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 (13,100 units × $30 per unit)	$	393,000
Variable expenses		196,500
Contribution margin		196,500
Fixed expenses		219,000
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 $6,200 increase in the monthly advertising budget, combined with an intensified effort by the sales staff, will result in an $87,000 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 $40,000 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 $0.70 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 $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 21,000 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 21,000)?

Answer 1

1. Compute the company’s CM ratio and its break-even point in unit sales and dollar sales.

CM Ratio = Contribution/Sales * 100

         = $196500/$393000 * 100 = 50%

BEP in units = Fixed cost/Contribution per unit

Contribution per unit = $196500/13100 units = $15 per unit

$219000/$15 = 14600 units

BEP in dollars = Fixed cost/CM ratio

       = $219000/50% = $438000

2. The president believes that a $6,200 increase in the monthly advertising budget, combined with an intensified effort by the sales staff, will result in an $87,000 increase in monthly sales. If the president is right, what will be the increase (decrease) in the company’s monthly net operating income?

Increase in sales = $87000

Increase in contribution = $87000 * 50% = $43500

Increase in advertising cost = $6200

Increase in net operating income = $43500 - $6200 = $37500

3. Refer to the original data. The sales manager is convinced that a 10% reduction in the selling price, combined with an increase of $40,000 in the monthly advertising budget, will double unit sales. If the sales manager is right, what will be the revised net operating income (loss)?

Units sold * (SP – VC) – Fixed cost – increased advertising cost

Units sold = 13100 * 2 = 26200 units

SP = $30 * 90% = $27

26200 * ($27 - $15) - $219000 - $40000 = $55400

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 $0.70 per unit. Assuming no other changes, how many units would have to be sold each month to attain a target profit of $4,300?

Target Profit = $4300

New VC = $15 + $0.70 = $15.70

Target Profit = Units sold * (SP – VC) – Fixed cost

$4300 = Units sold * ($30 - $15.70) - $219000

Units sold = 15615.38

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.

New VC = $15 - $3 = $12

New Fixed cost = $219000 + $54000 = $273000

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

CM Ratio = Contribution per unit/SP * 100

($30 -$12)/$30 * 100 = 60%

BEP in units = Fixed cost/Contribution per unit

     = $273000/$18 = 15167 units

BEP in dollars = Fixed cost/CM ratio

   = $273000/60% = $455000

b. Assume that the company expects to sell 21,000 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.)

	Not Automated			Automated
	Total	Per Unit	%	Total	Per Unit	%
Sales (21000 units)	$ 630,000	$        30	100%	$ 630,000	$        30	100%
Variable expenses	$ 315,000	$        15	50%	$ 252,000	$        12	60%
Contribution margin	$ 315,000	$        15	50%	$ 378,000	$        18	40%
Fixed expenses	$ 219,000			$ 273,000
Net operating income	$    96,000			$ 105,000

c. Would you recommend that the company automate its operations (Assuming that the company expects to sell 21,000)?

Yes, automation should be done (higher income)