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 (12,800 units × $30 per unit) $ 384,000

Variable expenses 192,000

Contribution margin 192,000

Fixed expenses 214,500

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 $6,600 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 $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 per unit. Assuming no other changes, how many units would have to be sold each month to attain a target profit of $4,500?

5. Refer to the original data. By automating, the company could reduce variable expenses by $3 per unit. However, fixed expenses would increase by $54,000 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 20,000 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 20,000)?

Answer 1

1	CM ratio = Contribution Margin / Sales
		= 192,000 / 384,000
		= 50%
	Break Even Point ( Units sales ) = Fixed expenses / Contribution margin per unit
	Contribution margin per unit = $ 192,000 / 12,800 units
			= $ 15 per unit
	Break Even Point ( Units sales ) = $ 214,500 / $ 15
				= 14,300 units
	Break Even Point ( Dollar sales ) = Fixed expenses / Contribution margin ratio
				= $ 214,500 / 50%
				= $ 429,000
2	Increase in Fixed Cost = $ 6,600
	Increase in Sales = $ 85,000
	Increase in Operating Income = ( Increase in Sales * Contribution margin ratio ) - Increase in Fixed cost
				= ( 85,000 * 50% ) - $ 6,600
				= $ 35,900
	Increase in Operating Income by $ 35,900
3	Old selling Price = $ 30
	New Selling Price = $ 30* 90% = $ 27
	New Fixed expenses = $ 214,500 + $ 37,000 = $ 251,500
	New sales Unit = 12,800 * 2 = 25,600 units
	Sales ( 25,600 * 27 )	691200
	Variable expenses ( 25,600 * 15 )	384000
	Contribution margin	307200
	Fixed expenses	251500
	Net operating income / ( loss )	55700
4	Target Profit = $ 4,500
	Sales Price = $ 30
	Variable Cost= $ 15 + $ 0.40 = $ 15.40
	Unit sales = ( $ 214,500 + $ 4,500 ) / ( $ 30 - $ 15.40 )
	= 15,000 units
5 - a	New variable Cost = $ 15 - $ 3 = $ 12
	Contribution margin per Unit = $ 30 - $ 12 = $ 18
	Total Contribution Margin = 12800 units * $ 18 = $ 230,400
	new fixed cost = $ 214,500 + $ 54,000 = $ 268,500
	CM ratio = $ 230,400 / 384,000
	= 60%
	Break Even Point ( Unit sales ) = $ 268,500 / $ 18
	= 14,917 units
	Break Even Point ( Dollar sales ) = $ 268,500 / 60%
	= $ 447,500
5 - b	Contribution Margin Income Statement
		Not Automated			Automated
		Per Unit	Total	%	Per Unit	Total	%
	Sales	30	600000	100	30	600000	100
	Variable expenses	15	300000	50	12	240000	40
	Contribution margin	15	300000	50	18	360000	60
	Fixed expenses		214500			268500
	Net operating income / ( loss )		85500			91500
5 - c	Yes, the company should automte its operations