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 (13,400 units × $30 per unit)	$	402,000
Variable expenses		201,000
Contribution margin		201,000
Fixed expenses		223,500
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 $6,100 increase in the monthly advertising budget, combined with an intensified effort by the sales staff, will result in an $85,000 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 $36,000 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 per unit. Assuming no other changes, how many units would have to be sold each month to attain a target profit of $4,300?

5. Refer to the original data. By automating, the company could reduce variable expenses by $3 per unit. However, fixed expenses would increase by $60,000 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

1.CM Ratio = Contribution Margin/Sales

= 201,000/402000

= 50%

Break even point in unit sales = Fixed costs/CM per unit

= 223500/15

= 14,900 units

Break even point Dollar sales = Fixed costs/CM ratio

=223500/50%

= $447,000

2.Increase in Net Operating Income = Increase in Contribution Margin – Increase in cost

= 85000*50% - 6100

= $36,400

3.

Contribution format Income Statement
Sales 26800*27	723,600
Less: Variable expenses	402,000
Contribution Margin	321,600
Less: Fixed Expenses	259,500
Net Operating Income	62,100

4.Target Profit = $4300

Fixed costs = 223500

Target Contribution Margin = $227,800

Units required to be sold = 227800/(30-15-0.7)

= 15,930.07 units

5.CM Ratio = (30-12)/30 = 60%

Break even point in unit sales = (223500+60,000)/18 = 15,750 units

Dollar sales = 283500/60%

= $472,500

b.

	Without Automation			With Automation
	Per unit	Total	%	Per unit	Total	%
Sales	30	606,000	100.00%	30	606,000	100.00%
Variable expenses	15	303,000	50.00%	12	242,400	40.00%
Contribution Margin	15	303,000	50.00%	18	363,600	60.00%
Fixed Expenses	11.06435644	223,500	36.88%	14.03465347	283,500	46.78%
Net operating income	3.935643564	79,500	13.12%	3.965346535	80,100	13.22%

Yes, should automate