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 (13,300 units × $20 per unit)	$	266,000
Variable expenses		159,600
Contribution margin		106,400
Fixed expenses		118,400
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 $6,200 increase in the monthly advertising budget, combined with an intensified effort by the sales staff, will result in an $90,000 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 $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 0.70 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 20,900 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 20,900)?

Answer 1

Requirement 1:
Contribution margin: $106,400
Sales revenue: $ 266,000
Contribution margin ratio = Contribution / Sales *100
		(106400/ 266000) *100 = 40%
Number of units sold: 13300 units
Contribution margin per unit ($106,400 / 13300) = $8 per unit
Fixed cost: $ 118,400
Break even in terms of unit : Fixed cost/ contribution per unit
		(118,400 / $8 per unit) = 14,800 units
Break even in $ = Fixed cost / Contribution margin ratio
	( $118,400 / 40%) = $296,000
Requirement2:
Additional Fixed cost: $ 6,200 (advertiing expense)
Increase in Sales revenue: $ 90,000
Contribution margin ratio = 40%
Increase in contribution margin: $ 90,000 *40% = $ 36,000
Increase in Net operating income = Increased contribution - Additional fixed cost
			(36,000 - $ 6,200) = $ 29,800
Requirement3:
Revised selling price per unit ($20- 10%) = $ 18.00 per unit
Variablecost per unit ($159600/13300)= $ 12 per unit
Revised constribution margin per unit: $ 18.00 - $ 12.00 = $ 6.00 per unit
Revised fixed cost = $118400+39,000 = $ 157,400
Revised number of units sold (13300*2)= 26,600 units
Net Operating income is as follows:
Sales revenue (26600units@$18)				478800
Less: variable cost (26600 units@$12)				319200
Contribution margin (26600 units@ 6)				159600
Less: Fixed cost				157400
Net operating income:				2200
Requirement4:
New package cost: 0.70 per unit
Revised variable cost per unit: $ 12.00 +0.70 = $ 12.70 per unit
Seling price per unit: $ 20 per unit
Contrribution margin per unit: Selling price - Variable cost per unit
		($ 20.00 - $ 12.70 ) = 7.30 per unit
Fixed cost: $ 118400
Desired profits: $4400
Desired contribution = fixed cost + desired profits
		(118400+ 4400) = $122,800
Desired sales in terms of units = Desired contribution / Contribution margin per unit
			($122,800 / $ 7.30 per unit) = 16,822 units