Break Even Analysis Questions and Answers

Answer: A

Correct answer: 2, 4, 1, 3

Costs must first be separated into fixed and variable, since nothing else can be done until they are. The contribution per unit follows from the price and the variable cost. Dividing the fixed cost by that contribution gives the break-even quantity. And comparing it with expected sales gives the margin of safety, which is what the exercise was for.

Answer: B

Correct answer: 1 and 2 only are correct

Statements 1 and 2 are correct. Statement 3 is the reverse of the truth - a high proportion of fixed cost raises operating leverage, making profit more sensitive to volume in both directions. That is exactly why a capital-intensive firm is more exposed in a downturn and more profitable in a boom.

Answer: C

Correct answer: raising the variable cost per unit

A higher variable cost narrows the contribution and so raises the break-even point, which is the opposite of what was asked for. The other three all lower it: cutting fixed costs reduces what has to be covered, raising the price widens the contribution, and shifting the mix towards the higher-margin product raises the weighted average contribution.

Answer: D

Correct answer: that the sales mix varies with volume

The analysis assumes the mix is constant, since a weighted average contribution can only be computed at a stated mix. The other three are genuine assumptions: constant price per unit, constant variable cost per unit, and production equal to sales so that no fixed cost is carried forward in stock.

Answer: A

Correct answer: the mix shifted toward lower-margin products

Revenue can be met by selling more of the cheaper, thinner-margin lines, and the profit will then fall short because the weighted average contribution is lower than budgeted. The other three explanations would all have raised profit rather than lowered it. This is the practical reason sales targets are set by product or by margin rather than by total revenue alone.

Answer: B

Correct answer: continue, if the overhead continues whether or not it operates

Head office overhead that continues regardless is not avoidable by closing, so it is irrelevant to the decision. What matters is whether the plant covers its own variable costs and any fixed costs that closure would actually save. If it does, closing makes the firm worse off by the amount of the contribution lost, whatever the allocated overhead makes the plant’s accounts look like.

Answer: C

Correct answer: both the assertion and the reason are true and the reason explains the assertion

Both are true and the reason gives the mechanism. Automation buys a machine that must be paid for whether it runs or not and displaces labour that was charged per unit, so the fixed cost rises and the contribution per unit widens. Since the break-even quantity is fixed cost over contribution, the numerator usually rises faster than the denominator and the break-even volume goes up - while the profit beyond it grows more steeply than before.

Answer: D

Correct answer: the assertion is false although the reason offered is a true statement in itself

The reason correctly describes what an accounting loss means, but the assertion does not follow. Only avoidable costs are relevant to a closure decision: if the plant covers its variable costs and any fixed costs that closing would save, then closing makes the firm worse off by the contribution it would lose, and the unavoidable overhead continues to be borne regardless. A plant showing a loss on its allocated overhead may be well worth keeping.

Answer: A

Correct answer: makes a smaller loss or a profit sooner

At low volume the high-variable-cost structure has less fixed cost to cover, so it reaches break-even at a smaller quantity and loses less below it. The high-fixed-cost structure has the wider contribution margin, so it overtakes above the indifference volume and earns more thereafter. Low leverage is the safer structure at low or uncertain volume; high leverage is the more profitable at high volume.

Answer: B

Correct answer: additional fixed cost caused by making it

A relevant cost is one that changes as a result of the decision. Fixed cost incurred specifically because the component is made in-house qualifies; factory rent, continuing head office overhead and depreciation on equipment already owned and idle are all unaffected by the choice and are therefore irrelevant, however they are allocated in the accounts. Including them is the standard way a make-or-buy analysis reaches the wrong answer.