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 companies contribution format income statement for the most recent month is given below:

Sales (19,500 units x $30 per unit) $585,000

Variable expenses 409,500

Contribution margin 175,500

Fixed expenses 180,000

Net operating loss $(4,500)

1) Compute the company's CM ratio and its break-even point in unit sales and dollar sales.

2) The president believes that a $16,000 increase in the monthly advertising budget , combined with an intensified effort by the sales staff, will result in an $80,000 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 $60,000 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 75 cents per unit. Assuming no other changes, how many units would have to be sold each month to attain a target profit of $9,750?

5) Refer to the original data. By automating, the company could reduce variable expenses by $3 per unit. However fixed expenses would increase by $72,000 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 26,000 units next month. Prepare two contribution format income statements, one assuming that the 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 the company automate its operations? Explain

Answer 1

1. Contribution margin per unit = $ ( 30 - 21 ) = $ 9

Contribution margin ratio = $ 9 / $ 30 * 100 = 30 %

Break-even point in units = Fixed Expenses / Contribution Margin per Unit = $ 180,000 / $ 9 = 20,000 units

Break-even sales dollars = Fixed Expenses / Contribution Margin Ratio = $ 180,000 / 30 % = $ 600,000.

2. Increase ( decrease ) in monthly net operating income = $ 80,000 x 30 % - $ 16,000 = $ 8,000 increase

3. Revised sales price = $ 27

Revised unit sales = 19,500 x 2 = 39,000

Revised contribution margin = $ 27 - $ 21 = $ 6

Revised net operating income ( loss ) = 39,000 x $ 6 - $ ( 60,000 + 180,000) = $ ( 6,000 ) net operating loss.

4. Variable cost per unit = $ 21 + $ 0.75 = $ 21.75

Contribution margin per unit = $ 30 - $ 21.75 = $ 8.25

Sales required for target profit of $ 9,750 = $ ( 180,000 + 9,750 ) / $ 8.25 = 23,000 units.

5. a. New CM ratio = $ 12 / $ 30 * 100 = 40 %

New break-even point in units = $ ( 180,000 + 72,000 ) / $ 12 = 21,000 units

New break-even sales dollars = $ ( 180,000 + 72,000 ) / 40 % = $ 630,000.

b.

Contribution Margin Income Statement
	No Automation			Automation
	Per Unit	Total	%	Per Unit	Total	%
Sales	$ 30	$ 780,000	100 %	$ 30	$ 780,000	100 %
Variable Expenses	21	546,000	70	18	468,000	60
Contribution Margin	9	234,000	30	12	312,000	40
Fixed Expenses		180,000			252,000
Net Operating Income ( Loss )		$ 54,000	6.92		$ 60,000	7.69

c. Yes.. Though breakeven point increases on automation from 20,000 units to 21,000 units, the contribution margin ratio increases from 30 % to 40 %. This means that after break-even is achieved, the rate of earning profit would be higher if automation is implemented. But it all depends on how much is the demand for the product.