Chapter 12

Illustrative Problem 12.8. Use of CVP in Decision Making

The Income Statement for the Woodstock Company for the past year is:

Sales (150,000 @ P30) 4,500,000Cost of Goods Sold:

Materials1,050,00

0

Labor1,500,00

0Variable Factory Overhead 450,000Fixed Factory

Overhead 500,000 3,500,000Gross Profit 1,000,000Variable Marketing Expenses 135,000Fixed Marketing Expenses 185,000Fixed Manufacturing Expenses 180,000 500,000Income Before Income tax 500,000Income Tax 250,000Net Income 250,000

Woodstock is preparing its budget for the coming year and has made the following projections about cost increases: materials 5%, labor 8%, and all other costs (including fixed) 6%. Production capacity is 200,000 units.

The President has been offered various proposals by the division manager as follows:

a. Maintain the present volume and sales price.

b. Produce and sell at capacity and reduce the unit price to P28.

c. Raise the unit price to P32, spend an extra P300,000 on advertising, and produce and sell 180,000 units.

Required: Recommend action, based on quantification of alternatives.

Solution: Woodstock Campany

Alternatives(a) (b) (c)

Sales 4,500,000 5,600,000 5,760,000Variable Costs 3,342,600 4,456,800 4,011,120Contribution Margin 1,157,400 1,143,200 1,748,880Fixed Costs 916,900 916,900 1,216,900Income Before Income tax 240,500 226,300 531,980

Recommendation: Proposal (c) should be adopted because it will yield the highest amount of profit.