Question

Tracey Incorporated has been experiencing difficulty for some time due to erratic sales of its only product. The company’s contribution format income statement for the most recent month is given below:

	Total	Per Unit	Percent of Sales
Sales (19,500 units)	$585,000
Variable expenses	409,500
Contribution margin	175,500
Fixed expenses	180,000
Net operating loss	($4,500)

1. Complete the table above with the per unit information and the percent of sales information.

2. The president believes that a $16,000 increase in the monthly advertising budget, combined with an intensified effort by the sales staff, will result in an $80,000 increase in monthly sales. If the president is right, what will be the effect on the company’s monthly net operating income or loss?

3. Refer to the original data. The sales manager is convinced that a 10% reduction in the selling price, combined with an increase of $60,000 in the monthly advertising budget, will double unit sales. What will the new contribution format income statement look like if these changes are adopted? Should the changes be adopted?

	Total	Per Unit	Percent of Sales
Sales
Variable expenses
Contribution margin
Fixed expenses
Net operating income

4. Refer to the original data. The Marketing Department thinks that a fancy new package for the product would help sales. The new package would increase packaging costs by 75 cents per unit. Assuming no other changes, how many units would have to be sold each month to earn a profit of $9,750?

5. Refer to the original data. By automating, the company could reduce variable expense by $3 per unit. However, fixed expenses would increase by $72,000 each month. Assuming that the company expects to sell 26,000 units next month, prepare two contribution format income statements, one assuming that operations are not automated and one assuming that they are.

NOT AUTOMATED

	Total	Per Unit	Percent of Sales
Sales (26,000 units)
Variable expenses
Contribution margin
Fixed expenses
Net operating income

AUTOMATED

	Total	Per Unit	Percent of Sales
Sales (26,000 units)
Variable expenses
Contribution margin
Fixed expenses
Net operating income

1. Computer the break-even point in both units sales and dollar sales for both the Not Automated and the Automated scenarios.

2. Computer the margin of safety in units, dollars, and percentage for both the Not Automated and the Automated scenarios.

3. Computer the degree of operating leverage for both the Not Automated and the Automated scenarios.

4. Compute the unit sales volume at which the net operating income is the same for either metho (This would be ‘the point of indifference’ and it is computed by taking the difference in the fixed expenses and dividing it by the difference in the variable expenses per unit.)

5. Would you recommend that the company automate its operations? Explain.

Answer 1

Particulars	Total		per unit	Percentage of Sales
Sales(19500 units)	585000		30	100%
Variable Expenses	409500		21	70%	(409000/585000)
Contribution Margin	175500		9	30%	(175500/585000)
Fixed Expenses	180000
Net Operating Loss	-4500
Increase in advertising cost by $ 16000
Increase in Sales	$80,000
Increase in units	$2,667		Sales/per unit cost		(80000/30)
Total Units	$22,167			$465,500
Variable Cost	22167*21			$465,500		$2,667
Particulars	Total		per unit	Percentage of Sales
Sales(22267 units)	665000		$30.00	100%
Variable Expenses	465500		21.00	70%	(465500/665000)
Contribution Margin	199500		$9.00	30%	(199500/665000)
Fixed Expenses	196000
Net Operating Profit	3500
Reduction in Selling price by 10%
New Selling Price			30*90%=$27 per unit
Units			19500*2	39000
Particulars	Total		per unit	Percentage of Sales
Sales(39000 units)	1053000	(39000*27)	$27.00	100%
Variable Expenses	819000	(39000*21)	21.00	78%	(819000/1053000)
Contribution Margin	234000		$6.00	22%	(234000/1053000)
Fixed Expenses	240000
Net Operating Profit	-6000
Increase in packaing cost by 75cent per unit
Let the units to be sold to earn the profit of $ 9750 be X
Profit to be earned =	Fixed Cost+.75* x+Profit/ Contribution margin
X=	(180000+.75x+9750)/30-21
9X=	180000+.75x+9750
9X=	189750+.75x
9X-.75x=	189750
8.25X=	189750
X=	189750/8.25
	23000
23000 units must be sold to earn the profit of $ 9750