CHAPTER 7: COST-VOLUME-PROFIT ANALYSIS

QUESTIONS

7-1 The underlying relationship in cost-volume-profit analysis is that costs, revenues, and profits all change in a predictable way as the volume of activity changes.

7-2 It is more practical to find the breakeven point in sales dollars for companies having thousands of individual items. Finding the breakeven point for each item would be laborious and meaningless.

7-3 The contribution margin ratio is: price - variable costs price

The contribution margin ratio (CMR) represents the net contribution per sales dollar. The CMR tells us the change in profit associated with a given change in sales dollars. It is a useful measure of the relative contribution to profit of different products, divisions, or sales units. The use of this ratio can give a retail store a good approximation of the sales dollars necessary for the store to break even. A higher CMR is associated with higher risk. A higher CMR can have a more favorable impact on profit. However, if sales fall below breakeven, then a high CMR will yield a relatively more negative impact on profits.

7-4 The basic assumption of the CVP model is that the behavior of revenues and total costs is assumed to be linear over the relevant range of activity. Managers must be careful to remember that the calculations done within the context of a given CVP model cannot be interpreted safely outside of the relevant range of output for that particular model. Other assumptions include: fixed costs are measured by all fixed costs if a long-term perspective (i.e., breakeven over a longer period of time) is to be taken, while only incremental fixed costs for the project or activity are included if a short- term perspective (i.e., to determine when the firm will achieve breakeven on a new product) is taken. Also, allocated fixed costs are not