The PV graph Curriculum linkage . This example illustrates how individual managers can use CVP analysis to make cost structure choices that fit their own risk–return preferences. Trading off higher FC to reduce VC increases managers downside risk if demand is low, but increases the potential upside) return if demand is high (because the lower VC per unit increases CM per unit. This is the operating leverage concept students may have encountered it in a finance course. As explained previously, relative to the curvilinear economist’s model, the linear CVP model tends to overestimate profits. Consequently, the PV relation is especially sensitive to violations of the linearity assumption, so it is important to confine the analysis to a relevant range within which linearity is a reasonable approximation. The following linkage helps students integrate several topics in Chapter 8. The text discusses two approaches to dealing with uncertainty in CVP analysis (i.e. violation of CVP assumption 3) – sensitivity analysis and decision models that explicitly incorporate uncertainty via probability distributions (i.e. expected value analysis presented in the Appendix to Chapter 8). The sensitivity analysis presented here estimates outcomes under various combinations of USP, UVC, FC and TOI. This approach can be viewed as estimating payoffs (TOI) under a variety of actions (UVC and FC) and states (revenue EUR. The Appendix explains how to employ payoffs under various actions/states of nature in combination with the probabilities of these states occurring indecision models that help managers choose the action that maximises expected monetary value.
