Capital Budgeting Assignment, Essay Example

A company is said to be at break-even when it is making neither profit nor loss meaning its total revenue at this point equals total costs. At break even, the contribution margin is also equal to fixed costs and any production above this point generates profit. A break-even analysis therefore enables a firm to make short-term decisions like setting prices and production levels. (Schweltzer 2010)

CVP (cost-volume-profit) on the other hand is described by Wiley (2004) as a method that examines changes in profits in response to changes in price, cost and volume. Even though both techniques assist a firm in decision making, CVP differs to break-even analysis in that several assumptions are made in this analysis. Some of them include all production is sold, sales and all costs (both fixed and variable) are constant, change in activity affects costs and more than one product sale is sold in the same mix.

Contribution margin is the difference between revenue and variable costs. It is the amount that can be attributed to fixed costs from each unit of sale.

Every manager desires a bigger contribution margin to be a large figure since it will increase the company’s ability to cover fixed costs.

Below the breakeven point, every dollar of contribution margin goes toward making a loss.

Above the breakeven point, every dollar of contribution margin goes toward profit in a  company.

• Breakeven point in units

Contribution=40-28= $12

If BEP in units=1,000,000/12=83,333.33 units

Contribution margin ratio=12/40=30%

BEP in dollars=1,000,000/30% =$3,333,333.33

• Expected profitability if price increases

45-28=$17

0.9*17*1000000/17=900,000

Profit=900,000-1,000.000= (100,000)-loss

The price should not be raised since despite selling at a high price, the company makes a loss in the long run because its unit sales decrease.

• 1,000,000+100,000/40-28

1,100,000/12=91,667 units

91666.67-83,333.33= 8,333 units

To earn $ 150,000 profit,

12x-1,000,000=150,000

12x=1,150,000

X=95,833 units have to be sold

References

Schweltzer. M, (2010). Explanation of breakeven point analysis. Retrieved on Oct 26, 2010 from http://www.12manage.com/methods_break-even_point.html

Wiley (2004). Cost-Volume-Profit  Analysis.  Retrieved on Oct 26, 2010 from http://www.wiley.com/college/sc/eldenburg/ch03.