Cost-volume-profit
- Contribution margin = Sales − Variable costs
- Contribution margin ratio = CM ÷ Sales
- Breakeven in units = Fixed costs ÷ CM per unit
- Breakeven in dollars = Fixed costs ÷ CM ratio
- Target profit units = (Fixed costs + Target profit) ÷ CM per unit
- Margin of safety = Actual (or budgeted) sales − Breakeven sales
EXAMPLE: Price $50, variable cost $30, fixed costs $200,000. CM per unit = $20, CM ratio = 40%. Breakeven = 10,000 units, or $500,000 of sales. To earn $60,000 of profit: ($200,000 + $60,000) ÷ $20 = 13,000 units.
Variance analysis
| Variance | Formula |
|---|---|
| Direct material price | (Actual price − Standard price) × Actual quantity purchased |
| Direct material quantity | (Actual quantity used − Standard quantity allowed) × Standard price |
| Direct labor rate | (Actual rate − Standard rate) × Actual hours |
| Direct labor efficiency | (Actual hours − Standard hours allowed) × Standard rate |
Memory aid: the price/rate variance uses actual quantity; the quantity/efficiency variance uses standard price.
Valuation approaches
| Approach | Method |
|---|---|
| Income | Discounted cash flow — project free cash flows, discount at WACC, add terminal value |
| Market | Multiples of comparable companies or transactions (EV/EBITDA, P/E) |
| Asset | Adjusted net asset value — useful for holding companies and liquidation scenarios |
WACC = (E/V × Cost of equity) + (D/V × Cost of debt × (1 − tax rate)). The after-tax adjustment applies only to debt, because interest is tax-deductible while dividends are not.
EXAM TIP: In a DCF, the terminal value often represents the majority of total value, so small changes in the growth rate or discount rate move the answer dramatically. Perpetuity growth formula: TV = CFn+1 ÷ (WACC − g).