a Critically appraise the merits and limitations of Cost Vol

(a) Critically appraise the merits and limitations of Cost Volume Profit (CVP) analysis as a management technique (10 marks) (b)\"As most organis ations are price takers, an understanding of market dynamics and costs has little relevance to the pricing decision\". (15 marks) (Total 25 marks) Do you agree? Give reasons in support of your answer

Solution

Question a). Answer :-  Merits of Cost Volume Profit (CVP) analysis :-

1). CVP analysis is the analysis of three important variables viz., cost, volume and profit. Such an analysis clearly explores the relationship existing amongst costs, revenue, activity levels and the resulting profit.

2). CVP analysis measures variations of cost with sales volume very well.

3). Cost-volume-profit (CVP) relationship is the most significant factor in the profit planning of business.

4). The biggest merit of CVP analysis is its capability of depicting clearly the effect on profit and breakeven point of any changes in the variables.

Limitations of Cost Volume Profit (CVP) analysis :-

1). Assumptions of CVP analysis like costs behaving in a linear fashion or sales revenue remain constant at different sales level or the stocks shall remain constant period after period are quite unrealistic.

2). The assumption of CVP analysis that the only factor which influences costs is the \'activity level achieved\' is erroneous because other factors like inflation is also have bearing on the costs.