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 (12,800 units × $30 per unit)	$	384,000
Variable expenses		230,400
Contribution margin		153,600
Fixed expenses		171,600
Net operating loss	$	(18,000	)

Required:

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 $4,200?

5. Refer to the original data. By automating, the company could reduce variable expenses by $3 per unit. However, fixed expenses would increase by $54,000 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 20,700 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 20,700)?

Answer 1

Solution 3:

New selling price per unit = $30 * 90% = $27 per unit

New contribution margin per unit = $27 - ($230,400 / 12800) = $9 per unit

New fixed costs = $171,600+ $33,000 = $204,600

New sales volume = 12800*2 = 25600 units

New operating income = Contribution margin - Fixed Costs = (25600*$9) - $204,600 = $25,800

solution 4:

New contribution margin per unit = $12 - $0.50 = $11.50 per unit

Nos of units to be sold to attain target profit = (Fixed costs + Target income) / Contribution margin per unit

= ($171,600 + $4,200) / $11.50 = 15287 units

Solution 5a:

New contribution margin per unit = $12 + $3 = $15 per unit

New CM ratio = $15/ $30 =50%

New fixed costs = $171,600 + $54,000 = $225,600

new breakeven point in unit sales = $225,600 / $15 = 15040 units

Breakeven dollar sales = $225,600 / 50% = $451,200

Solution 5b:

Contribution format income statement - Operation Automated
Particulars	Per unit	%	Total
Sales	$30.00	100%	$621,000.00
Variable costs	$15.00	50%	$310,500.00
Contribution margin	$15.00	50%	$310,500.00
Fixed costs			$225,600.00
Net operating income			$84,900.00

Contribution format income statement - Operation not Automated
Particulars	Per unit	%	Total
Sales	$30.00	100%	$621,000.00
Variable costs	$18.00	60%	$372,600.00
Contribution margin	$12.00	40%	$248,400.00
Fixed costs			$171,600.00
Net operating income			$76,800.00

Solution 5c:

As net operating income is increasing, it is recommended that the company automate its operations.