Question

Menlo Company distributes a single product. The company’s sales and expenses for last month follow:

	Total			Per Unit
Sales	$	308,000		$	20
Variable expenses		215,600			14
Contribution margin		92,400		$	6
Fixed expenses		72,000
Net operating income	$	20,400

Required:

1. What is the monthly break-even point in unit sales and in dollar sales?

2. Without resorting to computations, what is the total contribution margin at the break-even point?

3-a. How many units would have to be sold each month to earn a target profit of $31,800? Use the formula method.

3-b. Verify your answer by preparing a contribution format income statement at the target sales level.

4. Refer to part 3 and now assume that the tax rate is 30%. How many units would need to be sold each month to an after-tax target profit of $31,800?  (Round the final answer to the nearest whole number.)

5. Refer to the original data. Compute the company's margin of safety in both dollar and percentage terms. (Round your percentage answer to 2 decimal places (i.e .1234 should be entered as 12.34).)

6. What is the company’s CM ratio? If monthly sales increase by $77,000 and there is no change in fixed expenses, by how much would you expect monthly net operating income to increase?

Answer 1

Answer:

1. Calculation of monthly break-even point in unit & dollar sales:

Break-even point in units = Fixed Costs / Contribution margin per unit

= $72,000 / $6

  = 12,000 Units

Break-even point in sales dollar = (Fixed Costs / Contribution margin per unit) x Sales per unit

= ($72,000 / $6) x $20

= $240,000

2. Total contribution margin at the break-even point is equal to fixed costs i.e. $72,000.

3-a. Calculation of a number of units need to be sold to earn a target profit of $31,800:

Desired no. of units sold = (Fixed Costs + Target income) / Contribution margin per unit

= ($72,000 + $31,800) /$6

= 17,300 Units

3-b. Verification of answer by preparing contribution format income statement at the target sales level:

Menlo Company

Income Statement

	Amount per unit	Amount
Sales	$20	$346,000
Variable expenses	$14	$242,200
Contribution margin	$6	$103,800
Fixed Costs		$72,000
Net operating income		$31,800

4. Refer to part 3 and now assume that the tax rate is 30%, Number of units would need to be sold each month to an after-tax target profit of $31,800:

Desired no. of units = (Fixed Costs + after tax target profit) / Contribution margin per unit

   = ($72,000 + $45,429) /$6

   = 19,572 Units

Note: Calculation of after tax target profit:

After tax target profit = target profit after tax/ 0%

   = $31,800 / 70%

   = $45,429

5. Calculation of margin of safety in both dollar & percentage terms:

Margin of safety in dollars = (Net operating income / Contribution margin per unit) x Sales price per unit

= ($20,400 / $6) x $20

= $68,000

Margin of safety in percentage terms = (Current sales level - Break even sales level) / Current Sales level

= (15,400 -12,000) / 15,400

= 22.08%

or,

Margin of safety in percentage terms = (Margin of safety / Sales)

= $68,000 / $308,000) x 100

= 22.08%

6. Calculation of company CM ratio:

CM Ratio = (Contribution margin / sales) x 100

= ($92,400 / $308,000) x 100

= 30%

If monthly sales increase by $77,000 and there is no change in fixed expenses, then net operating income  would be increase by $23,100 i.e. ($77,000 x 30%).