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		192,000
Contribution margin		192,000
Fixed expenses		214,500
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 $6,900 increase in the monthly advertising budget, combined with an intensified effort by the sales staff, will increase unit sales and the total sales by $89,000 per month. 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 $35,000 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 $0.40 per unit. Assuming no other changes, how many units would have to be sold each month to attain a target profit of $4,100?

5. Refer to the original data. By automating, the company could reduce variable expenses by $3 per unit. However, fixed expenses would increase by $57,000 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 20,600 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 20,600 units)?

Answer 1

	Total	Per unit	Percent of sales
Sales (12800 units)	384,000	$ 30 per unit	100%
Variable expenses	192,000	15	50%
Contribution margin	192,000	15	50%

1.

Contribution margin ratio is 50%

Break-even point shall be:

Unit sales to breakeven = Fixed expenses/unit contribution margin = 214,500/15 = 14,300 units

Dollar sales to breakeven = Fixed expenses/CM ratio = 214,500/0.5 = $ 429,000

2.

$89,000 increased sales X Contribution ratio 50%	44,500
Less: increased advertising cost	6900
Increase in net monthly operating income	37,600

Currently the company is making loss of 22,500 which shall be increased by 37,600 when the sales are increased. The profit would turn into 37600-22500 = $15,100

3.

New selling price = 30 -10% of 30 = $ 27

Sales (12800 *2 =25,600) = 25600*27	691,200
Variable expenses (25600*15)	384000
Contribution margin	307,200
Fixed expenses (214500+35000)	249,500
Operating gain	57,700

4.

New contribution margin = 15- 0.40 = 14.6

Unit sales to attain target profit = (Target profit +Fixed expenses)/ CM per unit

                                                                = (4100+214,500)/14.6

                                                                = 14972.60 units rounded off to 14973 units

5. Reducing variable expenses by $ 3 and increasing fixed cost by 57,000

	Total	Per unit	Percent of sales
Sales (12800 units)	384,000	$ 30 per unit	100%
Variable expenses	153600	15-3 = 12	40 %
Contribution margin	230,400	18	60%

Contribution margin ratio is 60%

Break-even point shall be:

Unit sales to breakeven = Fixed expenses/unit contribution margin = (214,500+57,000)/18 = 15083.3 units

Dollar sales to breakeven = Fixed expenses/CM ratio = (214,500+57000)/0.6 = $ 452,500

b.

Contribution margin statement

For 20,600 units	Non-automated	Automated
	Total	Per unit	%	Total	Per unit	%
Sales	618,000	30	100	618000	30	100
Variable expenses	309,000	15	50	247,200	12	40
Contribution margin	309,000	15	50	370,800	18	60
Fixed expenses	214,500			271500
Net operating income	94,500			99,300

c. Automation should be recommended as there is more net operating income than non-automated