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 (13,100 units × $20 per unit)	$	262,000
Variable expenses		131,000
Contribution margin		131,000
Fixed expenses		146,000
Net operating loss	$	(15,000	)

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 $88,000 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 $31,000 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 $0.80 per unit. Assuming no other changes, how many units would have to be sold each month to attain a target profit of $4,600?

5. Refer to the original data. By automating, the company could reduce variable expenses by $3 per unit. However, fixed expenses would increase by $52,000 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 21,000 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 21,000)?

Answer 1

	PEM.inc Company
	Contribution Income Statement
		Part 1
	Particulars	Amount	Per Unit	CMR
	Sales(13100 units *$20)	$262,000	$20
	Less: Variable Cost	$131,000	$10
	Contribution	$131,000	$10	50%
	Less: Fixed Cost	$146,000
	Income	($15,000)
	* CMR= Contribution Margin Ratio
	Break Even point (In Dollars)	Fixed Cost /CMR
			292,000
	Break Even Point(In units)		Fixed Cost/Contribution per unit
			14600
		Part 2
	Particulars	Amount	Per Unit	CMR
	Sales(17500 units *$20)	$350,000	$20
	Less: Variable Cost	$175,000	$10
	Contribution	$175,000	$10	50%
	Less: Fixed Cost	$152,600
	Income	$22,400
1	New Fixed Cost	$152,600	(increased by $6600)
2	Sales	$350,000	(increased by $88000)
		Part 3
	Particulars	Amount	Per Unit	CMR
	Sales	$471,600	$18
	Less: Variable Cost	$262,000	$10
	Contribution	$209,600	$8	44%
	Less: Fixed Cost	$177,000
	Income	$32,600
1	New Selling price	$18	($20-10%)
2	No. of units	$26,200	(13100*2)
3	New Fixed Cost	$177,000	(increased by $31000)
	Part 4
i	Calculation of contribution per unit
	Sales	$20
	Less: Variable Cost	$10.80
	Contribution	$9
ii	Calculatio of no.of units to earn a net profit of $4600
	No. of units	(Fixed Cost + Profit )/contribution per unit
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