Cvp Analysis

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QUESTION a). Name five assumptions that underline the use of break – even analysis. It is essential that anyone preparing or interpreting CVP information is aware of the underlying assumptions on which the information has been prepared. If these assumptions are not recognized, serious errors may result and incorrect conclusions may be drawn from the analysis.(Drury, 2004). Breakeven analysis (cost-volume-profit analysis) is an approach to profit planning that requires derivation of various relationships among revenue, fixed costs, and variable costs in order to determine units of production or volume of sales at which firm “breaks even” (where total revenues equal total of fixed and variable costs). The analysis is built on various…show more content…
2. Improving the quality of the product. This would result in an increase in the variable cost per unit by shs 30. Revised variable cost per unit will be shs (150 +30) = shs 180. Therefore contribution margin per unit will be shs (200 – 180) = shs 20. Hence, Break-even point in units = Fixed costs/contribution margin per unit = shs 800,000/20 = 40,000 units. Break – even point in revenues = Fixed costs/ contribution margin percentage Where Contribution margin percentage = Contribution margin per unit/ selling price = 20/200 = 0.1 So, Break – even point in revenue = 800,000/0.1 = shs 8,000,000. In order to succeed with this option the company must increase its sales to at least shs 8,000,000 or by 100% Changes in contribution margin as a result of the option is as follows: Contribution margin from increasing VC to shs 180: shs (200 -180) x 20,000 units = shs 400,000

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