Book: Cost Volume Profit Analysis And Capil Investment Decitions Flashcards
Are all costs relevant for decision making
No, only avoidable costs
What are sunk costs
Costs created by decisions in the past that cannot be changed by decisions in the future. Committed costs
What is the sunk cost falacy
The human tendency to get emotionally invested in sunk cost. “Now when we have payed 100k for this crappy thing we should pay a million to finish it so at least we get something out of it (even if it is not worth it)”
What is opportunity cost
The cost of not taking other opportunities with your resources
What is incremental or differential costs
The difference between the costs of each action considered
What are marginal costs
The cost of producing one additional unit
What is the use of cost volume profit analysis
Too see how many units need to be sold to break even, how selling more by reducing price would affect profits, what additional volume is required to justify an add campaign and if sales should be rewarded by salary or commission
What is the break even point
The level of production on which no profits or losses occur
What is CVP analysis
The study of how activity volumes affect financial ratios
How does the CVP relationship between cost and revenue apear in a graph
At first revenue is linear as higher prices lead to larger revenue but as demand wavers it begins to curve down. The costs behave in a similar way but at first there is a spike because inefficiency and fixed costs and later there is also a spice when operating over capacity
What is increasing return to scale
The increased revenue when a business scales cuz division of labor and lower portion fixed costs
Why is there decreasing return to scale in the upper levels of the cpv relationship
Because when facilities operate beyond their capacity bottlenecks develop
How many break even points are there in a cpv relationship curve
Two
What is a relevant range in a cpv curve
The output range the firm assumes to operate in the short term. Analyses should be done here.
Why does management accounting often assume a straight line cvp relationship on short time periods
Becouse it is simpler and therefor cheaper
How does the fixed cost function work
It is constant until a threshold is reached where it behaves like a staircase. Use If functions in exel
Is the revenue function assumed to be linear in the short term
Yes but in the long run it slopes when demand fades and you have to lower price to sell more
What is contribution margin
The difference between dales revenue and variable cost
How do you calculate the breaking point
Contribution margin = fixed costs
What is contribution margin ratio aka contribution sales ratio or profit volume ratio
Contribution margin divided by sales price
What is the margin if safety
Expected sales - break even divided by expected sales. Unit distance from break even in percent
What is contribution margin ratio
The CM divided by sales
What does a profit volume graph show
The levels of profit at different levels of production with the break even point at zero y
How do you make cost volume profit analysis on multiple products
You place the products in batches with simple ratios like two x is sold for every y and put a price on the batch. Then the relationship is.
Break even number of batches = total fixed costs / contribution margin per batch
How does the sales mix affect the break even point
If more products with a high profit margin is sold in relation to the whole the break even point comes down
What are the seven assumptions of cvp analysis
- All other variables (taxes and inflation) remain constant, 2. A single product or constant sales mix, 3. Total cost and revenue are linear, 4. Profits are calculated on a variable costing basis, 5. Costs can be accurately divided into fixed and variable, 6. The relevant range, 7. This is a short time horizon.
What is sensitivity analysis
The analysis of how cvp is affected by changes in different variables such as sales mix, fixed and variable costs
What assumptions are often done when comparing investment opportunities
All cash in and outflows are known with certainty, sufficient funds are available, taxes are absent and so is inflation
What are some other names of opportunity cost
Minimum required rate of return, cost of capital, discount rate or interest rate
Explain the concept of risk return tradeof
That for a risky investment to be worth it, it should offer a higher return than a lower risk one. The benchmark is a risk free government guaranteed bond
What is the relationship between discounted cash flow and compounding interest
They are opposites
How is future value of cash now calculated
FV(n) = V(0)*(1+K)^n
K is interest rate
V is value
Explain discounting
To translate future cash into todays value accounting for the time value of money through interest rate resulting in the discounted present value
Explain compounding
Translating present value to future value accounting for the time value of money by interest rate
How is present value of future cashflow calculated
V(0) = FV(n) / (1+K)^n
n is time into future in years
What is net present value NPV
The present value of each yearly return of an investment minus the initial cost
What is an annuity
An asset that pays a fixed term each period for a specific number of periods
How is present value calculated of an annuity
V(0) = A*(1-(1/(1+K)^n))/K
where A is the amount received each peruod
What is the internal rate of return or discount rate of return
The sum of the return of an investment accounting for the time value of money
What is the maximum amount a company can pay for an investment without hurting equity
The investments internal rate of return
What is the payback method to compare investments
To compare the time for different investments to pay back what they cost
When is the payback method for comparing investments appropriate
When investments are risky and when the company faces liquidity problems
