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 × $40 per unit) $ 508,000 Variable expenses 254,000 Contribution margin 254,000 Fixed expenses 284,000 Net operating loss $ (30,000) Required: 1. Compute the company’s CM ratio and its break-even point in both 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 $82,000 increase in monthly sales. If the president is right, what will be the effect on the company’s monthly net operating income or loss? (Use the incremental approach in preparing your answer.) 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. What will the new contribution format income statement look like if these changes are adopted? 4. Refer to the original data. The Marketing Department thinks that a fancy new package for the laptop computer battery would help 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 earn a profit of $4,300? (Do not round your intermediate calculations. Round your final answer to nearest whole number.) 5. Refer to the original data. By automating, the company could reduce variable expenses in half. However, fixed expenses would increase by $52,000 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 20,300 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

Solution
1)
The CM ratio is 50%.
Total Per Unit Percent of Sales

Sales (12,700 units) $ 508,000 $ 40 100 %

Variable expenses $ 254000 $ 20 50 %

Contribution margin $ 254,000 $ 20 50 %

Break even in units = Fixed cost/cm per unit = 284000/20 = 14200
Break even in sales = Fixed cost/cm ratio = 284000/0.5 = 568000

2)
Incremental contribution margin:

$82,000 increased sales × 50% CM ratio $ 41,000

Less increased advertising cost $ 6,000

Increase in monthly net operating income $ 35,000

Since the company is now showing a loss of $30,000 per month, if the changes are adopted, the loss will turn into a profit of $ 5,000 each month ($35,000 less $30,000 = $5000)
3)
Sales: (25,400 units @ $36.00 per unit*) $914,400
Variable expenses: (25,400 units @ $18 per unit) ($457,200)
Contribution margin: (25,400 units @ $18 per unit) $457,000
Fixed expenses:($280,000 + $37,000) ($317,000)
Net Income $ 140,000
4)
Profit = Unit CM × Q ? Fixed expenses
$4,300 = ($40.00 ? $20.50*) × Q ? $284,000
$4,300 = ($19.50) × Q ? $284,000
19.50Q = $288,300
Q = $288,300 ÷ $19.50
Q = 14,785 units

*$20.00 + $0.50 = $20.50.