How would you assess the risk of a new project using cost-volume-profit analysis?

• A. Break-even point, margin of safety, and contribution per unit; consider sensitivity to changes in selling price, variable costs, and volume.
• B. Payback period only.
• C. Net present value only.
• D. Accounting rate of return only.

Answer: (A)

Cost-volume-profit analysis focuses on how profits respond to changes in selling price, variable costs, and the level of activity. The key tools are contribution per unit, break-even point, and margin of safety, together with sensitivity analysis.

Contribution per unit (selling price minus variable cost per unit) shows how much each unit contributes to fixed costs and profit. The break-even point—fixed costs divided by the contribution per unit—tells you the sales level needed to cover all costs; if forecasted sales are close to or below this, risk is high because profits vanish and small adverse changes can push you into loss. The margin of safety measures how much current or projected sales exceed the break-even level; a larger margin means the project can absorb volume or price fluctuations without incurring a loss.

Sensitivity analysis brings these ideas together by testing how profit changes when selling price, variable costs, or volume shift. This directly reveals the project’s vulnerability to uncertainty and helps gauge risk.

Other methods like the payback period, net present value, or accounting rate of return look at different aspects (liquidity, time value of money, overall return) and don’t provide the same direct view of how profit responds to operating volume and cost behavior, which is central to assessing risk in a new project.