Question

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

	Total			Per Unit
Sales	$	608,000		$	40
Variable expenses		425,600			28
Contribution margin		182,400		$	12
Fixed expenses		147,600
Net operating income	$	34,800

Required:

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

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

c. How many units would have to be sold each month to attain a target profit of $64,800?

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

e. Refer to the original data. Compute the company's margin of safety in both dollar and percentage terms.

f. What is the company’s CM ratio? If sales increase by $52,000 per month and there is no change in fixed expenses, by how much would you expect monthly net operating income to increase?

Answer 1

1.

Profit	= Unit CM × Q − Fixed expenses
$0	= ($40 − $28) × Q − $147,600
$0	= ($12) × Q − $147,600
$12Q	= $147,600
Q	= $147,600 ÷ $12
Q	= 12,300 units, or at $40 per unit, $492,000

Alternative solution:

Unit sales to break even

= Fixed expenses / Unit contribution margin

= $147,600 / 12 = 12,300 units

Or at $40 per unit , $492,000.

2.

The contribution margin is $147,600 because the contribution margin is equal to the fixed expenses at the break-even point.

3. Units sold to attain target profit

= Target profit + Fixed expenses. / Unit contribution margin

= $64,800 + $147,600 / $12

= 17,700 units.

4.

	Total	Unit
Sales (17,700 units × $40 per unit)	$708,000	$40
Variable expenses (17,700 units × $28 per unit)	495,600	28
Contribution margin	212,400	$12
Fixed expenses	147,600
Net operating income	$ 64,800

5.   Margin of safety in dollar terms:

= Total sales – Break even sales

= $608,000 – $492,000

= $116,000.

Margin of safety in percentage terms:

= Margin of safety in dollars / Total sales

= $116,000 / $608,000

= 19%

6. $52,000 incremental sales × 30% ( $182,400 / $608,000 ) CM ratio = $15,600

Given that the company’s fixed expenses will not change, monthly net operating income will also increase by $15,600.