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 (12,700 units × $20 per unit)	$	254,000
Variable expenses		152,400
Contribution margin		101,600
Fixed expenses		113,600
Net operating loss	$	(12,000	)

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 $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 $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 $4,300?

5. Refer to the original data. By automating, the company could reduce variable expenses by $3 per unit. However, fixed expenses would increase by $58,000 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 20,200 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 20,200)?

Answer 1

1.particulars    per unit   total

sales           20           254000

variable cost(1524000/12700) 12            152400

contribution                            08            101600

fixed cost                                               113600

profit/(loss)                                            (12000)

( a)CM Ratio =(contribution margin/sales)*100             (b) Break even point = fixed cost/contribution per unit

                 =(101600/254000)*100                                  (units)                    =113600/8

                 =40%                                                                                       =14200 (units)

   (c) Break even points value = fixed cost/p v ratio

                                           =113600/40%

                                           =284000

2. advertisement is treated as fixed cost so total fixed cost=113600+6200 =119800

increase in sales, so total sales= 254000+81000 =335000     increase in variable cost so total variable cost = (per unit is constant) =8*12700+4050*8 =134000

statement of operating income

sales (254000+81000) = 335000

variable expenses        = 134000

contribution margin      = 201000

fixed expenses            = 119800

net operating profit       = 81200

3.present s.p = 20 reduction = 10%(20) =2 so proposed s.p =20-2 = 18

so total fixed expenses = 113600+33000=146600

so total sales =12700*2 = 25400*18 =457200

so total variable cost =152400/12700 =12*25400 = 304800

statement of operating income

sales    = 457200

variable expenses        = 304800

contribution margin      = 152400

fixed expenses            = 146600

net operating profit       = 5800

4. 0.50 cents = 0.005 dollars

packing cost is variable cost so total variable cost =12-0.005=11.995                      cross check (14728.29*20) =294565.8

given target profit = 4300                                                                                    variable cost(14728.29*11.995) =176665.8

fixed cost does not change = 113600                                                                  contribution                           = 117900

so contribution = 113600+4300 = 117900                                                             fixed cost                              = 113600

so new contribution per unit = 20-11.995 = 8.005                                                profit                                     = 4300

so new sales units to be sold =117900/8.005 = 14728.29 units

5.a. so new variable cost = 12-3 = 9(12700*9)=114300

   so new fixed cost     = 113600+58000 =171600

    sales = 254000(12700*20)

contribution = (20-9)=11/unit= 254000-114300 = 139700

so CM ratio = 139700/254000 =55%

so break even point (units) = fixed cost/contribution per unit   = 171600/11 = 15600 units.

so break even point(sales value) =fixed cost /p v ratio =171600/55% =312000

b.Income statements

particulars                    present with out automation(20200)              proposed with automation(20200)

                                           per unit   percentage    total                       per unit     percentage         total

sales                                20          100%           404000                                   20          100%              404000

variable cost                                    12         60%    242400                                   09        45%    181800

contribution 08       40%     161600 11 55%    222200

fixed cost    28.12%     113600 42.48% 171600

operating income     11.88%      48000    12.52%        50600

c. company should automate its operations since it will give higher operating income of 50600 compared to 48000