Question

Due to erratic sales of its sole product—a high-capacity battery for laptop computers—PEM, Inc., has been experiencing financial difficulty for some time. The company’s contribution format income statement for the most recent month is given below:

  

Sales (13,500 units × $30 per unit)	$	405,000
Variable expenses		202,500
Contribution margin		202,500
Fixed expenses		225,000
Net operating loss	$	(22,500	)

Required:

1. Compute the company’s CM ratio and its break-even point in unit sales and dollar sales.

2. The president believes that a $6,900 increase in the monthly advertising budget, combined with an intensified effort by the sales staff, will result in an $87,000 increase in monthly sales. If the president is right, what will be the increase (decrease) in the company’s monthly net operating income?

3. Refer to the original data. The sales manager is convinced that a 10% reduction in the selling price, combined with an increase of $36,000 in the monthly advertising budget, will double unit sales. If the sales manager is right, what will be the revised net operating income (loss)?

4. Refer to the original data. The Marketing Department thinks that a fancy new package for the laptop computer battery would grow sales. The new package would increase packaging costs by 0.80 cents per unit. Assuming no other changes, how many units would have to be sold each month to attain a target profit of $4,200?

5. Refer to the original data. By automating, the company could reduce variable expenses by $3 per unit. However, fixed expenses would increase by $51,000 each month.

a. Compute the new CM ratio and the new break-even point in unit sales and dollar sales.

b. Assume that the company expects to sell 20,300 units next month. Prepare two contribution format income statements, one assuming that operations are not automated and one assuming that they are. (Show data on a per unit and percentage basis, as well as in total, for each alternative.)

c. Would you recommend that the company automate its operations (Assuming that the company expects to sell 20,300)?

Answer 1

1. a) Contribution Margin Ratio :- (Contribution Margin/Sales)*100

= ($202,500/$405,000)*100 = 50%

b) Break even point (units sales):- Total Fixed Costs/ Contribution per unit

Total Fixed Costs = $225,000

Contribution per unit = Contribution Margin/Total units sold

= $202,500/$13,500 = $15

Break even point (units):- $225,000/$15 = 15000 units

c) Break even point (dollar sales):-   Break even point (units) * Sale price per unit

= 15,000 units *$30 = $450,000

2.Calculation of Net Income is shown as follows:-

By increasing monthly advertising budget with $6,900, the fixed cost will increase by $6900.

Therefore,

Total Fixed Expenses = $225,000+ $6,900 = $231,900

Due to increase in sale,variable expenses will increase proportionately.

New sales =$405,000+$87,000 = $492,000

No. of units sold = $492,000/$30 = 16,400 units

Variable expense per unit = $202,500/13,500 units = $15 per unit

New Variable Expenses = 16,400 units*$15 per unit = $246,000

Table Showing Net Operating Income:- (Amounts in $)

Sales	492,000
Variable Expenses	(246,000)
Contribution Margin	246,000
Fixed Expenses	(231,900)
Net Operating income	14,100

Increase In Operating Income = $14,100 - ($22,500) = $14,100 + $22,500 = $36,600.

3. Calculation of New Revised Net Operating Income :-

New Selling Price = $30- (0.1*30) = $30 - $3 = $27

New Sales = 13,500 units *2 = 27,000 units

With an increase in Monthly Advertising Budget, the total fixed cost will increase by $36,000.

New Total Fixed Cost = $225,000+$36,000 = $261,000

New Variable Expenses = 27,000 units * $15 per unit = $405,000

Table Showing Net Operating Income:- (Amounts in $)

Sales (27,000 units * $27)	729,000
Variable Expenses	(405,000)
Contribution Margin	324,000
Fixed Expenses	(261,000)
Net Operating income	63,000

Therefore, the revised net operating income will be $63,000.

4.Calculation of Unit Sales is shown as follows :-

Selling Price per unit = $30

New Variable Cost per unit:- $15 per unit + 0.80 cents = $15.08 per unit

Target profit = $4,200

Contribution Margin per unit = $30 - $15.08 = $14.92

Sales (units) = (Fixed costs + Targeted profit)/ Contribution Margin per unit

= ($225,000+ $4,200)/ $14.92 = 15,362 units