Transcript Slide 1

To DO or not to Do
Marginal Cost Analysis
By Rahul Jain
Marginal Cost Analysis
Examines the behavior of total revenues,
total costs, and operating income as
changes occur in the output level, selling
price, variable costs or fixed costs
Contribution Margin
Contribution margin is equal to the
difference between total revenue and total
variable costs
Contribution margin per unit
= Selling price - Variable cost per unit
Contribution margin percentage
= Contribution margin per unit / selling price
per unit
Contribution Margin Income
Statement
Income statement that groups line items
by cost behaviour to highlight the
contribution margin
Packages Sold
0
1
2
25
40
$0
$200
$400
$5,000
$8,000
Variable costs
0
120
240
3,000
4,800
Contribution margin
0
80
160
2,000
3,200
2,000
2,000
2,000
2,000
2,000
$(2,000)
$(1,920)
$(1,840)
$0
$1,200
Revenue
Fixed costs
Operating income
Quick Check 
Coffee Klatch is an espresso stand in a downtown
office building. The average selling price of a cup of
coffee is $1.49 and the average variable expense per
cup is $0.36. The average fixed expense per month is
$1,300. 2,100 cups are sold each month on average.
What is the CM Ratio for Coffee Klatch?
a. 1.319
b. 0.758
c. 0.242
d. 4.139
Quick Check 
Coffee Klatch is an espresso stand in a
downtown office building. The average selling
price of a cup of coffee is $1.49 and the average
variable expense per cup is $0.36. The average
fixed expense per month is $1,300. 2,100 cups
are sold each month on average. What is the
Unit contribution margin
CM Ratio for Coffee
Klatch?
CM Ratio
=
Unit selling price
a. 1.319
($1.49-$0.36)
=
b. 0.758
$1.49
c. 0.242
$1.13
=
= 0.758
d. 4.139
$1.49
Breakeven Point
Quantity of output where total revenues
equal total costs
Point where operating income equals
zero
Breakeven point in units
= Fixed costs / Contribution margin per unit
= $2,000 / $80
= 25 units
Breakeven point in dollars
= Fixed costs / contribution margin %
= $2,000 / 40%
= $5,000
Quick Check 
Coffee Klatch is an espresso stand in a downtown
office building. The average selling price of a cup of
coffee is $1.49 and the average variable expense per
cup is $0.36. The average fixed expense per month is
$1,300. 2,100 cups are sold each month on average.
What is the break-even sales in units?
a. 872 cups
b. 3,611 cups
c. 1,200 cups
d. 1,150 cups
Quick Check 
Coffee Klatch is an espresso stand in a downtown
office building. The average selling price of a cup of
coffee is $1.49 and the average variable expense per
cup is $0.36. The average fixed expense per month is
$1,300. 2,100 cups are sold each month on average.
What is the break-even sales in units?
a. 872 cups
Fixed expenses
Break-even =
Unit CM
b. 3,611 cups
c. 1,200 cups
$1,300
=
$1.49/cup - $0.36/cup
d. 1,150 cups
=
$1,300
$1.13/cup
= 1,150 cups
Cost-Volume-Profit Graph
$10,000
Total revenues
line
Breakeven
Point
25 units
$8,000
Total costs
line
$6,000
Operating
income
$4,000
$2,000
Operating
loss
$0
0
10
20
30
Units Sold
40
50
Sensitivity Analysis
Sensitivity analysis is a “what-if” technique that
examines how a result will change if the original
predicted data are not achieved or if an underlying
assumption changes
What will happen to operating income if Mark up
declines by 5%?
What will happen to operating income if mark up
increase by 10% ?
sensitivity analysis broadens management’s
perspectives about possible outcomes
Shut Down Point
The output level at which price equals
average variable cost and losses equal
total fixed costs, whether the firm
produces or not.
Thus the point at which AVC=Sales Price
Contribution Margin & Gross
Margin
Contribution Margin
Format
Revenues
$1,000
Variable costs:
Manufacturing
$250
Non-manufacturing
270 520
Contribution margin
480
Fixed costs:
Manufacturing
160
Non-manufacturing
138 298
Operating income
$182
Gross Margin
Format
Revenues
$1,000
Cost of goods sold (250+160)
410
Gross margin
590
Non-manufacturing (270+138)
408
Operating income
$182
End Term Log Book Assignment
Submission
( To be submitted on 22/04/2008)
– Marking Linked to End term
– Typed Report (A4 Pages) submission with full
explanation
– See Template I, Template II, End term Brief