Pre-class questions
18.1 Briefly explain how the break-even point is calculated:
a) in sales unit
b) in sales dollars
c) using a graph
The break-even point is the volume of sales at which the total revenues and costs are equal. At this level of
sales, there is no profit or loss; the operation BREAKS EVEN.
The break-even point can be calculated for an entire organisation or for individual projects or activities that
an organisation undertakes.
a) Break-even point in sales unit – we emphasise the UNIT CONTRIBUTION MARGIN, which is the
difference between sales price per unit and variable cost per unit:
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sales volume∈units∗( unit sales price−unit variable cost )−¿ cost=0
sales volume∈units∗unit contributionmargin=¿ cost
¿ costs
Break−even point (¿unit )=
Unit contribution margin
b) Break-even point in dollars – we use the UNIT CONTRIBUTION MARGIN RATIO:
¿ costs
Break−even point ( ¿ dollars )=
unit contributionmargin/unit sales price
c) Break-even point using a graph:
There are 5 steps to follow in order to prepare the graph
1. Draw the axes of the graph;
2. Draw the fixed cost line;
3. Draw total cost line (we need to calculate total cost at any
volume);
4. Draw the total revenue line;
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5. Find the break-even point – this can
be determined by the coordinates of
the point at the intersection of the
total revenue line and the total cost
line.
18.8 Explain what SAFETY MARGIN means? How can managers use this information to manage the
profitability of a business?
SAFETY MARGIN is the difference between the budgeted sales revenue and the break-even sales revenue. It
is the amount by which actual sales can fall below budgeted sales before losses are incurred. The SAFETY
MARGIN gives management a feel for how close projected operations are to the break-even point. In this
way, managers can focus on keeping operations profitable, which adds to shareholder value.
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18.9 A not-for-profit art gallery covers its operating costs by charging an admission fee. A local arts
enthusiast has offered to make an annual donation of $10.000 to the gallery. Explain how this donation
will affect the gallery’s break-even point.
The annual donation will partially offset the art gallery’s fixed costs. The reduction in net fixed costs will
reduce the gallery’s break-even point.
18.22 University Pizza delivers pizzas to the residential colleges and flats near a major university. The
company’s annual fixed costs are $54,000. The sales price of a pizza is $10, and it costs the company $6 to
make and deliver each pizza.
REQUIRED:
1. Using the contribution margin approach, calculate the company’s break-even point in units
(pizzas);
2. What is the contribution margin ratio?
3. Calculate the break-even point in sales dollars. Use the contribution margin ratio in your
calculation;
4. How many pizzas must the company sell to earn a target profit of $60,000? Use the CVP equation.
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1. Fixed costs = $54,000
Unit sell cost = $10
Unit variable cost = $6
(10 * X) – (6 * X) – 54,000 = 0
10X – 6X = 54,000
4X = 54,000
X = 54,000 / 4
X = 13,500 pizzas
2. The contribution margin ratio is:
($10 - $6) / $10 = $4 / $10 = 0.4
3. The break-even point in sales dollars is:
54,000 / 0.4 = $135,000
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4. To calculate how many pizzas the company needs to sell to reach a target profit of $60,000 we need
to calculate as follow:
¿ costs+Target profit
Target sales volume=
Unit contribution margin
= (54,000 + 60,000) / 4 = 28,500 pizzas
During workshop questions
18.2 What us the meaning of the term Unit Contribution Margin? Contribution to what?
Unit contribution margin is the difference between the sales price per unit and variable costs per unit. It is
an alternative way to calculate the break-even point. It measures the relationship between sales price and
variable costs per unit, by removing fixed costs.
18.6 Suppose the variable costs of a veterinary practice decrease. What types of costs might these be?
How this change the break-even point?
Variable costs that could decrease include payments to suppliers, the cost of hiring veterinary equipment,
the cost of veterinary supplies and animal food supplies. A decrease in variable costs will increase the
contribution margin, and therefore decrease the break-even point. An increase in contribution margin
would move the practice away from the break-even point to profitability.
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18.14 Explain how income taxes affect the calculation of a firm’s break-even point.
When a company is liable for income taxes, then this may be considered when determining the target sales
volume. When a target profit is stated as an after-tax amount, then the break-even formula must be
modified to account for the amount of taxation payable. However, income taxes make no difference to
determining the break-even point, as there is no tax payable on zero profit.
CLASS ACTIVITY
Slide 13
Abbott Ltd is considering selling hot air balloon rides next year. The following information is relevant:
Fixed costs $1 000 000
Selling price $300
Variable costs $100
How many balloon rides will Abbott Ltd need to provide in order to break-even?
Contribution margin = 300 – 100 = $200
Break-even point = 1 000 000/200 = 5000 hot air balloon rides
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Slide 18
You are in the business of printing specialised t-shirts which you can sell for $25 each.
The cost of a t-shirt is $6 and the cost of printing materials for each one is $4.
The overall cost of running your home-based business for a month, in terms of office expenses, printing
machine depreciation, electricity and rent etc amount to $300.
1. What is the variable cost of printing a t-shirt?
2. What is the contribution per t-shirt?
3. What are your fixed costs?
4. How many t-shirts would you need to sell to break even each month?
1. Variable cost = 6 + 4 = $10
2. Contribution per t-shirt = 25 – 10 = $15
3. Fixed costs = $300
4. Break-even point = 300/15 = 20 t-shirts
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Slide 21
Same info of the previous exercise.
How many t-shirts would you need to sell if you wanted to make a profit of $2 100 per month?
Break-even point = (300 + 2100)/15 = 160 t-shirts
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