but of course, is vitally interested in forecasting profitability under different scenarios. He asked you, the management accountant, to begin your report by answering a few basic questions he's always wondered about. He has also given you some data to review and has asked you to report on the expected profitability under some given scenarios.

Company Data

Company's average selling price (SP) per unit = $20
Product's variable cost per unit = $10
Company's budgeted fixed costs for the upcoming year are expected to be $500,000
You must complete the following:

Write a report of 200รข?"300 words including the following:
What are two situations when the CEO would use CVP analysis?

CVP analysis gives the impact on operating income for changes in volume, selling price, variable cost or fixed costs. CVP analysis can be used for
1. Finding out the breakeven volume given the selling price, variable cost and fixed costs
2. Assessing the impact on operating income of changes in volume due to increase in fixed costs such as advertising.
In simple terms, what is contribution margin? ...

Solution Summary

This solution provides calculations and feedback on the cost-volume-profit analysis in 482 words.

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