Week Nine

Question 1

Break even analysis

Answer 1

calculation of the necessary levels of activity require in order to break even in a given period

Question 2

Break even calculation

Answer 2

fixed costs/contribution margin per unit = break even (units)

Question 3

Particular profit calculation

Answer 3

fixed costs + desired profit/contribution margin per unit = x sales units to earn a desired profit

Question 4

Weighted average contribution margin

Answer 4

number of sale of product/total number of sales units for all products

Question 5

break even (wacm)

Answer 5

fixed costs/wacm

Question 6

targer pre-tax profit

Answer 6

fixed costs + pre tax profit target/contribution margin er unit

Question 7

contribution margin ratio

Answer 7

contribution margin per unit / selling price per unit x 100/ = x

or total contribution margin / total sales

Question 8

cvp assumptions

Answer 8

• the behaviour of costs can be neatly classified as fixed or variable
• cost behaviour is linear
• fixed costs remain fixed over the time period and or a given range of activity
• unit price and cost data remain constant over the time period and relevant range
• for multi product entities, the sales mix between the products is constant. if the conditions and environments for the entity fall outside the assumptions (eg not all costs can easily be classified as fixed or variable) then such analysis is of benefit

Question 9

using break even data

Answer 9

• identifying the number of products or services required to be sold to meet break even or profit targets
• resource allocation by focusing on those products that contribute more to profits
• determining the impact on profit of changes in the mix of fixed and variable costs
• pricing products

Question 10

Define fixed, variable and mixed costs.

Answer 10

Fixed costs are commonly identified as those that remain the same in total (within a given range of activity and timeframes), irrespective of the level of activity. Variable costs are commonly identified as those that change in total as the level of activity changes. Mixed costs are those appear to possess fixed and variable cost characteristics.

Question 11

Prepare a cost-volume-profit (CVP) analysis for single-product and multi-product entities.

Answer 11

CVP analysis commonly requires the use of the contribution margin concept to calculate the break-even number of units. Data are needed on fixed and variable costs in order to execute the calculation. When calculating break-even for multi-product or service entities, we need to calculate the weighted average contribution margin before calculating the break-even units

Question 12

Apply the contribution margin ratio to CVP calculations.

Answer 12

The contribution margin ratio can be used to perform break-even calculations by focusing on the ratio of the contribution margin to sales. This can be particularly useful when seeking the total break-even sales dollars, rather than the per unit numbers.

Question 13

Explain the key assumptions underlying CVP analysis

Answer 13

The key assumptions underlying CVP analysis include the assumption that the behaviour of costs can be neatly classified as fixed or variable – which may not be the case, as some costs do not behave as expected; cost behaviour is generally assumed to be linear (see figures 10.1 and 10.2, p. 446); fixed costs are believed to remain ‘fixed’ over the time period and/or a given range of activity (often referred to as the relevant range); unit price and cost data are assumed to remain constant over the time period and relevant range; and, for multi-product entities, the sales mix between the products is assumed to be constant.

Question 14

Discuss the use of break-even data

Answer 14

Break-even data can be used in a number of ways, including identifying the number of products or services required to be sold to meet break-even or profit targets; planning products and allocating resources by focusing on those products that contribute more to profitability; determining the impact on profit of changes in the mix of fixed and variable costs; and pricing products.

Question 15

Outline the concept of operating leverage

Answer 15

The margin of safety is commonly regarded as the excess of revenue (or units of sales) above the break-even point. It provides an indication of how much revenue (sales in units) can decrease before reaching the break-even point. Operating leverage refers to the mix between fixed and variable costs in the cost structure of an entity. A knowledge of operating leverage helps in understanding the impact of changes in revenue on profit.

Question 16

Assess the profitability of output when there are resource limitations.

Answer 16

For some businesses, sales are not limited by market demand, but by production/operational limitations including shortage of any factor such as labour, materials, space or equipment. For each output, the contribution margin per limiting factor needs to be calculated to identify the most profitable use of the limited resource.

Question 17

Assess relevant information for decision making

Answer 17

Relevant costs and relevant income are those that differ among alternative courses of action, with the focus being on identifying incremental income and incremental costs, which represent the additional income/costs as a result of taking an alternative course of action. It is also important to identify if there is an opportunity cost (i.e. what is given up if one alternative is chosen over another) as a result of the decision.

Question 18

Analyse an outsourcing decision.

Answer 18

Whether it is for cost savings or other factors, an entity may decide to outsource a product or business activity to an external provider. To assess such a decision, the entity would need to compare the inhouse costs with those of the external provider. Costs that will be incurred regardless of the decision taken are unavoidable and therefore irrelevant.

Question 19

In managing the level of net working working capital, the entity is concerned with three aspects

Answer 19

• maintaining liquidity
• the need to earn the required rate of return on assets
• the cost and risk of short term funding

Question 20

mangaing cash

Answer 20

• the need to have sufficient cash
• timing of the cash flows
• the cost of cash
• the cost of not having enough cash

Question 21

Instalment loans

Answer 21

fixed repayment schedules are neogiated at the outset.

Question 22

interest only loans

Answer 22

taken out to finance special situations. during the term of the loan only interset is paid, while the repatment of the principal amount is made in full at the expiry of the term. these tyoes if loans are suitable for situations where, say, an asset is bought for a specific period with the expectationthat it will be sold at the end of the period. the sale of the asset then provides funds to repay the loan. this, the payment of interest in the intervening period many be considered a holding cost for owning the asset.

Question 23

fully drawn advances

Answer 23

are a major form of entity financing. amounts avalible from some institutions may mary from as low as 5k to any amount at all. terms are normally set up to 10 years. rates are normally vaiable. often, financial institutions will set a system where interest is charged to a separate account, while the FDA accout merely keeps track of the balance of the principal. normally, a regular repayment schedule is set up, so that the balance in the FDA account decreases continually over the term of the loan. FDA loans are usually secured.

Question 24

Leases

Answer 24

is significant form of finance for entities. the major financial institutions provide full range of leasing options and products to complement their other loans, and to assist entities with financing specific assets such as motor vehicles, construction and manufacturing plant and it/office equipment.