Question

Problem 5-22 CVP Applications; Contribution Margin Ratio; Break-Even Analysis; Cost Structure [LO5-1, LO5-3, LO5-4, LO5-5, LO5-6]

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 (13,200 units × $20 per unit)	$	264,000
Variable expenses		158,400
Contribution margin		105,600
Fixed expenses		117,600
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 $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 $34,000 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 $4,600?

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 20,100 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 20,100)?

Answer 1

Original Data:

Selling Price per unit = $20.00

Variable Cost per unit = Variable Expenses / Number of units sold
Variable Cost per unit = $158,400 / 13,200
Variable Cost per unit = $12.00

Contribution Margin per unit = Selling Price per unit - Variable Cost per unit
Contribution Margin per unit = $20.00 - $12.00
Contribution Margin per unit = $8.00

Answer 1.

Contribution Margin Ratio = Contribution Margin per unit / Selling Price per unit
Contribution Margin Ratio = $8.00 / $20.00
Contribution Margin Ratio = 40%

Breakeven Point in unit sales = Fixed Expenses / Contribution Margin per unit
Breakeven Point in unit sales = $117,600 / $8.00
Breakeven Point in unit sales = 14,700

Breakeven Point in dollar sales = Fixed Expenses / Contribution Margin Ratio
Breakeven Point in dollar sales = $117,600 / 0.40
Breakeven Point in dollar sales = $294,000

Answer 2.

Increase in Sales = $87,000
Increase in Fixed Expenses = $6,200

Increase in Net Operating Income = Increase in Sales * Contribution Margin Ratio - Increase in Fixed Expenses
Increase in Net Operating Income = $87,000 * 0.40 - $6,200
Increase in Net Operating Income = $28,600

Answer 3.

Selling Price per unit = $20.00 - 10% * $20.00
Selling Price per unit = $18.00

Fixed Expenses = $117,600 + $34,000
Fixed Expenses = $151,600

Number of units sold = 2 * 13,200
Number of units sold = 26,400

Net Operating Income (Loss) = Number of units sold * (Selling Price per unit - Variable Cost per unit) - Fixed Expenses
Net Operating Income (Loss) = 26,400 * ($18.00 - $12.00) - $151,600
Net Operating Income (Loss) = $6,800

Answer 4.

Variable Cost per unit = $12.00 + $0.70
Variable Cost per unit = $12.70

Contribution Margin per unit = Selling Price per unit - Variable Cost per unit
Contribution Margin per unit = $20.00 - $12.70
Contribution Margin per unit = $7.30

Required Unit Sales = (Fixed Expenses + Target Profit) / Contribution Margin per unit
Required Unit Sales = ($117,600 + $4,600) / $7.30
Required Unit Sales = 16,740

Answer 5-a.

Variable Cost per unit = $12.00 - $3.00
Variable Cost per unit = $9.00

Fixed Expenses = $117,600 + $57,000
Fixed Expenses = $174,600

Contribution Margin per unit = Selling Price per unit - Variable Cost per unit
Contribution Margin per unit = $20.00 - $9.00
Contribution Margin per unit = $11.00

Contribution Margin Ratio = Contribution Margin per unit / Selling Price per unit
Contribution Margin Ratio = $11.00 / $20.00
Contribution Margin Ratio = 55%

Breakeven Point in unit sales = Fixed Expenses / Contribution Margin per unit
Breakeven Point in unit sales = $174,600 / $11.00
Breakeven Point in unit sales = 15,873

Breakeven Point in dollar sales = Fixed Expenses / Contribution Margin Ratio
Breakeven Point in dollar sales = $174,600 / 0.55
Breakeven Point in dollar sales = $317,455

Answer 5-b.

Answer 5-c.

Yes, company should automate its operations