The questions I need help with are in bold

A practice problems dealing with cost, volume, profit (CVP) and breakeven analysis.

The primary key to CVP analysis is to focus on the behavior of the various relationships within

the financial performance of a firm. The value of many line items in a budget can only be

forecasted after another item (the cost driver) has been forecasted. Many times there is more

than one cost driver that has influence on the item being forecasted (budgeted) but for our

purposes were going to focus on the primary cost driver.

For example, if I ask you to forecast the cost of vehicle fuel for the next year youre going to ask

me for an estimate of miles to be driven. If you are the manager of a McDonalds and I ask you

to forecast the total cost of buns for the next year youll need to reflect upon the number of

sandwiches expected to be sold. And if you are the production manager for Under Armors

new shoe line you wont schedule production until you receive guidance from the sales

department about expected unit sales. The point is that the financial manager must

understand cost / revenue behavior to fully engage in the financial planning process.

The problem below, on one level, is reasonably straightforward but it represents the type of

analysis that a financial manager must move through to gain true cost volume profit insight.

Some of the costs noted in the problem below depend upon the passage of time, some on how

many units are sold, some on how management decides to staff operations........... for example

how many hours to be open, how many employees to be working at any point in time, etc..

sustainable business operations are about balance. Too many employees and the owner is

paying for too much idle time, not enough employees and customers and employees are

frustrated. How many employees want to show up for only a one hour shift during the very

busy time. None likely. The key is resource balance.

Heres an example of a cost volume profit planning problem. The Snowball Business

When you answer the questions that I ask you to answer at the end think not just about the

math involved but also the business operations, staffing, etc. You had to start somewhere with

your planning so you started with the info below.

The Target Business

You want to start a business selling snowballs from two trailers parked at different locations

several miles apart at the beach (I was in Ocean City, MD starring at one of these trailers when I

thought of this example). Youre not sure you want to do this in the future but you have some

spirit of adventure inside of you and wanted to give it a try for this summer. You did some

reasonable research and decided to take the plunge.

Your research revealed the following.

(1) You need a permit from the city at a cost of $600 for each vendor location to operate

each trailer. The permit gives you the authority to operate for six months between April

1 2020 and September 30 2020. A total cost of $1,200 for two trailers for the permit

period. You may not be open this entire time but the cost of the permit is for the six

month season. Whether you are open or not the city wants $600 for each location.

(2) You can rent a trailer to operate out of that you can pull behind a truck you already

own. The rent for each trailer is $1,000 / month. Two trailers will cost you a total of

$2,000 per month. The rental contract is month to month. The owner of the trailers

has a policy of a minimum of one month whether you use the trailer for one day during

the month or all days in the month. Therefore if you begin renting on May 15 you must

pay for the full month of May. If you return the trailer on September 4

th

you have to

pay for all of September.

(3) You want to use commercial grade reliable ice shaver machines. You can buy the ice

shaver machine for $1,800 (a commercial grade machine). If you buy and then sell the

used machine at the end of the summer youll recover $800 of your $1,800 machine

cost. Or you can rent a machine for $175 per month. You want to place two machines

in each trailer (for the busy times and if one breaks down). You decide to rent the

machines for this first season (four machines in total). Once again, if you use the

machine for any part of a month the rental company charges a full months rent.

(4) Youll want to rent a port-a-pot for each location (2 in total). Rental and maintenance

fees will be $180 per month each for any part of a month.

(5) Insurance coverage is expected to be $800 per location (anytime food is involved the

cost is higher). This is a flat rate for six months of operation whether you are open part

of the six month season or all of the season.

(6) You will be working as well as managing but youll need additional employees. You

want two employees in each trailer at all times (in addition to the time youll be there).

You plan on paying employees from 11 am until midnight seven days a week from May

15 August 31. On August 31 you and the employees will clean and then return the

trailers, the ice shavers, and have port a pots picked up. (lets assume that your

college starts after labor-day for the fall semester). You calculate a total of 109 days

(May 15 August 31) at 13 hours per day allowing for training, start-up, and tear down

time. 109 days at 13 hours per day with 4 employees equals 5,668 total hours youll

need to pay for (109 times 13 times 4). Youll likely be hiring about 10 employees for

the season. This is your first year and if you continue youll likely refine your business

model in the future. The pay rate (fully loaded with all required taxes and employee

insurances) will be $12 per hour. You allow a tip jar to be placed on the counter of the

walk up trailer. Employees will split tips at the end of each shift. You ignore this for the

purpose of this model (The IRS tax rules are different but well set those aside for the

purposes of this problem).

(7) Each snowball (the blended averages) will cost you 26 cents in consumables. This

includes the paper cup (cone), the ice, the syrup, the plastic spoon, the napkin that each

customer gets and a certain amount built in for a waste/spillage factor for all of the

consumable supplies.

(8) You expect the cost of electric usage for the season to be $1,600 (total of the two

trailers combined for the entire operating period). One of the reasons the trailer is so

expensive to rent is the need for the higher end electrical ability to service the needed

refrigeration and ice machine operation.

(9) You decide to add in a fixed amount of $2,000 for the season to cover the cost of your

gas driving back and forth between the trailers, cleaning supplies, minor repair costs,

and the cost of some signs. The $2,000 covers the full operation of both trailers.

Pricing - You decide to use a blended average price point of $3 for each snowball that

you sell.

Prior to signing any rental / permit agreements you want to perform some preliminary

calculations to see if it appears that this adventure is estimated to produce a reasonable reward

for a full summers work. You certainly dont have a perfect crystal ball but you use your best

effort to identify profit potential. When appropriate, prepare a brief income statement in the

contribution format d(as we discussed in class) to prove your answers. Ignore minor rounding

differences (you cant sell part of a snowball always round up). The values you calculate

below are prior to any income taxes, sales taxes, and related. For purposes of this problem

ignore those.

To refresh your memory, a

contribution format income statement

uses the following structure:

Total sales (units times selling price)

Minus variable costs

Equals contribution margin

Minus fixed costs

Equals net operating income.

Prior to signing any agreements you decide to calculate the following:

1. The number of snowballs needed to be sold over the season to reach the breakeven

point for the summer? (where your total income equals your total expenses in this

total case cash in equals total cash out)

2. Its sure not your desire to just walk away from the summer having just achieved

breakeven. You need to earn a profit. If you dont earn a profit of $10,000 (total) for

the summer youll be disappointed. You think you could have earned that amount

working at one of the nicer restaurants in town plus a little part time work here and

there on your off days. How many snowballs do you need to sell to earn a net operating

income (net cash in your pocket) of $10,000 for the summer?

3. Youll be somewhat disappointed but encouraged that your idea has some potential if

you earn a minimum $7,500 for the summer. How many snowballs need to be sold to

reach this point?

4. Youll be very pleased if the amount earned reaches $15,000. How many snowballs are

needed to reach this level?