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PMAverage C/S Ratio

Mmalcolmtucker12y ago
Hi everybody The BPP study text has 2 different ways to calculate the average C/S ratio for multiple products, which give different answers, as far as I can see. I want to know if I'm missing something. e.g. Suppose product X has selling price $50 and variable costs of $25 per unit and product Y has selling price of $30 and variable costs of $20 per unit. X and Y are manufactured in the ratio 2: 5. Overall the fixed costs are $150,000. Find the breakeven sales revenue X's contribution per unit = $50 - $25 = $25 Y's contribution per unit = $30 - $20 = $10 Method 1: The first way is to find average contribution per mix and average revenue per mix and divide them. Contribution per mix = 2 x $25 + 5 x $10 = $50 + $50 = $100 Revenue per mix = 2 x $50 + 5 x $30 = $100 + $150 = $250 Average C/S Ratio = Contribution per mix / Revenue per mix = $100 / $250 = 0.4 Breakeven Sales Revenue = Fixed Costs / Average C/S Ratio = $150,000 / 0.4 = $375,000 Method 2: The second way is if we are given the C/S ratio for individual products and the fixed costs, as in the question at the bottom of page 78 of the BPP text. C/S ratio for X = $25 / $50 = 0.5 or 50% C/S ratio for Y = $10 / $30 = 0.33 or 33 1/3 %, to avoid rounding errors So if the question instead had stated that X and Y are manufactured in the ratio 2:5, where X has a C/S ratio of 20% and Y has a C/S ratio of 33 1/3 % and fixed costs are $150,000, then, following the textbook, we would calculate Average C/S ratio = [ (2 x 50%) + (5 x 33 1/3 %) ] / (2 + 5) Average C/S ratio = (8/3) / 7 = 8 / 21 {leaving as fraction to avoid rounding errors} Already, the average C/S ratio calculated with this method differs from the one calculated in the first method. The difference is not due to rounding since exact decimals and fractions were used throughout. Breakeven Sales Revenue = FIxed costs/ Average C/S ratio = $150,000 / (8/21) = $393,750. Method 3: Using the method which does not involve the C/S ratio at all: Breakeven # of mixes = Fixed cost / contribution per mix = $150,000 / $100 = 1,500 Breakeven # of X's = 1,500 x 2 = 3,000 Breakeven # of Y's = 1,500 x 5 = 7,500 Breakeven sales revenue = 3,000 x $50 + 7,500 x $30 = $375,000 Check Back: 3,000 X's and 7,500 Y's cost 3,000 x $25 + 7,500 x $20 + $150,000 = $375,000 So methods 1 and 2 give the same, (apparently) correct answers. Clearly, method 2 is the odd one out. Am I skipping a step in method 2, or is it just wrong?
Ssara11y ago#1
I have the same issue
John MoffatJohn MoffatTutor11y ago#2
Method 2 is not valid - at best, it simply gives an approximation, but that is all. It is not a method to use in the exam. Methods 1 and 3 are both valid, which is why they both give the same answers.
LLe9y ago#3
I think the difference between 2 methods, it is because the difference in average C/S ratios calculated by Method 1 and method 2. Method 1: average C/S ratio=(x*C1+y*C2)/(x*S1+y*S2) Method 2: average C/S ratio=(x*C1/S1+y*C2/S2)/(x+y)=(x*C1+y*C2)/(S1*(x+y)+S2*(x+y)) Obviously, following method 2, it is not right to the concept of C/S ratio.
John MoffatJohn MoffatTutor9y ago#4
Can I suggest that you watch my free lectures on CVP analysis? :-)
JJoenzacca9y ago#5
I think when you can calculate total sales and contribution always use method 1 as it will always give an answer without having to round off a lot.
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