Q30E - Horngren'S Financial And Managerial Accounting

Question

Analyzing a cost-volume-profit graph

Nolan Rouse is considering starting a Web-based educational business, e-Prep MBA. He plans to offer a short-course review of accounting for students entering MBA programs. The materials would be available on a password-protected Web site; students would complete the course through self-study. Rouse would have to grade the course assignments, but most of the work would be in developing the course materials, setting up the site, and marketing. Unfortunately, Rouse’s hard drive crashed before he finished his financial analysis. However, he did recover the following partial CVP chart:

Requirements 

1. Label each axis, the sales revenue line, the total costs line, the fixed costs line, the operating income area, and the breakeven point. 

2. If Rouse attracts 300 students to take the course, will the venture be profitable? Explain your answer. 

3. What are the breakeven sales in students and dollars?

Step-by-Step Solution

Answer

1. Blue line: Sales revenue; Green line: Total cost; Black line: Fixed cost; green portion: Operating income and an orange portion is reflecting operating loss. 
2. The education business will suffer a loss on the admission of 300 students.
3. Break-even sales in students: $40,000; Break-even sales in dollars: 400 units.

Step 1: Definition of CVP Analysis

The analysis was carried out to identify the relationships between the cost incurred by the business entity, volume of production, and the profit generated from these operations, known as CVP analysis.

Step 2: Labelling each axis

Step 3: Profitability at 300 students

From the graph, it can be concluded that break-even is achieved after 300 students. Therefore, the business entity will suffer a loss when 300 students take admission. The education business will suffer a loss at all levels of activity below the break-even point.

Step 4: Calculation of break-even sales in students and dollars

According to the above graph, it can be stated that the education business will achieve its break-even point at 400 students and $40,000.