The Portable MBA in Finance and Accounting, 3rd Edition

Cost-Volume -Profit Analysis 109

what is sacrificed when we choose one alternative, selling through the Web
site, over the next best alternative, staying with the publisher. If we think this
way, our contribution margin is now only $11 ($80 selling price less $57 vari-
able costs less $12 royalty per book sacrificed). We do arrive at the same indif-
ference point using this method—using the general rule:

I think this is the better way to think about the Web-site alternative. Note,
using this method, at 20,000 books per year we make a total contribution of
$220,000 (20,000×$11), which covers our fixed costs and yields the $120,000
incremental profit—same as ($360,000−$240,000).”
Abbey was becoming very interested in this business opportunity. She
liked the 50% greater return ($120,000/$240,000). “How fast can we get this
Web site up and running?”
“Let’s talk a bit more. I also presented today in class what we have done so
far. Many students liked the idea. The only criticism was that Web customers
expect lower prices since they know the middle person has been eliminated.
The class agreed that a 10% to 15% price decline would be very likely, resulting
in a price closer to $70. This is not so good for us. Even though our variable cost
will fall to $67.50 since part of it is price dependent ($35 printing+$10 logis-
tics+$12 opportunity cost+[15% ×$70]), our contribution margin would
now only be $2.50 per book. Just to match what you could make with your
publisher, we would have to sell about 40,000 books a year ($100,000/$2.50
per book). At the 20,000-book level, we would now be worse off by $50,000
([20,000× $2.50]−$100,000). Well, you asked about the risks and here they
are. The price could even be lower, so there is a high probability we could wind
up worse off.”
“So, you’re my business partner, what do you suggest?” was Abbey’s reply.
“That’s a hard one,” was all Stephen could say.

CVP for Decision Making

The next day Abbey called Stephen for more advice. “Public Broadcasting Sys-
tem of Florida called me after our talk yesterday. They just began planning
their end-of-year membership drive and heard about my book project. They
want to offer a free copy of my book to any member who donates $250
or more.”
Stephen thought that was great.
“Unfortunately, since they are a public company they have constraints on
their spending. They can give a gift equivalent to only 20% of the donation.

CVP Point

Fixed Costs

Contribution Margin

units

=

=

=

$,

$

,

100 000

11

9 091