CMA P2 Decision Analysis: practice questions with answers

Question 1

Corvane Ltd. makes a single product that sells for $48 per unit. Variable manufacturing cost is $24 per unit and a sales commission of $6 per unit is paid on every unit sold. Annual fixed costs are $243,000. What is Corvane's breakeven point in units?

1. A 10,125 units
2. B 8,100 units
3. C 13,500 units
4. D 5,063 units

Show the answer

Answer: C. Breakeven units = Fixed costs / Contribution margin per unit.

Contribution margin per unit = $48 - $24 - $6 = $18 (the sales commission is a variable cost).

Breakeven = $243,000 / $18 = 13,500 units.

Check: 13,500 x $18 = $243,000, exactly covering fixed costs.

Question 2

On a profit-volume (P/V) graph for a single-product company, units sold are on the horizontal axis and operating income is on the vertical axis. What do the slope of the profit line and the point where it crosses the vertical axis represent?

1. A The slope is the selling price per unit; the vertical-axis intercept is minus total fixed costs
2. B The slope is the contribution margin per unit; the vertical-axis intercept is minus total fixed costs
3. C The slope is the variable cost per unit; the vertical-axis intercept is total fixed costs
4. D The slope is the contribution margin ratio; the vertical-axis intercept is the breakeven point in units

Show the answer

Answer: B. A P/V graph plots operating income = (CM per unit x units) - fixed costs.

- Slope = CM per unit (the profit added by each extra unit).
- Vertical-axis intercept = -fixed costs (the loss at zero volume).
- Horizontal-axis intercept = breakeven volume, where operating income is zero.

If sales dollars were on the horizontal axis instead, the slope would be the CM ratio.

Question 3

A city has dozens of independent bakeries. Each sells products that customers see as slightly different in taste and style, each can raise its prices a little without losing all its customers, and new bakeries open easily. In the long run, economic profits tend toward zero. Which market structure does this describe?

1. A Perfect competition
2. B Monopolistic competition
3. C Oligopoly
4. D Monopoly

Show the answer

Answer: B. Monopolistic competition: many firms, differentiated products (each faces a downward-sloping demand curve, so has some pricing power), low barriers to entry. Entry erodes economic profit in the long run. Perfect competition requires identical products and price-taking firms; oligopoly involves few interdependent firms; monopoly a single seller.

Question 4

Calder Audio sells a speaker for $150. Variable cost is $90 per unit, annual fixed costs are $480,000 and the company currently sells 12,000 units a year. Management proposes cutting the price by 10% to win volume, with no change in unit variable cost or fixed costs. How many units must Calder sell at the new price to keep operating income at its current level?

1. A 13,333 units
2. B 10,667 units
3. C 16,000 units
4. D 13,200 units

Show the answer

Answer: C. Current contribution margin = $150 − $90 = $60 per unit.
Current operating income = 12,000 × $60 − $480,000 = $240,000.

New price = $150 × 0.90 = $135; new contribution margin = $135 − $90 = $45 per unit.

Required units = (Fixed costs + target operating income) / CM per unit = ($480,000 + $240,000) / $45 = 16,000 units.

A 10% price cut removes 25% of the unit contribution margin, so volume must rise by one-third to hold income steady.

Question 5

Aldwick Plastics makes 10,000 units a month at a total cost of $250,000, an average of $25 per unit. Its cost accountant estimates that total monthly cost would be $262,000 at 11,000 units, which is within capacity. A distributor offers to buy an extra 1,000 units this month at $18 each, with no effect on regular sales. Which conclusion is correct?

1. A Accept; operating income rises by $6,000
2. B Reject; operating income falls by $7,000
3. C Reject; operating income falls by $5,818
4. D Accept; operating income rises by $18,000

Show the answer

Answer: A. Decisions at the margin depend on marginal (incremental) cost, not average cost.

- Marginal cost of 1,000 extra units = $262,000 - $250,000 = $12,000 ($12 per unit).
- Incremental revenue = 1,000 x $18 = $18,000.
- Change in operating income = $18,000 - $12,000 = +$6,000.

Average cost ($25, or $23.82 at 11,000 units) includes fixed costs that do not change with the order and so overstates the cost of the extra units.

Question 6

Zennor Diagnostics holds a patent on a home allergy test kit and faces no close substitutes. Marginal cost is constant at $36 per kit, and market research estimates that the price elasticity of demand is 4.0 (absolute value) over the relevant price range. What price per kit maximises Zennor's profit?

1. A $45.00
2. B $27.00
3. C $48.00
4. D $36.00

Show the answer

Answer: C. A profit maximiser sets marginal revenue equal to marginal cost. With price elasticity E (absolute value), MR = P x (1 - 1/E), so:

P x (1 - 1/E) = MC, which gives P = MC x E / (E - 1).

P = $36 x 4 / (4 - 1) = $36 x 1.333 = $48.00.

Check with the Lerner index: (P - MC) / P = ($48 - $36) / $48 = 0.25 = 1/E. The less elastic the demand, the higher the markup a firm with market power can charge.