NAME - Shorya Agarwal

SAP ID - 500096592

Roll No. - R2142211150

Batch - B5

B.Tech CSE AIML

Class Test 2

Q1 A company produces two products, A and B. Product A has a variable cost of $20
per unit, while Product B has a variable cost of $30 per unit. If the selling price for
both products is $50, determine the contribution margin and the contribution
margin ratio for each product
Ans :
Contribution Margin and Ratio for Products A and B:
Product A:

Selling price: $50

Variable cost: $20
Contribution margin:

Contribution margin = Selling price - Variable cost

Contribution margin = $50 - $20
Contribution margin = $30

Contribution margin ratio:

Contribution margin ratio = Contribution margin / Selling

price
Contribution margin ratio = $30 / $50
Contribution margin ratio = 0.6 or 60%

Product B:
Selling price: $50
Variable cost: $30
Contribution margin:

Contribution margin = Selling price - Variable cost

Contribution margin = $50 - $30
Contribution margin = $20

Contribution margin ratio:

Contribution margin ratio = Contribution margin / Selling

price
Contribution margin ratio = $20 / $50
Contribution margin ratio = 0.4 or 40%

Summary:

Product A has a higher contribution margin and contribution

margin ratio than Product B. This means that Product A
contributes more to covering fixed costs and generating profit
for the company per unit sold.

Here's a table summarizing the results:

Product Selling Price Variable Cost Contribution Margin

Contribution Margin Ratio
A $50 $20 $30 60%
B $50 $30 $20 40%
Q2 Calculate the break-even point in units for a product with a selling price of $100,
variable cost per unit of $60, and fixed costs of $50,000.
Let's calculate the break-even point in units for a product
with a selling price of $100, variable cost per unit of $60,
and fixed costs of $50,000.

We can find the break-even point by setting the total revenue

equal to the total cost and then solving for the number of
units produced and sold.

Here's how we can do it:

Step 1: Define the variables and equations.

Let:

P be the total profit

x be the number of units produced and sold
We know the following:

Selling price per unit = $100

Variable cost per unit = $60
Fixed costs = $50,000
The total revenue can be expressed as:

R = 100x

The total cost can be expressed as:

C = 60x + 50,000

Step 2: Set the revenue equal to the cost and solve for x.

At the break-even point, the total revenue equals the total

cost. Therefore:

R = C

100x = 60x + 50,000

40x = 50,000

x = 1250

Step 3: Calculate the total profit at the break-even point.

Now that we know the number of units sold at the break-even

point, we can calculate the total profit:

P = 100x - (60x + 50,000)

P = 40x - 50,000

P = 40(1250) - 50,000

P = 50,000 - 50,000

P = 0
Therefore, the break-even point is 1250 units. At this point,
the total profit is $0, meaning the company covers its fixed
and variable costs but doesn't make any profit or loss

Q3 A company aims to achieve a profit of $50,000. If the

contribution margin ratio is 40%, calculate the required sales
revenue.
Calculating Required Sales Revenue for $50,000 Profit
With a 40% contribution margin ratio and a desired profit of
$50,000, here's how to calculate the required sales revenue:

1. Define the formula:

We can use the following formula to relate sales revenue,

contribution margin ratio, and desired profit:

Required Sales Revenue = Desired Profit / Contribution Margin

Ratio
2. Plug in the values:

Desired Profit: $50,000

Contribution Margin Ratio: 40% (expressed as a decimal, 0.4)
3. Calculate the required sales revenue:

Required Sales Revenue = $50,000 / 0.4

Required Sales Revenue = $125,000
Therefore, the company needs to generate $125,000 in sales
revenue to achieve its desired profit of $50,000 with a 40%
contribution margin ratio.

Additional notes:

This calculation assumes that all variable costs are covered

within the contribution margin.
Fixed costs are not considered in this calculation as they do
not impact the break-even point or target profit.
Knowing the break-even point (sales revenue required to cover
all costs) can be helpful for further analysis and planning.

Q4 If a company experiences a 20% increase in sales volume,

calculate the change in total contribution margin and net
profit.
Understanding the Relationships:

Change in Total Contribution Margin: Directly proportional to

the change in sales volume and the contribution margin per
unit. A 20% increase in sales volume will lead to a 20%
increase in total contribution margin, assuming the
contribution margin per unit remains constant.
Change in Net Profit: Depends on the change in contribution
margin and the fixed costs. If the change in contribution
margin exceeds the fixed costs, net profit will increase.
However, if the change in contribution margin is less than the
fixed costs, net profit could decrease.
General Approach with Variables:

Let Q0 represent the initial sales volume.

Let CM0 represent the initial contribution margin per unit.
Let FC represent the fixed costs.
Calculations:

Change in Sales Volume = 0.20 * Q0

Change in Total Contribution Margin = Change in Sales Volume *
CM0
Change in Net Profit = Change in Total Contribution Margin -
FC
Interpretation:

If Q0 and CM0 are known, you can substitute them into the
formulas to obtain numerical results.
If only some values are known, you can express the results in
terms of the variables to understand the relationships and
potential outcomes.
Example with Variables:

Assuming Q0 = 1000 units, CM0 = $50 per unit, and FC =

$20,000:

Change in Sales Volume = 0.20 * 1000 = 200 units

Change in Total Contribution Margin = 200 * $50 = $10,000
Change in Net Profit = $10,000 - $20,000 = -$10,000 (a
decrease in net profit)
Key Points:

A 20% increase in sales volume does not guarantee an increase

in net profit.
The change in net profit depends on the magnitude of the
contribution margin change relative to the fixed costs.
Understanding the relationships between these variables is
crucial for making informed business decisions.

Q5 A company is considering whether to make a component in-

house or buy it externally. The in-house production has a
variable cost of $15 per unit, and external suppliers offer it
at $12 per unit. If the fixed costs associated with in-house
production are $10,000, determine the breakeven point for both
options.
The breakeven point determines the quantity of a product at
which the total costs of both in-house production and external
purchase are equal. In this case, we need to consider the
variable cost difference and the fixed costs associated with
in-house production.

Step 1: Calculate the Contribution Margin per Unit for In-

House Production:

Contribution Margin = Selling Price - Variable Cost per Unit

Since the selling price isn't provided, let's denote it as
"Sp". Therefore:

Contribution Margin (In-House) = Sp - $15

Step 2: Calculate the Breakeven Point for In-House Production:

At the breakeven point, the total cost (fixed + variable)

equals the total revenue. Since external purchase doesn't have
fixed costs, it will always have a breakeven point of 0 units.

Breakeven Point (In-House) = Fixed Costs / (Contribution

Margin per Unit)

Breakeven Point (In-House) = $10,000 / (Sp - $15)

Step 3: Compare Break-even Points:

As mentioned earlier, the breakeven point for external

purchase is always 0 units. Therefore, to decide which option
is cheaper at different production volumes, we need to compare
the in-house production cost per unit to the external purchase
cost per unit.

In-House Production Cost per Unit = Fixed Costs / Production

Volume + Variable Cost per Unit

In-House Production Cost per Unit = $10,000 / Production

Volume + $15

Decision Rule:
If the In-House Production Cost per Unit is less than the
External Purchase Cost per Unit ($12), then in-house
production is cheaper.
If the In-House Production Cost per Unit is greater than the
External Purchase Cost per Unit, then external purchase is
cheaper.
Example:

Assume the selling price is $50 per unit.

In-House Production Cost per Unit at 1000 units = $10,000 /

1000 + $15 = $20
In-House Production Cost per Unit at 2000 units = $10,000 /
2000 + $15 = $17.50
In this example, at 1000 units, in-house production is more
expensive than buying externally ($20 vs. $12). However, at
2000 units, in-house production becomes cheaper ($17.50 vs.
$12).

Therefore, the specific production volume determines which

option is more cost-effective. You can calculate the in-house
production cost per unit for different volumes and compare it
to the external purchase cost to make an informed decision.

Q6 How would a 10% increase in variable costs affect the

breakeven point and the profit of a product?

a 10% variable cost increase:

Makes it harder to break even (requires more sales).

Makes each unit less profitable (decreases profit margin).
Overall, reduces total profit unless you significantly
increase sales.

Q7 A company produces three products: X, Y, and Z. Calculate

the weighted average contribution margin for the product mix
if the individual contribution margins are $30, $40, and $25,
respectively, and the sales mix is 2:3:1.
to calculate the weighted average contribution margin for the
product mix:

1. Multiply each individual contribution margin by its

corresponding sales mix weight:

Product X: $30 contribution margin * 2 sales mix weight = $60

Product Y: $40 contribution margin * 3 sales mix weight = $120
Product Z: $25 contribution margin * 1 sales mix weight = $25
2. Sum the products of individual contribution margins and
sales mix weights:

$60 (Product X) + $120 (Product Y) + $25 (Product Z) = $205

3. Divide the sum by the total sales mix weight (sum of all
weights):

$205 total contribution margin / (2 + 3 + 1) total sales mix

weight = $205 / 6 sales mix weight

4. Simplify the result:

$205 / 6 = $34.17 (rounded to two decimal places)

Therefore, the weighted average contribution margin for the

product mix is $34.17. This means that, on average, each unit
sold across all three products contributes $34.17 towards
covering fixed costs and generating profit.

Q8 A company has a limited resource, and it can produce either Product A or Product B.
Product A has a contribution margin of $15 per unit, and Product B has a contribution
margin of $20 per unit. If there is a constraint on the resource, determine the optimal
product mix.
To determine the optimal product mix given the limited resource and different
contribution margins, we need to consider an additional factor: the resource
consumption per unit of each product.

1. Define the resource consumption:

Let's denote the resource consumption per unit of Product A as R_A and the resource
consumption per unit of Product B as R_B. We need to know these values to analyze the
constraint.

2. Analyze the constraint:

Once you provide the specific constraint on the resource (e.g., total available resource,
maximum resource allocated to one product), we can determine the feasible production
levels for each product.

3. Calculate the contribution margin per unit of resource:

Divide the contribution margin by the resource consumption for each product:

Contribution Margin per Unit of Resource for Product A (CM_A/R_A)

Contribution Margin per Unit of Resource for Product B (CM_B/R_B)
4. Optimal Product Mix:

Compare the contribution margins per unit of resource for each product. The product
with the higher contribution margin per unit of resource should be prioritized within
the resource constraint. This will maximize the contribution to covering fixed costs and
generating profit with the limited resource available.

Example:

Suppose the resource constraint is a total of 100 units of the resource available.
Resource consumption is R_A = 2 units per unit of Product A and R_B = 1 unit per unit of
Product B.
CM_A = $15, R_A = 2, CM_A/R_A = $7.50 per unit of resource
CM_B = $20, R_B = 1, CM_B/R_B = $20 per unit of resource
In this case, Product B has a higher contribution margin per unit of resource ($20 vs.
$7.50). Therefore, the optimal product mix would be to prioritize the production of
Product B within the resource constraint. You could potentially produce up to 100 units
of Product B, reaching the maximum resource limit.

Q9 A product line is generating a negative contribution margin. Analyze and discuss

whether the company should consider shutting down the production of that product
line.
Arguments for Shutting Down:

Stop losses: Continuing production incurs variable costs that directly contribute to the
overall loss. Shutting down eliminates these ongoing losses.
Free up resources: Resources (materials, labor, equipment) allocated to the losing
product could be used for more profitable lines, potentially boosting overall profitability.
Improve morale: Employees working on a consistently unprofitable product might
experience low morale. Shutting down can signal a proactive approach and shift focus to
successful areas.
Arguments for Continuing:

Potential future improvement: Market conditions or product improvements could turn

the tide and make the line profitable. Shutting down now might mean missing out on a
future turnaround.
Complementary product: The product line might offer value beyond its direct
contribution margin by, for example, enhancing the image of the company or attracting
customers for other profitable products.
Sunk costs: Fixed costs already incurred cannot be recovered by shutting down.
Focusing on improving efficiency and marketing might still lead to a marginal gain,
making it preferable to abandoning the entire investment.
Further Analysis:

Identify the reasons for the negative contribution margin: Are variable costs too high,
selling price too low, or demand insufficient? Addressing these issues could improve
profitability without a complete shutdown.
Analyze potential cost savings from shutting down: Consider not just variable costs but
also potential reductions in fixed costs associated with production and overhead.
Evaluate alternative uses for resources: Clearly identify how freed-up resources would
be utilized and assess the potential profitability of those other uses.
Consider future market trends: Is the product in a declining market, or is there potential
for growth in the future?
Decision:

Weigh the arguments for and against shutting down considering your specific
company's situation and future prospects. Analyze all available data and make an
informed decision based on what optimizes long-term profitability and strategic
alignment.

Remember, there's no one-size-fits-all answer. A thorough analysis based on your

specific circumstances is crucial for making the best decision for your company.

Q10 A company is considering introducing a new product. The estimated selling price is
$80 per unit, variable cost is $40 per unit, and fixed costs associated with the new
product are $20,000. Determine the breakeven point and the required sales volume for a
target profit of $10,000.

1. Calculate the Contribution Margin:

Contribution Margin = Selling Price - Variable Cost

Contribution Margin = $80 - $40 = $40 per unit
2. Calculate the Breakeven Point:

Breakeven Point = Fixed Costs / Contribution Margin

Breakeven Point = $20,000 / $40 = 500 units
3. Calculate the Required Sales Volume for Target Profit:

Needed Profit = Target Profit + Fixed Costs

Needed Profit = $10,000 + $20,000 = $30,000
Required Sales Volume = Needed Profit / Contribution Margin
Required Sales Volume = $30,000 / $40 = 750 units
Therefore:

The breakeven point for the new product is 500 units. This means the company needs to
sell 500 units to cover its fixed and variable costs and break even.
The company needs to sell 750 units to achieve its target profit of $10,000.
Additional Points:

These calculations assume a linear relationship between sales volume and cost.
Other factors, like discounts, taxes, and production capacity, could influence the actual
results.