Question

Problem 5-22 CVP Applications; Contribution Margin Ratio; Break-Even Analysis; Cost Structure [LO5-1, LO5-3, LO5-4, LO5-5, LO5-6]

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 × $20 per unit)	$	254,000
Variable expenses		152,400
Contribution margin		101,600
Fixed expenses		113,600
Net operating loss	$	(12,000	)

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 $6,000 increase in the monthly advertising budget, combined with an intensified effort by the sales staff, will result in an $87,000 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 $36,000 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 0.70 cents per unit. Assuming no other changes, how many units would have to be sold each month to attain a target profit of $4,400?

5. Refer to the original data. By automating, the company could reduce variable expenses by $3 per unit. However, fixed expenses would increase by $56,000 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 20,300 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 20,300)?

Answer 1

1	Contribution Margin Ratio = Sales-Variable Cost/Sales
	= $254000-$152400/$254000
	= $101600/$254000
	= .40 or 40%
	BEP in Unit Sales = Fixed Cost/ Selling Price-Variable Cost
	= $113600/($20-$12)
	= $113600/$8
	= 14200 Units
	BEP In Dollar Sales = Fixed Cost / Contribution Margin Ratio
	= $113600/.4
	=$284000
2	Let us use the following formula to find the Change in Operating Income
	Operating Income = Revenue -Costs
	Sales = Fixed Cost+Profit/Contribution Margin
	( $254000+$87000) = ($113600+$6000)+P/.4
	$341000= $ 119600+P/.4
	$119600+P = $341000*.4
	$119600+P = $136400
	P = $136400-$119600
	P = $16800
3	New Selling Price = $20-($20*10%)
	= $20-$2   = $18
	Present Sales Units = 12700
	Expected Sales Units = 12700*2 = 25400
	New Contribution Margin = New Selling Price-Variable Cost Per Unit/Selling Price per unit
	= $18-$12/$18
	= $6/$18
	=.333333 or 33.3333%
	Sales = Fixed Cost+Profit/Contribution Margin
	25400*18 = ($113600+$36000)+P/.333333
	$457200   = $149600+P/.333333
	$149600+P = $457200*.333333
	$149600+P = $152400
	P = $152400-$149600
	= $2800
4	The increase in Packaging cost will increase the Variable cost by .70 Cents
	The New Variable Cost will be $12+.70 =$12.70
	New Contribution Margin = $20-$12.70
	= $7.3
	Sales(Units) = Fixed Cost+Profit/Contribution Margin
	= $113600+$4400/$7.3
	= 16164.38 units
5
a	New Variable Cost = $12-$3 = $9
	New Fixed Cost      = $113600+$56000	169600
	= $169600
	New CM Ratio = Selling Price-Variable Cost/Selling Price
	= $20-$9/$20	11
	= .55 or 55%	0.55
	New Break even Point = Fixed Cost/Contribution Margin	15418.18182
	= $169600/$11	308363.6364
	= 15418.18 units	308363.6364
	New Break even Dollar Sales = Fixed Cost/Contribution Margin Ratio
	= $169600/.55
	= $308363.6
b	Income Statement
	Particulars	Per Unit	%	Amount	Per Unit	%	Amount
	Sales (20300 units)	$20	100%	$406,000	$20	100%	$406,000
	Variable Expenses	$12	60%	$243,600	$9	45%	$182,700
	Contribution Margin	$8	40%	$162,400	$11	55%	$223,300
c	Yes, As the contribution margin in increased when the company automated its operations so we can recommend it