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 (12,500 units × $30 per unit)	$	375,000
Variable expenses		225,000
Contribution margin		150,000
Fixed expenses		168,000
Net operating loss	$	(18,000	)

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 $6,100 increase in the monthly advertising budget, combined with an intensified effort by the sales staff, will result in an $83,000 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 $30,000 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 0.80 cents per unit. Assuming no other changes, how many units would have to be sold each month to attain a target profit of $4,800?

5. Refer to the original data. By automating, the company could reduce variable expenses by $3 per unit. However, fixed expenses would increase by $53,000 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)	CM ratio = contribution/sales
		150,000/375,000
		40.00%
	Break even point (units) = fixed cost/contribution per unit
			168,000/12
			14000	units
	Break even point (sales) = fixed cost/contribution margin
			168000/40%
			420000
	CM ratio				40%
	Break even point in units				14,000
	Break even point in dollars				420,000
2)	Contribution margin (83000*40%)=					33200
	Advertising expense					6,100
	net income					27,100
	increases	by	$27,100
3)	New sales units 12500*200%=					25000
	New sales price = 30*90%=			$27
	Revised net operating income(loss)
	Sales (25000*27)					675000
	variable expense (25000*18)					450000
	Contribution margin					225000
	Fixed expenses (168000+30,000)					198000
	Net operating income					27000
4)	New contribution = $12-.80 =			11.2
	units to be sold = (fixed cost+target profit)/contibution margin
	=(168000+4800)/11.2
			15429	units
5)	New contribution = 30-15 =			$15
	new fixed expenses = 168000+53000=				221000
	New CM ratio =		15/30=	50%
	BEP(units)=		221000/15
			14733	units
	BEP(sales)=		221000/50%
			442000
5b)			Not Automated			Automated
			total	per unit	%	total	per unit	%
	Sales		609000	30	100%	609000	30	100%
	Variable expenses		365400	18	60%	304500	15	50%
	Contribution margin		243600	12	40%	304500	15	50%
	Fixed expenses		168000			221,000
	Net operating income		75600			83,500
5c)	Yes