Question

Due to erratic sales of its sole product—a high-capacity battery for laptop computers—PEM, Inc., has been experiencing 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:

5.	Refer to the original data. By automating, the company could reduce variable expenses in half. However, fixed expenses would increase by $60,000 each month.

  

a.	Compute the new CM ratio and the new break-even point in both unit sales and dollar sales. (Use the CM ratio to calculate your break-even point in dollars. Do not round your intermediate calculations. Round up your final break even answers to the nearest whole number.)

  

  

b.	Assume that the company expects to sell 20,500 units next month. Prepare two contribution format income statements, one assuming that operations are not automated and one assuming that they are.

  

c.	Would you recommend that the company automate its operations?
	Yes No

Answer 1

5.

Variable cost per unit = $152,400 / 12,700 units

= $12

By automating, variable cost = $12 / 2

= $6

Fixed cost = $113,600

By automating, fixed cost = $113,600 + $60,000

= $173,600

a.

New CM ratio = (Selling price - variable cost per unit) / Selling price

= ($20 - $6) / $20

= 70%

Break even point in units = Fixed cost / contribution margin per unit

= $173,600 / ($20 - $6)

= $173,600 / $14

= 12,400 units

Break even point in sales dollar = Fixed cost / contribution margin ratio

= $173,600 / 70%

= $248,000

b.

Automated

Sales (20,500 * $20)	$410,000
(-) Variable cost ($20,500 * $6)	$123,000
Contribution margin	$287,000
(-) Fixed costs	$173,600
Net operating income	$113,400

Non Automated

Sales (20,500 * $20)	$410,000
(-) Variable cost (20,500 * $12)	$246,000
Contribution margin	$164,000
(-) Fixed costs	$113,600
Net operating income	$50,400

c.

Yes, because net operating income in automated is more than the net operating income in non automated.