Question

Memofax, Inc. produces memory enhancement software for computers. Sales have been very erratic, with some months showing a profit and some months showing a loss. The company’s contribution format income statement for the most recent month is given below:

  

Sales (17,500 units at $20 per unit)	$	350,000
Less: Variable expenses		210,000
Contribution margin		140,000
Less: Fixed expenses		147,000
Net operating loss	$	(7,000)

Required:

1.	Compute the company’s CM ratio and its break-even point in both units and dollars.

      

2.

The sales manager feels that an $19,000 increase in the monthly advertising budget, combined with an intensified effort by the sales staff, will result in a $125,000 increase in monthly sales. If the sales manager is right, what will be the effect on the company’s monthly net operating income or loss? (Use the incremental approach in preparing your answer.)

    

3.	Refer to the original data. The president is convinced that a 10% reduction in the selling price, combined with an increase of $75,000 in the monthly advertising budget, will double unit sales. What will the new contribution format income statement look like if these changes are adopted?

    

4.	Refer to the original data. The company’s advertising agency thinks that a new package would help sales. The new package being proposed would increase packaging costs by $0.5 per unit. Assuming no other changes, how many units would have to be sold each month to earn a profit of $6,750? (Do not round intermediate calculations.)

      

  

5.	Refer to the original data. By automating, the company could slash its variable expenses in half. However, fixed costs would increase by $49,000 per month.

a.	Compute the new CM ratio and the new break-even point in both units and dollars. (Do not round intermediate calculations. Round "Contribution Margin Ratio" to 2 decimal places.)

            

b.	Assume that the company expects to sell 25,000 units next month. Prepare two contribution format income statements: one assuming that operations are not automated, and one assuming that they are. (Do not round intermediate calculations. Round "Per Unit" and "Percentage" to 2 decimal places.)

            

Answer 1

Req 1 :
Contribution margin per unit = Contribution margin / Units sold = 140000 / 17500	8
CM ratio = Contribution margin / Sales = 140000 / 350000	40%
Break-even point in units = Fixed expenses / Contribution margin per unit = 147000 / 8	18375
Break-even point in dollars = Fixed expenses / Contribution margin ratio = 147000 / 40%	367500

Req 2 :
Increase in Contribution margin ( Increase in sales * Contribution margin ratio = 125000* 40% )	50000
(-) Increase in advertising budget	19000
Increase (decrease) in net operating income	31000
Increase in monthly net operating income	31000

Req 3 :
Revised selling price = Current selling price * ( 1 - % reduction ) = 20 * ( 1 - 10% )	18
Current unit variable cost = Variable expenses / Units sold = 210000 / 17500	12
Revised fixed costs = Current fixed costs + Increase in advertising expense = 147000 + 75000	222000
Revised sales units = Current sales units * 2 = 17500 * 2	35000

Sales ( 35000 * 18 )	630000
(-) Variable expenses ( 35000 * 12 )	420000
Contribution margin	210000
(-) Fixed expenses	222000
Net operating loss	(12000)

Req 4 :
Revised unit variable cost = Current unit variable cost + 0.50 = 12 + 0.50	12.50
Units sales to attain target profit = ( Target profit + Fixed expenses ) / ( Selling price - Unit variable cost ) = ( 6750 + 147000 ) / ( 20 - 12.50 )	20500

Req 5A :
Current unit variable cost = Variable expenses / Units sold = 210000 / 17500	12
Revised unit variable cost = 12 * 1/2	6
Revised fixed expenses = 147000 + 49000	196000
Contribution margin per unit = Selling price - Unit variable cost = 20 - 6	14
CM ratio = Contribution margin per unit / Selling price = 14 / 20	70%
Break-even point in unit sales = Fixed costs / Contribution margin per unit = 196000 / 14	14000
Break even point in dollar sales = Fixed costs / CM ratio = 196000 / 70%	280000

Req 5B :
	Not automated			Automated
	Total	Per unit	%	Total	Per unit	%
Sales	500000	20.00	100.00%	500000	20.00	100.00%
Variable expenses	300000	12.00	60.00%	150000	6.00	30.00%
Contribution margin	200000	8.00	40.00%	350000	14.00	70.00%
Fixed expenses	147000			196000
Net operating income	53000			154000