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 (12,800 units × $30 per unit)	$	384,000
Variable expenses		192,000
Contribution margin		192,000
Fixed expenses		214,500
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 increase unit sales and the total sales by $81,000 per month. 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 $0.60 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 20,600 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 20,600 units)?

Answer 1

Data Given

	Unit	Price	Total Value
Sales	12800	$30	$384000
-Variable cost	12800	$15	($192000)
Contribution		$15	$192000
-Fixed Cost			($214500)
Net operating Loss			($22500)

1. Contribution margin ratio= Contribution/sales*100

= $192000/$384000*100=50%

Break Even Point in Unit sales= Fixed cost/ Contribution per Unit

                            Contribution per unit = $30-$15= $15

Break Even Point              =$214500/$15= 14300 Unit

Break even point in dollar sales= Fixed cost/ Contribution margin ratio

Break Even Point= $214500/50%=$429000

Or Break even point in $ sales can be calculated by multiplying Break even point in unit sales to selling price per unit = 14300*$30=$429000

2. The advertisement expenses is incurred $6700

Total fixed cost will be $214500+$6700=$221200

The sales will be increased by $81000

Total sales= $81000+$384000=$465000

Variable cost was the 50% of sales. It is calculated as follows-

$192000/$384000*100=50%

	Unit	Price	Total Value
Sales	15500	$30	$465000
-Variable cost	15500	$15	($232500)
Contribution		$15	$232500
-Fixed Cost			($221200)
Net operating profit			11300

The net profit is increased by 11300+22500=$33800

The variable cost per unit will be the same i.e. $15. The sales unit will be changed from 12800 to 15500.

Variable cost= $465000*50%=$232500

Sale unit= Total variable cost/ variable cost per unit= $232500/$15=15500

3. Selling price is reduced by 10% i.e. $30-10%=$27

Increase in fixed expenses= $39000

Total fixed expenses=$214500+$39000=$253500

It will double the unit sales

Total sales= 12800*2=25600

	Unit	Price	Total Value
Sales	25600	$27	$691200
-Variable cost	25600	$15	($384000)
Contribution		$12	$307200
-Fixed Cost			($253500)
Revised Net operating profit			53700

4. The packaging cost increase by $0.60 per unit.

Variable cost= $15+$0.60= $15.60

No other changes in original data.

Target profit should be $4600

	Unit	Price	Total Value
Sales	15215	$30	$456450
-Variable cost	15215	$15.60	$237350
Contribution		$14.4	$219100
-Fixed Cost(same)			$214500
Net operating profit(given)			$4600

Contribution per unit= Sales- Variable cost

                                =$30-$15.60=$14.4

Total contribution= Fixed cost+ Net profit

                                =$214500+$4600=$219100

Sales Unit= Total Contribution/ Contribution per unit

                =219100/14.4=15215 unit

15215 units need to be sold each month to attain the profit of $4600.

5. Variable expenses are reduced by $3 i.e. Now the variable expenses per unit= $15-$3=$12

Fixed expenses would increase by $52000 i.e. Now the fixed cost is $214500+$52000=$266500

	Unit	Price	Total Value
Sales	12800	$30	$384000
-Variable cost	12800	$12	($153600)
Contribution		$18	$230400
-Fixed Cost			($266500)
Net operating loss			($36100)

a) Contribution margin ratio= Contribution/sales*100

= $230400/$384000*100=60%

Break Even Point in Unit sales= Fixed cost/ Contribution per Unit

                            Contribution per unit = $30-$12= $18

Break Even Point              =$266500/$18= 14805 Unit

Break even point in dollar sales= Fixed cost/ Contribution margin ratio

Break Even Point= $266500/60%=$444150

Or Break even point in $ sales can be calculated by multiplying Break even point in unit sales to selling price per unit = 14805*$30=$444150

b)

If operations are not automated and sales unit is 20600 and all the data is same as 1^st point except sales unit.

	Unit	Price	Total Value
Sales	20600	$30	$618000
-Variable cost	20600	$15	($309000)
Contribution		$15	$309000
-Fixed Cost			($214500)
Net operating profit			$94500

If operations are automated and units are 20600 and all the data is same as 5^st point except sales unit.

	Unit	Price	Total Value
Sales	20600	$30	$618000
-Variable cost	20600	$12	($247200)
Contribution		$18	$370800
-Fixed Cost			($266500)
Net operating profit			$104300

		Not Automated operations		Automated operations
Sales	$618000		$618000
-Variable cost	($309000)	50%	($247200)	40%
Contribution	$309000	50%	$370800	60%
-Fixed Cost	($214500)		($266500)
Net operating profit	$94500	15.29%	$104300	16.88%

% is calculated on the sales

Net profit= Net profit/ sales*100

Variable cost= Variable cost/sales*100

Contribution= Contribution/ sales*100

c) Yes, I would recommend that the company should automate its operations on 20600 units. The operating profit without automate is 15.29% and with automate is 16.88% hence it leads to more profit hence it should be adopted.