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 (13,500 units × $20 per unit)	$	270,000
Variable expenses		162,000
Contribution margin		108,000
Fixed expenses		120,000
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 $6,400 increase in the monthly advertising budget, combined with an intensified effort by the sales staff, will result in an $86,000 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 $36,000 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 per unit. Assuming no other changes, how many units would have to be sold each month to attain a target profit of $4,900?

5. Refer to the original data. By automating, the company could reduce variable expenses by $3 per unit. However, fixed expenses would increase by $55,000 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 20,800 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 20,800)?

Answer 1

Part 1 –

Contribution Margin Ratio
Unit Selling Price (A)	$20.00
Less: Unit Variable Cost (B) ($162,000 / 13,500 Units)	$12.00
Unit Contribution Margin (A - B)	$8.00
Contribution Margin Ratio	40.00%

Break Even Point in Unit Sales
Total Fixed Cost	$120,000
Contribution Margin Per Unit	$8.00
Break Even Point in Units (Fixed Cost / Unit CM)	15000	Units

Break Even Point in dollar sales
Total Fixed Cost	$120,000
Contribution Margin Ratio (Refer Note 1)	40.00%
Break Even Point in dollar sales (Fixed Cost / CM Ratio)	$300,000

Part 2 –

Increase (decrease) in the company’s monthly net operating income
Increase in Contribution Margin (Increase in Sales $86,000 * 40%)	$34,400
Less: Increase in Monthly Advertising Expense	-$6,400
Increase in monthly net operating income	$28,000

Part 3 –

Revised Net Operating Income (loss)
Sales (13,500*2 = 27,000 Units *$18)	$486,000
Variable Expenses (27,000 Units * $12)	$324,000
Contribution Margin	$162,000
Fixed Expenses (120,000 + 36,000)	$156,000
Revised Net Operating Income	$6,000

Part 4 –

Number of Units to be sold to attain target profit
Total Fixed Costs	$120,000
Plus: Target Profit	$4,900
	$124,900
Contribution Margin Per Unit (Refer note 1)	$7.50
Break Even Point in unit sales ($124,900 / $7.50)	16653	Units

Note 1 –

Unit Selling Price	$20.00
Less: New Variable Cost per Unit (Old $12 + Increase in packing cost $0.50)	$12.50
Contribution Margin Per Unit	$7.50

Hope the above calculations, working and explanations are clear to you and help you to understand the concept of question.... please rate my answer...in case any doubt, post a comment and I will try to resolve the doubt ASAP…thank you

Pls ask separate question for other parts problems