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 (12,700 units × $30 per unit)	$	381,000
Variable expenses		190,500
Contribution margin		190,500
Fixed expenses		213,000
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 $6,700 increase in the monthly advertising budget, combined with an intensified effort by the sales staff, will result in an $83,000 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 $39,000 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 cents per unit. Assuming no other changes, how many units would have to be sold each month to attain a target profit of $4,000?

5. Refer to the original data. By automating, the company could reduce variable expenses by $3 per unit. However, fixed expenses would increase by $51,000 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 20,700 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 20,700)?

Answer 1

1	Compute the company CM ratio and its breakeven point
	Contribution Margin
	Contribution/Sales
	190500/381000
	50%
	Break even point:
	in unit sales:
	Fixed cost/unit contribution per unit
	213000/15
	14200 units
	In dollar sales
	Fixed cost/ contribution Margin
	213000/50%
	$4,26,000

2. The president believes that a $6,700 increase in the monthly advertising budget, combined with an intensified effort by the sales staff, will result in an $83,000 increase in monthly sales. If the president is right, what will be the increase (decrease) in the company’s monthly net operating income?

	$
Incremental contribution Margin ($83000*40%)	33200
Less: Increased advertising cost	-6700
Increase in Monthly operating income	26500
Since the company is showing net loss of $22500, if the changes are adopted then the profit will be $4000 ($26500-22500)

3. Refer to the original data. The sales manager is convinced that a 10% reduction in the selling price, combined with an increase of $39,000 in the monthly advertising budget, will double unit sales. If the sales manager is right, what will be the revised net operating income (loss)?

	$
Sales (25400*$27)	685800
Variable expenses (25400*15)	381000
Contribution	304800
Fixed Cost (213000+39000)	252000
Net income	52800

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 cents per unit. Assuming no other changes, how many units would have to be sold each month to attain a target profit of $4,000?

Units sales to attain target profit

(Target profit+ Fixed expenses)/ contribution per unit

($4000+$213000)/($30 - $15.50)

$217000/$14.50

14965.5

14965 units

5. Refer to the original data. By automating, the company could reduce variable expenses by $3 per unit. However, fixed expenses would increase by $51,000 each month.

1. Compute the new CM ratio and the new break-even point in unit sales and dollar sales.

New contribution Margin
	$
Sales	$30
Variable cost	$12
Contribution per unit	$18
Contribution Margin	60%
Breakeven point:
in unit sales:
Fixed cost/unit contribution per unit
(213000+51000)/18
14667 units
In dollar sales
Fixed cost/ contribution Margin
(213000+51000)60%
440000 sales

1. Assume that the company expects to sell 20,700 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.)

	Not automated				Automated
		Per unit	%		Per unit	%
Sales	$6,21,000	$30	100	$6,21,000	$30	100%
Variable cost	$3,10,500	$15	50%	248400	$12	40%
Contribution per unit	$3,10,500	$15	50%	$3,72,600	$18	60%
Fixed expenses	213000			264000
Net income	$97,500			$1,08,600

1. Would you recommend that the company automate its operations (Assuming that the company expects to sell 20,700)?