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 × $30 per unit) $ 393,000

Variable expenses 235,800

Contribution margin 157,200

Fixed expenses 175,200

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 $6,500 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 $31,000 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 0.60 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 21,000 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 21,000)?

Answer 1

	contribution margin per unit=			157200/13100
				12
1)	CM ratio = contribution/sales
		157200/393000
		40.00%
	BEP(units) = total fixed cost/contribution margin per unit
		175200/12
		14600
	BEP(dollars) = 14600*30
		438000
	CM ratio			40%
	Break even point in units			14600
	Break even point in dollars			438000
2)	increase in contribution			(90000*40%)		36000
	less : increase in advertising budget					6,500
	increase in net income					29,500
	increases by		29,500
3)	units = 13,100*2 =		26200 units ; selling price = 30*90%=$27
		Contribution Income statement
	Sales	(26200*27)			707400
	Variable expense		(26200*18)		471600
	Contribution margin				235800
	Fixed expenses		(175200+31000)=		206,200
	Net income				29,600
4)	New contribution margin = 12-.60
			11.4
	BEP(units) = (total fixed cost+target profit)/contribution per unit
		(175200+4800)/11.4
		15789.47
	Sales units		15,789
5)
	CM ratio = contribution/sales
		15/30
		50.00%
	BEP(units) = total fixed cost/contribution margin per unit
		(175200+53000)/15
		15213
	BEP(dollars) =		228200/50%
		456400
	CM ratio			50%
	Break even point in units			15213
	Break even point in dollars			456400
			21,000 units
b)			Not Automated			Automated
			total	per unit	%	total	per unit	%
	Sales		630000	30	100%	630000	30	100%
	Variable expenses		378000	18	60%	315000	15	50%
	Contribution margin		252000	12	40%	315000	15	50%
	Fixed expenses		175,200			228,200
	Net operating income		76,800			86,800
c)		yes