Critical Thinking about CVP

CVP is more than just a mathematical tool to calculate values like the break-even point. It can be used for critical evaluations about business viability.

For instance, a manager should be aware of the margin of safety. The margin of safety is the degree to which sales exceed the break-even point. This will give a manager valuable information as he or she plans for inevitable business cycles.

A manager should also understand the scalability of the business. This refers to the ability to grow profits with increases in volume. Compare the income analysis for Mickey Mouse Corporation and Donald Duck Corporation:

Mickey Mouse Corporation
Contribution Margin Income Statement
year-end 2019
Sales (5,000 X $1,000)	$5,000,000		100%
Variable Costs (5,000 X $900)	$4,500,000		90%
Contribution Margin	$500,000		10%
Fixed Costs	$500,000
Net Operating Income	$0
Donald Duck Corporation
Contribution Margin Income Statement
year-end 2019
Sales (5,000 X $1,000)	$5,000,000		100%
Variable Costs (5,000 X $400)	$2,000,000		40%
Contribution Margin	$3,000,000		60%
Fixed Costs	$3,000,000
Net Operating Income	$0

Both companies broke even in 2019. Which company would you rather own? If you knew that each company was growing rapidly and expected to double sales each year (without any change in cost structure), which company would be preferred? With the added information, what would be the expected 2020 outcomes?

1. Which company would you rather own?
2. Which company would be preferred?
3. With the added information, what would be the expected 2020 outcomes? (Make sure to include specific numbers when addressing this one.)