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 (13,000 units × $30 per unit)	$	390,000
Variable expenses		195,000
Contribution margin		195,000
Fixed expenses		217,500
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 $6,000 increase in the monthly advertising budget, combined with an intensified effort by the sales staff, will result in an $83,000 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 $37,000 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 cents 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 $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 20,300 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 20,300)?

Answer 1

1)

a) Contribution Margin (CM) ratio = Contribution Margin / Sales

= $195,000 / $390,000

= 50%

b ) Break-even point in Unit Sales = Fixed costs / (Price per unit - Variable costs per unit)

Price Per Unit = $30

Variable cost per unit = ($195,000 / 13,000 units) = $15 Per unit

Break-even point in Unit Sales = $217,500 / ($30 - $ 15)

= $217,500 / 15

= 14,500 Units to be sold for break-even point

c) Break-even point in Dollar Sales = Fixed expenses / Contribution margin percentage

= $217,500 / 50%

= $435,000 worth sales to be made for break-even point

2)

Incremental contribution of margin
($83,000 increase sales * 50% CM)	$41,500
Less advertising costs	($6,000)
Change in monthly operating income	$35,500

If the president is right, the company's loss will be turn into net operating profit of $13,000 ($35,500 - Loss of $22,500)

3)

If the sales manager is right, the revised net operating profit will be $57,500

4)

Units Required to Earn Profit = Total fixed costs + Target profit / Contribution margin per unit

= $217,500 + $4,600 / ($30 - $15.4)

= 15,212 Units

$30 is selling price per unit, $15.4 is varible cost per unit ($15 privious + 0.4 increase in packaging cost)

5)

a) CM ratio = (($30 - ($15 - $3)) / $30 * 100 = 60%

$30 is Selling price per unit, $15 is old variable cost, $3 is Varibale cost reduced due to automation

BEP units = Fixed costs / Contribution margin

= ($217,500 + $58,000) / $12

= 22,958 Units

BEP Dollar = Fixed costs / Contribution margin ratio

=  ($217,500 + $58,000) / 60%

= $459,167