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		234,000
Contribution margin		156,000
Fixed expenses		174,000
Net operating loss	$	(18,000	)

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 $80,000 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 $33,000 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 cents per unit. Assuming no other changes, how many units would have to be sold each month to attain a target profit of $4,300?

5. Refer to the original data. By automating, the company could reduce variable expenses by $3 per unit. However, fixed expenses would increase by $52,000 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 20,200 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 20,200)?

Answer 1

	contribution margin per unit=			156000/13000
				12
1)	CM ratio = contribution/sales
		156,000/390,000
		40.00%
	BEP(units) = total fixed cost/contribution margin per unit
		174000/12
		14500
	BEP(dollars) = 14500*30
		435000
	CM ratio			40%
	Break even point in units			14500
	Break even point in dollars			435000
2)	increase in contribution			(80000*40%)		32000
	less : increase in advertising budget					6,900
	increase in net income					25,100
	increases by		25,100
3)	units = 13000*2 =		26000 units ; selling price = 30*90%=$27
		Contribution Income statement
	Sales	(26000*27)			702000
	Variable expense		(26000*18)		468000
	Contribution margin				234000
	Fixed expenses		(174000+33000)		207,000
	Net income				27,000
4)	New contribution margin = 12-.50
			11.5
	BEP(units) = (total fixed cost+target profit)/contribution per unit
		(174000+4300)/11.5
		15504.35
	Sales units		15,504
5)
	CM ratio = contribution/sales
		15/30
		50.00%
	BEP(units) = total fixed cost/contribution margin per unit
		(174000+52000)/15
		15067
	BEP(dollars) =		226000/50%
		452000
	CM ratio			50%
	Break even point in units			15067
	Break even point in dollars			452000
			20200 units
b)			Not Automated			Automated
			total	per unit	%	total	per unit	%
	Sales		606000	30	100%	606000	30	100%
	Variable expenses		363600	18	60%	303000	15	50%
	Contribution margin		242400	12	40%	303000	15	50%
	Fixed expenses		174,000			226,000
	Net operating income		68,400			77,000
c)		yes