Cost Management: A Strategic Emphasis 5th Edition by David Stout, Edward Blocher, Gary Cokins

Exercise 51

CVP Analysis in a Professional Service Firm Lang and Thomas, a local CPA firm, has been asked to bid on a contract to perform audits for three counties in its home state. Should the firm be awarded the contract, it must hire one new staff member at a salary of $41,000 to handle the additional workload. (Existing staff are fully scheduled.) The managing partner is convinced that obtaining the contract will lead to additional new profit-oriented clients from the respective counties. Expected new work (excluding the three counties) is 800 hours at an average billing rate of $60.00 per hour. Other information follows about the firm’s current annual revenues and costs:

Firm volume in hours (normal)	30,750
Fixed costs	$ 470,000
Variable costs	$ 20.00/hr

Should the firm win the contract, these audits will require 900 hours of expected work.

Required

1. If the managing partner’s expectations are correct, what is the lowest bid the firm can submit and still expect to increase annual net income?

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2. If the contract is obtained at a price of $30,000, what is the minimum number of hours of new business in addition to the county work that must be obtained for the firm to break even on total new business?

Step 1 of 2

1.?If operating profit is to increase the contribution margin of the new business must be positive.

Y + Revenue from New Work =  Variable cost  + Fixed cost  +  profit

Y +  $60(800) = $20(800 + 900) + $41,000 + 0

Y = $27,000

where Y is the minimum revenue that must be earned from the county work in order to insure that operating profit of the firm does not decrease. Revenue above this level will result in incremental profit. The average billing rate at the breakeven rate of $27,000 would be $27,000/900 = $30 per hour.   Clearly, the key to the bidding strategy is the desirability of bringing in 800 hours of new business at the going billing rate.