Question

Due to erratic sales of its sole product—a high-capacity battery for laptop computers—PEM, Inc., has been experiencing difficulty for some time. The company’s contribution format income statement for the most recent month is given below:

  

Sales (12,700 units × $40 per unit)	$	508,000
Variable expenses		254,000
Contribution margin		254,000
Fixed expenses		284,000
Net operating loss	$	(30,000)

  

Required:
1.	Compute the company’s CM ratio and its break-even point in both unit sales and dollar sales.
	CM ratio 50 % Break-even point in units 14,200 Break-even point in dollars $568,000

2.	The president believes that a $6,400 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 effect on the company’s monthly net operating income or loss? (Use the incremental approach in preparing your answer.)
	Increases by $37,600

3.	Refer to the original data. The sales manager is convinced that a 10% reduction in the selling price, combined with an increase of $32,000 in the monthly advertising budget, will double unit sales. What will the new contribution format income statement look like if these changes are adopted?
	PEM, Inc. Contribution Income Statement Sales $914,400 Variable expenses 508,000 Contribution margin 406,400 Fixed expenses 316,000 Net operating income $90,400

  

4.

Refer to the original data. The Marketing Department thinks that a fancy new package for the laptop computer battery would help sales. The new package would increase packaging costs by $0.60 cents per unit. Assuming no other changes, how many units would have to be sold each month to earn a profit of $4,800? (Do not round your intermediate calculations. Round your final answer to nearest whole number.)

Sales units 14,887

  

5.	Refer to the original data. By automating, the company could reduce variable expenses in half. However, fixed expenses would increase by $58,000 each month.

a. Compute the new CM ratio and the new break-even point in both unit sales and dollar sales. (Use the CM ratio to calculate your break-even point in dollars. Do not round your intermediate calculations. Round up your final break even answers to the nearest whole number.)
CM ratio % Break-even point in units Break-even point in dollars

  

b.	Assume that the company expects to sell 20,100 units next month. Prepare two contribution format income statements, one assuming that operations are not automated and one assuming that they are.
	PEM, Inc. Contribution Income Statement Not Automated Automated Total Per Unit % Total Per Unit % Sales % % Variable expenses % % Contribution margin 0 0 0 % 0 0 0 % Fixed expenses Net Operating Income $0 $0

  

Answer 1

Answer to Part 5-a.

Current Variable Expense per Unit = 254,000 / 12,700
Current Variable Expense per Unit = $20
Expected Variable Cost per Unit = $20 * ½ = $10

Current Fixed Cost = $284,000
Expected Fixed Cost = $284,000 + $58,000
Expected Fixed Cost = $342,000

Contribution Margin Ratio = Contribution Margin/ Sales * 100
Sales = $40
Contribution Margin = Sales – Variable Expenses
Contribution Margin = $40 - $10 = $30
Contribution Margin Ratio = 30/ 40 * 100
Contribution Margin Ratio = 75%

Break Even Point (in Units) = Fixed Cost / Contribution Margin per Unit
Break Even Point (in Units) = 342,000 / 30
Break Even Point (in Units) = 11,400 Units

Break Even Point (in Dollars) = Fixed Cost / Contribution Margin Ratio
Break Even Point (in Dollars) = 342,000 / 0.75
Break Even Point (in Dollars) = $456,000

Answer to Part 5-b.