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 (12,500 units × $30 per unit)	$	375,000
Variable expenses		187,500
Contribution margin		187,500
Fixed expenses		210,000
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 $6,900 increase in the monthly advertising budget, combined with an intensified effort by the sales staff, will result in an $85,000 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 $0.50 per unit. Assuming no other changes, how many units would have to be sold each month to attain a target profit of $4,300?

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 20,100 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

Req 1 :
Contribution margin per unit = Contribution margin / Units sold = 187500 / 12500 =	15
CM ratio = Contribution margin / Sales = 187500 / 375000 =	50%
Break-even point in units = Fixed expenses / Contribution margin per unit = 210000 / 15 =	14000
Break-even point in dollars = Fixed expenses / Contribution margin ratio = 210000 / 50% =	420000

Req 2 :
Increase in Contribution margin ( Increase in sales * Contribution margin ratio = 85000 * 50% )	42500
(-) Increase in advertising budget	6900
Increase (decrease) in net operating income	35600

Increase in monthly net operating income

35600

Req 3 :
Revised selling price = Current selling price * ( 1 - % reduction ) = 30 * ( 1 - 10% ) =	27
Current unit variable cost = Variable expenses / Units sold = 187500 / 12500 =	15
Revised fixed costs = Current fixed costs + Increase in advertising expense = 210000 + 34000 =	244000
Revised sales units = Current sales units * 2 = 12500 * 2 =	25000

Sales ( 25000 * 27 )	675000
(-) Variable expenses ( 25000 * 15 )	375000
Contribution margin	300000
(-) Fixed expenses	244000
Net operating Income (loss)	56000

Revised net operating Income (loss)

56000

Req 4 :
Revised unit variable cost = Current unit variable cost + 0.50 = 15 + 0.50 =	15.50
Units sales to attain target profit = ( Target profit + Fixed expenses ) / ( Selling price - Unit variable cost ) = ( 4300 + 210000 ) / ( 30 - 15.50 ) =	14779

Req 5A :
Current unit variable cost = Variable expenses / Units sold = 187500 / 12500 =	15
Revised unit variable cost = 15 - 3 =	12
Revised fixed expenses = 210000 + 58000 =	268000
Contribution margin per unit = Selling price - Revised Unit variable cost = 30 - 12 =	18
CM ratio = Contribution margin per unit / Selling price = 18 / 30 =	60%
Break-even point in unit sales = Fixed costs / Contribution margin per unit = 268000 / 18 =	14889
Break even point in dollar sales = Fixed costs / CM ratio = 268000 / 60% =	446667

Req 5B :
	Not automated	Automated
	Total	Per unit	%	Total	Per unit	%
Sales	603000	30.00	100.00%	603000	30.00	100.00%
Variable expenses	301500	15.00	50.00%	241200	12.00	40.00%
Contribution margin	301500	15.00	50.00%	361800	18.00	60.00%
Fixed expenses	210000			268000
Net operating income	91500			93800

Req 5C :

Answer : Yes

Explanation : If the company sells 20100 units, then the company will earn more net operating income if it automates its operations.