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What are the CVP assumptions?

Short Answer

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Answer

When the volume of a product changes, the price per unit does not change.

Step by step solution

01

CVP assumptions

CVP analysis assumes the following:

  1. The price per unit does not change as volume changes.
  2. Managers can classify each cost as variable, fixed, or mixed.
  3. The only factor that affects total costs is a change in volume, which increases or decreases total variable and mixed costs.
  4. Total fixed costs do not change.
  5. There are no changes in inventory levels.
02

Limitation of assumptions

The above assumptions do not meet all business conditions and may not be relevant for the businesses.

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Most popular questions from this chapter

Before you begin this assignment, review the Tying It All Together feature in the chapter.

Best Buy Co., Inc. is a leading provider of technology products. Customers can shop at more than 1,700 stores or online. The company is also known for its Geek Squad for technology services. Suppose Best Buy is considering a particular HDTV for a major sales item for Black Friday, the day after Thanksgiving, known as one of the busiest shopping days of the year. Assume the HDTV has a regular sales price of \(900, a cost of \)500, and a Black Friday proposed discounted sales price of \(650. Best Buyโ€™s 2015 Annual Report states that failure to manage costs could have a material adverse effect on its profitability and that certain elements in its cost structure are largely fixed in nature. Best Buy, like most companies, wishes to maintain price competitiveness while achieving acceptable levels of profitability. (Item 1A. Risk Factors.)

Requirements

1. Calculate the gross profit of the HDTV at the regular sales price and at the discounted sales price.

2. Assume that during the November/December holiday season last year, Best Buy sold an average of 150 of this particular HDTV per store. If the HDTVs are marked down to \)650, how many would each store have to sell this year to make the same total gross profit as last year?

3. Relative to Sales Revenue, what type of costs would Best Buy have that are fixed? What type of costs would be variable?

4. Because Best Buy stated that its cost structure is largely fixed in nature, what might be the impact on operating income if sales decreased? Does having a cost structure that is largely fixed in nature increase the financial risk to a company? Why or why not?

5. In the Tying It All Together feature in the chapter, we looked at the cost of advertising. Is advertising a fixed or variable cost? If the company has a small margin of safety, how would increasing advertising costs affect Best Buyโ€™s operating income? What would be the effect of decreasing advertising costs?

Why is the calculation to determine the target profit considered a variation of the breakeven calculation?

What effect does an increase in sales price have on contribution margin? An increase in fixed costs? An increase in variable costs?

Diversified Investor Group is opening an office in Boise, Idaho. Fixed monthly costs are office rent (\(8,000), depreciation on office furniture (\)1,700), utilities (\(2,400), special telephone lines (\)1,500), a connection with an online brokerage service (\(2,500), and the salary of a financial planner (\)11,900). Variable costs include payments to the financial planner (9% of revenue), advertising (11% of revenue), supplies and postage (4% of revenue), and usage fees for the telephone lines and computerized brokerage service (6% of revenue).

Requirements

  1. Use the contribution margin ratio approach to compute Diversifiedโ€™s breakeven revenue in dollars. If the average trade leads to \(800 in revenue for Diversified, how many trades must be made to break even?
  2. Use the equation approach to compute the dollar revenues needed to earn a monthly target profit of \)11,200.
  3. Graph Diversifiedโ€™s CVP relationships. Assume that an average trade leads to \(800 in revenue for Diversified. Show the breakeven point, the sales revenue line, the fixed cost line, the total cost line, the operating loss area, the operating income area, and the sales in units (trades) and dollars when monthly operating income of \)11,200 is earned.
  4. Suppose that the average revenue Diversified earns increases to $2,000 per trade. Compute the new breakeven point in trades. How does this affect the breakeven point?

Calculating breakeven point in units, contribution margin ratio given

Ocean Company sells a product with a contribution margin ratio of 80%. Fixed costs are \(2,800 per month. What amount of sales (in dollars) must Ocean Company have to break even? If each unit sells for \)30, how many units must be sold to break even?

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