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 (12,600 units × $30 per unit) $ 378,000

Variable expenses 189,000

Contribution margin 189,000

Fixed expenses 211,500

Net operating loss $ (22,500 )

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 $6,800 increase in the monthly advertising budget, combined with an intensified effort by the sales staff, will result in an $87,000 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 $34,000 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 0.50 cents per unit. Assuming no other changes, how many units would have to be sold each month to attain a target profit of $4,600? 5. Refer to the original data. By automating, the company could reduce variable expenses by $3 per unit. However, fixed expenses would increase by $54,000 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 20,200 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 20,200)?

Answer 1

	contribution margin per unit=			189000/12600
				15
1)	CM ratio = contribution/sales
		189000/378000
		50.00%
	BEP(units) = total fixed cost/contribution margin per unit
		211500/15
		14100
	BEP(dollars) = 14100*30
		423000
	CM ratio			50%
	Break even point in units			14100
	Break even point in dollars			423000
2)	increase in contribution			(87000*50%)		43500
	less : increase in advertising budget					6,800
	increase in net income					36,700
	increases by		36,700
3)	units = 12600*2 =		25200 units ; selling price = 30*90%=$27
		Contribution Income statement
	Sales	(25200*27)			680400
	Variable expense		(25200*15)		378000
	Contribution margin				302400
	Fixed expenses		(211500+34000)		245,500
	Net income				56,900
4)	New contribution margin = 15-.50
			14.5
	BEP(units) = (total fixed cost+target profit)/contribution per unit
		(211500+4600)/14.5
		14903.45
	Sales units		14,903
5)
	CM ratio = contribution/sales
		18/30
		60.00%
	BEP(units) = total fixed cost/contribution margin per unit
		(211500+54000)/18
		14750
	BEP(dollars) =		265500/60%
		442500
	CM ratio			60%
	Break even point in units			14750
	Break even point in dollars			442500
			20200
b)			Not Automated			Automated
			total	per unit	%	total	per unit	%
	Sales		606000	30	100%	606000	30	100%
	Variable expenses		303000	15	60%	242400	12	50%
	Contribution margin		303000	15	40%	363600	18	50%
	Fixed expenses		211,500			265,500
	Net operating income		91,500			98,100
c)		yes