Chapter 6

Cost-Volume-Profit Relationships

Solutions to Questions

6-1

The contribution margin (CM) ratio is

the ratio of the total contribution margin to total

sales revenue. It can be used in a variety of

ways. For example, the change in total contribution margin from a given change in total sales

revenue can be estimated by multiplying the

change in total sales revenue by the CM ratio. If

fixed costs do not change, then a dollar increase

in contribution margin will result in a dollar increase in net operating income. The CM ratio

can also be used in break-even analysis. Therefore, knowledge of a product’s CM ratio is extremely helpful in forecasting contribution margin and net operating income.

6-2

Incremental analysis focuses on the

changes in revenues and costs that will result

from a particular action.

6-3

All other things equal, Company B, with

its higher fixed costs and lower variable costs,

will have a higher contribution margin ratio than

Company A. Therefore, it will tend to realize a

larger increase in contribution margin and in

profits when sales increase.

6-4

Operating leverage measures the impact

on net operating income of a given percentage

change in sales. The degree of operating leverage at a given level of sales is computed by dividing the contribution margin at that level of

sales by the net operating income at that level

of sales.

6-5

The break-even point is the level of

sales at which profits are zero. It can also be

defined as the point where total revenue equals

total cost or as the point where total contribution margin equals total fixed cost.

6-6

Three approaches to break-even analysis are (a) the graphical method, (b) the equa-tion method, and (c) the contribution margin

method.

In the graphical method, total cost and total

revenue data are plotted on a graph. The intersection of the total cost and the total revenue

lines indicates the break-even point. The graph

shows the break-even point in…

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