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If scenario 2 yields a lower profit, why does the management team choose it? The short answer is
growth. How much growth in the service revenue would be necessary for scenario 2 to be more
profitable, and could the current four regional offices handle this increase? To answer the first
question it is easier to use a shortcut equation than to do the analysis longhand as illustrated in Exhibit
12.9. Following the analysis in the exhibit, the last equation in either scenario in words is: Profit
equals contribution margin less fixed costs. In these cases, we knew the cost structure and the output
levels, and we simply solved for the resulting profit. In the question above, we now know the target
profit of $75.8 in the first scenario and the cost structure of the second scenario and now must solve
for the level of output required. This can be done by rearranging the equation to what is known as the
classic CVP equation:
and therefore:
Contribution Margin × Quantity of Output = Fixed Cost + Target Profit
Quantity of Output = (Fixed Cost + Target Profit)/Contribution
To solve for what level of service revenue would be necessary to match the same profit level as
scenario 1:
Service Revenue = ($150 million + $75.8 million)/77%
Service Revenue = $293 million
This states that service revenue would have to increase by only approximately 7% for scenario 2 to
be as profitable. This should not be a surprise since for every additional dollar of revenue, 77 cents
drops through to the bottom line. Seven percent of $275 million is approximately $18 million in