Question

Menlo Company distributes a single product. The company’s sales and expenses for last month follow:

	Total			Per Unit
Sales	$	304,000		$	20
Variable expenses		212,800			14
Contribution margin		91,200		$	6
Fixed expenses		73,200
Net operating income	$	18,000

Required:

1. What is the monthly break-even point in unit sales and in dollar sales?

2. Without resorting to computations, what is the total contribution margin at the break-even point?

3-a. How many units would have to be sold each month to attain a target profit of $31,800?

3-b. Verify your answer by preparing a contribution format income statement at the target sales level.

4. Refer to the original data. Compute the company's margin of safety in both dollar and percentage terms.

5. What is the company’s CM ratio? If sales increase by $95,000 per month and there is no change in fixed expenses, by how much would you expect monthly net operating income to increase?

Answer 1

Answer:

1. Calculation of the monthly break-even point in unit sales and in dollar sales:

Break-even (In Units) = Fixed Costs / Contribution margin per unit

= $73,200 / $6

= 12,200 Units

Break-even (In dollar sales) = (Fixed Costs / Contribution margin per unit) x Unit selling price

= ($73,200 / $6) x $20

  = 244,000 Units

2. The total contribution margin at the break-even point is equal to fixed costs i.e. $73,200.

3-a. Determination of the number of units that would have to be sold each month to attain a target profit of $31,800.

No. of Units required to be sold = (Fixed costs + Target profit) / Contribution margin per unit

= ($73,200 + $31,800) / $6

= 17,500 units.

3-b. preparation of contribution format income statement at the target sales level:

Particulars	Amount
Sales (17,500 x 20)	$350,000
Variable costs (17,500 x $14)	($245,000)
Contribution margin	$105,000
Fixed costs	($73,200)
Net operating income	$31,800

4.Computation of the company's margin of safety in both dollar and percentage terms:

Margin of safety (In dollars) = (Profit / Contribution margin per unit) x Unit Selling price

  = ($18,000 / $6) x $20

  = $60,000

Margin of safety (In percentage) = Margin of safety / Sales

= $60,000 / $304,000

= 19.74%

5. Calculation of CM ratio:

CM ratio = Contribution margin / Sales

= $91,200 / $304,000

= 30%

Evaluation of impact on net operating income If sales increase by $95,000 per month and there is no change in fixed expenses:

Particulars	Amount
Sales ($304,000 + 95,000)	$399,000
Variable costs	($279,300)
Contribution margin	$119,700
Fixed costs	($73,200)
Net operating income	$46,500

Therefore, If sales increase by $95,000 per month and there is no change in fixed expenses then net operating income is increased by $28,500 i.e. ($46,500-$18,000).

Alternatively, we can can directly evaluate the impact of an increase in sales by $95,000 per month on net operating income by multiplying the increased sales with contribution margin ratio i.e. ($95,000 x 30%).