Emma could also ask, “At what price can I sell 50 units (purchased at $115 per unit) and still earn an operating income of $1,200?” The answer is $179, as the following calculations show:
Target operating income: 1,200 dollars
Add fixed costs: 2,000 dollars
Target contribution margin: 3,200 dollars
Divided by number of units sold: Divided by 50 units
Target contribution margin per unit: 64 dollars
Add variable cost per unit: 115 dollars
Target selling price: 179 dollars
Revenues, 179 dollars per unit times 50 units: 8,950 dollars
Variable costs, 115 dollars per unit times 50 units: 5,750 dollars
Contribution margin: 3,200 dollars
Fixed costs: 2,000 dollars
Operating income: 1,200 dollars
Emma should also examine the effects of other decisions, such as simultaneously increasing advertising costs and raising or lowering the price of GMAT Success. In each case, Emma compares the changes in contribution margin (through the effects on selling prices, variable costs, and quantities of units sold) to the changes in fixed costs and chooses the alternative that provides the highest operating income. Concepts in Action: Can Cost–Volume–Profit Analysis Help Whole Foods Escape the “Whole Paycheck” Trap? describes how Whole Foods, the supermarket chain, reduced prices of its products to increase contribution margin and operating income.
Strategic decisions invariably entail risk. Managers can use CVP analysis to evaluate how the operating income of their companies will be affected if the outcomes they predict are not achieved—say, if sales are 10% lower than they estimated. Evaluating this risk affects the strategic decisions a manager might make. For example, if the probability of a decline in sales is high, a manager may choose a cost structure with higher variable costs and fewer fixed costs, even if this cost structure results in lower operating income.