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 × $20 per unit)	$	262,000
Variable expenses		157,200
Contribution margin		104,800
Fixed expenses		116,800
Net operating loss	$	(12,000	)

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 $6,600 increase in the monthly advertising budget, combined with an intensified effort by the sales staff, will result in an $82,000 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 $32,000 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 cents per unit. Assuming no other changes, how many units would have to be sold each month to attain a target profit of $5,000?

5. Refer to the original data. By automating, the company could reduce variable expenses by $3 per unit. However, fixed expenses would increase by $51,000 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 20,300 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 20,300)?

Answer 1

1)

	Total	Per unit	Percent of Sales
Sales (13,100 units)	$ 262,000.00	$    20.00	100%
Variable expenses	$ 157,200.00	$    12.00	60%
Contribution margin	$ 104,800.00	$       8.00	40%

Units Sales to Break even  = Fixed Expenses/ Unit Contribution Margin

=116,800/8

=14,600 Units

Break Even in Dollars = 14,600 x 20 = 292,000

2)

Incremental contribution margin:
$82,000 increased sales × 40% CM ratio	$    32,800.00
Less increased advertising cost	$      6,600.00
Increase in monthly net operating income	$    26,200.00

Since the company is now showing a loss of $12,000 per month, if the changes are adopted, the loss will turn into a profit of $14,200 each month ($26,200 less $12,000 = $14,200).

3)

PEM INC
Contribution Income Statement
Sales	$ 471,600.00
Variable expenses	$ 314,400.00
Contribution margin	$ 157,200.00
Fixed Expense	$ 148,800.00
Net Operating Income	$      8,400.00

4)Unit sales to attain target profit = Target profit + Fixed expenses/CM Per unit

= 5,000+ 116,800/7.30

=16,685.

5)

a)

	Total	Per unit	Percent of Sales
Sales (13,100 units)	$ 262,000.00	$    20.00	100%
Variable expenses	$ 117,900.00	$       9.00	45%
Contribution margin	$ 144,100.00	$    11.00	55%

Units Sales to Break even  = Fixed Expenses/ Unit Contribution Margin

=167,800/11

=15254.55 Units

Break Even in Dollars = 15254.55 x 20 = 305,090.9

b)

	Non Automated			Automated
	Total	Per unit	Percent of Sales	Total	Per unit	Percent of Sales
Sales (20,300 units)	$ 406,000.00	$    20.00	100%	$ 406,000.00	$    20.00	100%
Variable expenses	$ 243,600.00	$    12.00	60%	$ 182,700.00	$       9.00	45%
Contribution margin	$ 162,400.00	$       8.00	40%	$ 223,300.00	$    11.00	55%
Fixed Expenses	$ 116,800.00			$ 167,800.00
Net Operating Income	$    45,600.00			$    55,500.00

c)Yes.. The Net Operating Income has Increased from 45,600 to 55,500