Cost-volume-profit analysis, Financial Management

Assignment Help:

Cost-Volume-Profit Analysis

The Cost-Volume-Profit (CVP) analysis provides answers to vital questions such as: At what sales volume would the firm break-even? How sensitive is the profit to variations in output? How sensitive is the profit to variations in selling prices? What should be the sales level in quantity terms for the firm to earn the target level of profits?

One basic assumption of CVP analysis is that all costs could be segregated into fixed and variable, and costs which are of a semi-fixed or semi-variable nature could be segregated into the fixed and variable components.

The method of simple linear regression is commonly used to segregate the fixed and variable components of semi-fixed or semi-variable costs. The illustration given below explains the application of regression technique in CVP analysis.

Example 

The following table gives the repairs and maintenance cost incurred in a cost center for various levels of annual production.

Output  

 (in thousands of units)

Repairs and Maintenance Cost Rs.(in thousands)


1.0

15

2.0

21

2.5

24

3.0

26

3.5

29

4.0

32

5.0

36

6.0

40

7.0

44

8.0

49

 

If the budgeted production of the cost center in the forthcoming year is 8500 units, what would be the estimated repairs and maintenance cost ignoring possible increase in price levels?

In order to segregate the repairs and maintenance cost into fixed and variable components and to forecast the estimated cost at a production level of 8,500 units, first of all, the estimating linear regression equation of the form Y = a + bX must be determined. In this equation, Y is the estimated total cost of repairs, 'a' is the fixed component of the total cost, 'b' is the variable component per unit of production and 'X' is the volume of production sought to be achieved.

In order to determine the estimating equation, the following table should be set up.

X

Y

XY

X2


1

15

15

1

2

21

42

4

2.5

24

60

6.25

3

26

78

9

3.5

29

101.5

12.25

4

32

128

16

5

36

180

25

6

40

240

36

7

44

308

49

8

49

392

64


  Total  42

316

1544.5

222.5

 

1593_cost volume profit analysis.png 

We know that,

 

b    =  2275_cost volume profit analysis1.png

From the table, we know that

1916_cost volume profit analysis2.png


          a        = 31.6 - (4.71)(4.2) = 11.818

Since 'a' the intercept represents the fixed cost, at any volume of production the fixed cost is Rs.11,818. The variable repairs and maintenance cost is Rs.4.71 per unit produced.

For a budgeted production of 8,500 units, the estimated repairs and maintenance cost will be as follows:

 

Rs.

Fixed Component

11,818

Variable Component (8,500 x 4.71)

40,035

Total

51,853

While budgeting this figure it may be approximated to Rs.52,000.

 


Related Discussions:- Cost-volume-profit analysis

Define variants of basic interest rate and currency swaps, Briefly discuss ...

Briefly discuss some variants of the basic interest rate and currency swaps. Answer:  In place of the basic fixed-for-floating interest rate swap, there are as well zero-coupo

Determining the appropriate rates in valuation process, After estimat...

After estimating the cash flows, the next step is to determine the appropriate interest rate that should be used to discount the cash flows. The minimum return re

Define the risk of cost of capital, Risk of cost of capital A straight...

Risk of cost of capital A straightforward assumption of traditional cost of capital analysis is that firm's business and financial risk are unaffected by acceptance and financ

Capital asset pricing model, Cascade Water Company (CWC) currently has 30 0...

Cascade Water Company (CWC) currently has 30 000 shares of common stock outstanding, trading at a price of R42 per share. CWC also has 500 000 bonds outstanding that are currently

Why business spend time, Why do businesses spend time, effort, and money to...

Why do businesses spend time, effort, and money to produce forecasts?  Explain. Businesses succeed or fail relies on how well organized they are to deal with the situations they

What are the weaknesses of the traditional approach, What are the Weaknesse...

What are the Weaknesses of the traditional approach The traditional approach to the scope of finance function evolved during 1920s and 1930s and dominated academic during 40's

Project-managing the budget process, Do a Gantts Chart, project-managing th...

Do a Gantts Chart, project-managing the Budget process. This task should contain a well designed chart with tables and discussion. Budgeting thus is identified as a project to be m

What is current asset, Q. What is Current Asset? Current Asset - ASSET ...

Q. What is Current Asset? Current Asset - ASSET which one can reasonably expect to convert into cash, sell or consume in operations within a single operating cycle or within a

What is the cash flows from financing activities, Cash flows from financing...

Cash flows from financing activities: Items included in this heading are: Cash receipts Cash payments Cash  receipts  from  iss

Case, Which type of financing is appropriate to each firm?

Which type of financing is appropriate to each firm?

Write Your Message!

Captcha
Free Assignment Quote

Assured A++ Grade

Get guaranteed satisfaction & time on delivery in every assignment order you paid with us! We ensure premium quality solution document along with free turntin report!

All rights reserved! Copyrights ©2019-2020 ExpertsMind IT Educational Pvt Ltd