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 × $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 both unit sales and dollar sales.

  

  

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 $84,000 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.)

  

  

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. What will the new contribution format income statement look like if these changes are adopted?

  

  

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 $0.70 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.)

  

  

5.	Refer to the original data. By automating, the company could reduce variable expenses in half. However, fixed expenses would increase by $60,000 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.)

  

  

b.	Assume that the company expects to sell 20,500 units next month. Prepare two contribution format income statements, one assuming that operations are not automated and one assuming that they are.

  

c.	Would you recommend that the company automate its operations?
	Yes No

Answer 1

SOLUTION

1. Contribution margin per unit = Selling price - Variable expense

= $20 - ($152,400/12,700)

= $20 - $12

= $8

Contribution margin ratio = Contribution margin per unit / Selling price

= $8 / $20 = 40%

Breakeven point in units = Fixed exepnse / Contribution margin per unit

= $113,600 / $8 = 14,200 units

Breakeven point in sales dollar = Fixed exepnse / Contribution margin ratio

=  $113,600 / 40% = $284,000

2. Incremental Contribution margin = Increased sales * Contribution margin ratio

= $84,000 * 40% = $33,600

Less: Increased advertising cost = $6,400

Increase in monthly net operating income = $27,200

Since the company presently has a loss of $12,000 per month, if the changes are adopted, the loss will turn into a profit of $15,200 (27,200 - 12,000) per month.

3.

Revised selling price = $20 - ($20 *10%) = $18

Revised sales unit = 12,700units * 2 = 25,400 units

Income statement

Particulars	Amount ($)
Sales (25,400 * $18)	457,200
Less: Variable expense (25,400 * $12)	304,800
Contribution margin	152,400
Fixed Expenses ($113,600 + $37,000)	150,600
Net Operating income	1,800

4.

Let the units be X

Sales = Variable Expense + Fixed expense + Profits

20X = ($12+ 0.70)X + $113,600 + $4,800

20X = $12.70X + $118,400

7.30X = $118,400

X = 16,219

16,219 units need to be sold to earn a profit of $4,800.