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 (13,000 units × $30 per unit)	$	390,000
Variable expenses		195,000
Contribution margin		195,000
Fixed expenses		217,500
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 $6,500 increase in the monthly advertising budget, combined with an intensified effort by the sales staff, will result in an $89,000 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 $39,000 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 $0.50 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 $57,000 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 20,900 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 20,900)?

Answer 1

1.

Variable cost per unit= $195000/13000= $15 per unit

Contribution margin per unit= Sales price per unit-Variable cost per unit

= $30-15= $15

Contribution margin ratio= Contribution margin*100/Sales

= $15*100/30= 50%

Break even point (unit) sales= Fixed cost/Contribution margin per unit

= $217500/15= 14500 units

Break even point dollar sales= Fixed cost/Contribution margin ratio

= $217500/50%= $435000

2.

Increase in contribution margin ($81000*50%)	$     44,500.00
Less: Increase fixed costs	$      -6,500.00
Increase in net operating income	$     38,000.00
Net operating income will increases by $38000

3.

New selling price= $30*0.90= $27 per unit
New sales units= 13000*2= 26000 units
New fixed costs= $217500+39000= $256500
Sales (26000 units*$27 per unit)	$ 7,02,000.00
Variable expenses (26000*$15)	$ -3,90,000.00
Contribution margin	$ 3,12,000.00
Fixed expenses	$ -2,56,500.00
Net operating income (loss)	$ 5,68,500.00

4.

New variable costs= $15+0.50= $15.50

New contribution margin per unit= Sales price per unit-Variable cost per unit

= $30-15.50= $14.50

Units= (Target profit+Fixed expenses)/Contribution margin per unit

= ($4200+217500)/14.50

= 15290 units

5.

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

New variable costs= $15-3=$12 per unit

New contribution margin per unit= Sales price per unit-Variable cost per unit

= $30-12= $18

New fixed expenses= $217500+57000= $274500

Contribution margin ratio= Contribution margin*100/Sales

= $18*100/30= 60%

Break even point (unit) sales= Fixed cost/Contribution margin per unit

= $274500/18= 15250 units

Break even point dollar sales= Fixed cost/Contribution margin ratio

= $274500/60%= $457500

b.

	Not automated	Automated
	Total	Per unit	Percentage	Total	Per unit	Percentage
Sales	(20900*$30)= $627000	$30	100%	(20900*$30)= $627000	$30	100%
Variable expenses	(20900*$15)= -313500	15	(15*100/30)= 50%	(20900*$12)= -250800	12	(12*100/30)= 40%
Contribution margin	313500	15	50%	376200	18	60%
Fixed expenses	-217500			-268500
Net operating income	531000			107700

c. Yes, the company should automate its operations as the net operating income of the company will increases if the company automated its operations