Slides 4 3 identify sensitive variables through what if sce

Review: Key Variables and Assumptions:• The Breakeven Equation: Revenue - Variable Cost - Fixed Cost = Profit • What are the key variables?. Sensitivity and Breakeven• The breakeven equa

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Identify Sensitive Variables

through What-if Scenarios

Intermediate Cost Analysis

and Management

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We assume cross traffic will stop What if our

assumption is incorrect?

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Terminal Learning Objective

• Action: Identify Sensitive Variables through What-if

Scenarios

• Condition: You are training to become an ACE with access

to ICAM course handouts, readings, and spreadsheet tools and awareness of Operational Environment

(OE)/Contemporary Operational Environment (COE)

variables and actors

• Standard: With 80% accuracy:

• Define “sensitive variable”

• Calculate new break even point given changes in assumptions

• Calculate break even selling price for a given sales quantity

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Review: Key Variables and Assumptions:

• The Breakeven Equation:

Revenue - Variable Cost - Fixed Cost = Profit

• What are the key variables?

Revenue = #Units Sold * Selling Price $/Unit Variable Cost = #Units Sold * Variable Cost $/Unit

• Assumes… ONLY ONE product or service is sold

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• Assumes ONLY ONE product or service is sold

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What is Sensitivity Analysis?

• Recognizes that the validity of the decision

depends on the validity of the underlying

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What if?

• How does my decision point or breakeven

point change if I change an assumption or an estimate?

• How does that change affect the overall

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Learning Check

• How do we test our assumptions?

• What is a sensitive variable?

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• Breakeven point = 100 Tickets

• How does breakeven point in units change if:

• Price decreases by $5/Ticket? Increases by $10?

• Unit variable cost increases 20%? Decreases 10%?

• Fixed cost increases by 10%? Decreases by 20%?

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Sensitive Variables

• $5 decrease in ticket price (17%) causes:

• 25% decrease in unit Contribution Margin

• 33% increase in the breakeven point in units

• The 20% increase in unit Variable Cost causes:

• 10% decrease in unit Contribution Margin

• 11% increase in breakeven point in units

• Which variable would you define as sensitive?

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Learning Check

• How will breakeven point in units change if

fixed cost increases?

• How will breakeven point in units change if

Contribution Margin increases?

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Sensitivity and Breakeven

• The breakeven equation includes five variables:

• Number of Units, Selling Price per Unit, Variable Cost per Unit, Fixed Cost, and Target Profit

Revenue – VC – FC = Profit

(Price$/Unit*#Units) – (VC$/Unit*#Units) – FC = Profit

-or-• So far, we have assumed all variables are known

except Number of Units

• What if one of the other variables is the unknown?

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• What if one of the other variables is the unknown?

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What Ifs Involving Other Variables

• What if quantity of tickets is limited to 80 due

to building capacity?

• Task: Calculate the breakeven price per ticket

• How would you set up the equation?

• What is the unknown variable?

• How would you express Revenue? Variable

Cost?

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Solving for Breakeven $Price

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$Price/Tkt(80 Tkts) - $10/Tkt(80 Tkts) - $2000 = $0

$35/Tkt(80 Tkts) - $10/Tkt(80 Tkts) - $2000 = $0

$2,800 -$800 - $2000=0

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Graphic Solution – 80 Tickets

VC

$10/tkt Fixed Cost

$

X Axis = Unknown Price per Ticket $35

VC = 80 tickets * $10/ticket

FC = $2000 Total Cost = $2800

VC = 80 tickets * $10/ticket

FC = $2000 Total Cost = $2800

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Interpreting the Result

• In order to breakeven at a volume of 80

tickets, we must charge $35 per ticket

• Questions to ask:

• Is the new price reasonable?

• Can we sell all 80 tickets for $35/ticket?

• What other factors might be considered?

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Learning Check

• When number of units is known, how will

variable cost be expressed in the breakeven equation?

• What does the horizontal (x) axis represent on the graph?

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• What if the market will not bear an increase in

ticket price above $30?

• AND Fixed Cost increases by 10%?

• Task: Calculate the target variable cost per ticket

that will maintain a breakeven of 100 tickets

• How would you set up the equation?

• How would you express Revenue? Variable Cost?

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Solving for Breakeven $VC/Ticket

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Solving for Breakeven $VC/Ticket

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$8

Revenue = 100 tickets * $30/ticket

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• In order to maintain the breakeven point of

100 tickets, we need to reduce variable cost per ticket from $10 to $8

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Sensitivity Analysis Spreadsheet

Select the “Solve Breakeven VC” Tab

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Help messages appear Help messages appear

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Enter problem data into the white cells:

# units = 100

$price/unit = $30 Fixed Cost = $2000 +$200 Profit Target = $0 (default value)

Enter problem data into the white cells:

# units = 100

$price/unit = $30 Fixed Cost = $2000 +$200 Profit Target = $0 (default value)

The spreadsheet automatically calculates the

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• What if the market will not bear an increase in ticket price above $30?

• Variable cost increases by 30%

• Task: Calculate target fixed cost that will

maintain a breakeven point of 100 tickets

• Which spreadsheet tool will I use?

• How would I set up the equation?

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Solving for Breakeven $Fixed Cost

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Solving for Breakeven $Fixed Cost

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$

X Axis = Unknown Fixed Cost $1700

VC = 100 tickets * $13/ticket Revenue = 100 tickets * $30/tkt

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• In order to maintain the breakeven point of

100 tickets, we need to reduce fixed cost from

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Your spreadsheet should look like this Your spreadsheet should look like this

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Your graph should look like

this

Your graph should look like

this

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Learning Check

• When using the Sensitivity Analysis

Spreadsheet, what is the first question we

should ask?

• Once we have found the solution to the

unknown variable, what questions should we ask?

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Practical Exercises

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