Chapter 6
Cost-Volume-Profit Relationships
Solutions to Questions
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.
Incremental analysis focuses on the
changes in revenues and costs that will result
from a particular action.
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.
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.
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.
Three approaches to break-even analysis are (a) the graphical method, (b) the equa-tion method, and (c) the contribution margin
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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