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		157,200
Contribution margin		104,800
Fixed expenses		116,800
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 $6,800 increase in the monthly advertising budget, combined with an intensified effort by the sales staff, will increase unit sales and the total sales by $86,000 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 $37,000 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 $0.40 per unit. Assuming no other changes, how many units would have to be sold each month to attain a target profit of $4,100?

5. Refer to the original data. By automating, the company could reduce variable expenses by $3 per unit. However, fixed expenses would increase by $55,000 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 20,000 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 20,000 units)?

Answer 1

1.

contribution margin =(104800 / 262000 )*100 = 40%

break-even sales units = fixed cost / contribution per unit

contribution per unit = 104800/ 13100 =8 per unit

break-even sales units = 116800 / 8 =14600

break-even sales dollar =fixed expense / CM ratio = 116800/40% = 292000

2.net income/(loss) if advertisement increased by 6800 and sales increased by 86000

total new sales will be = 348000 , CM ratio = 40% so contribution = 348000*40% =139200

net income / (loss) = contribution - fixed expense = 139200 - (116800+6800) = 15600 net income

3.net income/(loss) if advertisement increased by 37000 , selling price reduced by 10% and selling units increased to double

new total units sold = 13100*2 =26200 , selling price =20* 90% = 18

new CM ratio = (18-12)/18*100 = 33.33% , contribution = (26200*18)*33.33% = 157184

net income / (loss) = 157184 - (37000+116800) = 3384 net income

4. variable expense increased by 0.4 per unit , how much unit should be sold to earn a profit of 4100?

new variable expeense = 12+0.4 =12.4 per unit

contribution per unit = 20 - 12.4 = 7.6

number required to sold = (desired profit + fixed expense ) / contribution per unit = (4100+116800)/7.6 =15908 units

5. automated so variable expense decreased by 3 and fixed expense increased by 55000

a) new CM ratio = 20 - (12 - 3) = 11 / 20 *100 = 55%

break-even unit = new fixed expense / new contribution = (55000+116800)/ 11 = 15618 units

break-even dollar sale = (55000+116800) / 55% = 312364

b) variable expense in automated = 12-3 = 9 per unit, variable expense in non automated = 12 per unit

fixed expense in automated = 55000+116800 =171800 (8.59 per unit) ,

fixed expense in automated = 116800 (5.84 per unit)

c) yes, as the company can earn a profit of 2.41 per unit if comapny can sell 20000 units while using the automated facility