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Question 4.

a. Cost-volume-profit analysis mainly used by cost-management accountants, financial

accountants and microeconomist to understand production, cost, and profit behaviour. Explain

the inter-relationship among total revenue, marginal revenue, and profit maximization. Why

does understanding contribution margin play important role in recovering total cost?

b. Two UW students intending to open a milkshake bar on the Corniche, Al-Khobar. As part of the

feasibility study the students studied the industry reports about existing restaurants which offer

similar products and conducted some basic research to estimate demand, potential cost and

expected revenue. The students wish to offer shakes with different flavour which are currently

popular among younger generation. Given that the economic performance, household income

changes over time, they make certain assumptions about cost, demand and possible margin and

selling prices. The students will hire two part-time workers to operate the business. Based on the

research, they expect to sell 1600 shakes per month with the projected selling price of 15 SAR and

the variable cost is expected to be 25 % of the selling price. To set up the business, the students

have to rent Shack which will cost SAR5000 per month. The following are costs related to the

operation of the business.

Shack rental per month

Milk-Shake Makers (4 unit @SAR2200) 2 years life 2400/24

Freezer (5-year life)

Tables and benches (3 years life):

Insurance (annual):

Hire two part-time employees (SAR2400/ month)

Total monthly fixed cost

Total

cost

4800

6000

2400

1200

Fixed

Monthly

cost (SAR)

3000

?

?

?

?

5000

?

Fixed/ni)

ii)

Using above information calculate the number of milkshakes they should sell in order to

have break-even. If you are expecting to have monthly profit of SAR30,000 how may

shakes you have to sell per month?

Now assume that both selling price and variable cost increase by 15 percent what should

be the break-even sale to cover the cost.

Fig: 1

Fig: 2