Question

Problem 2-22 (Algo) CVP Applications; Contribution Margin Ratio; Break-Even Analysis; Cost Structure [LO2-1, LO2-3, LO2-4, LO2-5, LO2-6]

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 (12,700 units × $20 per unit)	$	254,000
Variable expenses		127,000
Contribution margin		127,000
Fixed expenses		142,000
Net operating loss	$	(15,000	)

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 $6,200 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 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 $0.60 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 $57,000 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 20,700 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 20,700)?

Answer 1

1)

CM Ratio =		Cont. Margin / Sales
	=	$ 127000 / $ 254000
	=	50%
Break even point in units =			Fixed cost / Cont. Margin per unit
		=	$ 142000 / $ 10
		=	14200
Break even point in dollar =			Fixed cost / Cont. Margin %
		=	$ 142000 / 50%
		=	$ 284,000.00

2)	Sales ($ 254000 + $ 80000)	$ 334,000.00
	Variable expenses	$ 127,000.00
	Contribution margin	$ 207,000.00
	Fixed expenses ($ 142000 + $ 6200)	$ 148,200.00
	Net operating Income	$   58,800.00
	Increase in Income =	$ 58800 - ($ 15000)
	=	$   73,800.00

3)	Sales (25400 units × $18 per unit)	$ 457,200.00
	Variable expenses	$ 127,000.00
	Contribution margin	$ 330,200.00
	Fixed expenses ($ 142000 + $ 34000)	$ 176,000.00
	Revised Net operating income	$ 154,200.00

4)

Sales (12,700 units × $20 per unit)	$ 254,000.00
Variable expenses (12700 x $ 10.6)	$ 134,620.00
Contribution margin	$ 119,380.00
Fixed expenses	$ 142,000.00
Net operating loss	$ (22,620.00)

Contribution Margin per unit =			$ 119380 / 12700
		=	$      9.40
Units to be sold to earn target profit of $ 4600 =					($ 4600 + $ 142000) / $ 9.40
				=	15596	units	(approx)

Note: As HOMEWORKLIB RULES's policy, I've completed the first four parts of the question