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 (12,900 units × $30 per unit)	$	387,000
Variable expenses		193,500
Contribution margin		193,500
Fixed expenses		216,000
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 $6,700 increase in the monthly advertising budget, combined with an intensified effort by the sales staff, will result in an $81,000 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 $32,000 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 $4,400?

5. Refer to the original data. By automating, the company could reduce variable expenses by $3 per unit. However, fixed expenses would increase by $55,000 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 20,800 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 20,800)?

Answer 1

	contribution margin per unit=			193500/12900
				15
1)	CM ratio = contribution/sales
		193500/387000
		50.00%
	BEP(units) = total fixed cost/contribution margin per unit
		216000/15
		14400
	BEP(dollars) = 14400*30
		432000
	CM ratio			50%
	Break even point in units			14400
	Break even point in dollars			432000
2)	increase in contribution			(81000*50%)		40500
	less : increase in advertising budget					6,700
	increase in net income					33,800
	increases by		33,800
3)	units = 12500*2 =		25800 units ; selling price = 30*90%=$27
		Contribution Income statement
	Sales	(25800*27)			696600
	Variable expense		(25800*15)		387000
	Contribution margin				309600
	Fixed expenses		216000+32000		248,000
	Net income				61,600
4)	New contribution margin = 15-.50
			14.5
	BEP(units) = (total fixed cost+target profit)/contribution per unit
		(216000+4400)/14.5
		15200
	Sales units		15,200
5)
	CM ratio = contribution/sales
		18/30
		60.00%
	BEP(units) = total fixed cost/contribution margin per unit
		(216000+55000)/18
		15056
	BEP(dollars) =		271000/60%
		451667
	CM ratio			60%
	Break even point in units			15056
	Break even point in dollars			451667
			20800 units
b)			Not Automated			Automated
			total	per unit	%	total	per unit	%
	Sales		624000	30	100%	624000	30	100%
	Variable expenses		312000	15	60%	249600	12	50%
	Contribution margin		312000	15	40%	374400	18	50%
	Fixed expenses		216,000			271,000
	Net operating income		96,000			103,400
c)		yes