Reference no: EM13154953

Using CVP analysis when applying for a loan

Jill owns and operates a business that makes hand-crafted rocking chairs. The business is expanding but the increasing costs of raw materials and labour, and the GST, have badly affected profit- ability. Jill believes that if she buys some wood-turning equipment that is more modern she could reduce her use of labour and wastage of wood and this would make her business profitable again. The price of the equipment that Jill wishes to install is $15 000, which she will have to borrow from the bank. Jill has done a CVP analysis under her existing structure and also for the new struc- ture if she buys the new wood-turning equipment. Although the new equipment would reduce the direct costs of labour and material, the fixed costs would increase so much that the break-even point of output would still exceed the likely level of rocking chair sales. Jill is passionate about her business and, although the CVP analysis doesn't support the purchase of the new equipment, she is determined to buy the equipment no matter what.
In making her presentation to the bank for the loan of $15 000, Jill uses CVP analysis to show how the new equipment would reduce the direct costs of labour and materials but does not show the fixed manufacturing costs as increasing.