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 x $30 per unit) Variable expenses Contribution margin Fixed expenses Net operating loss $ 393,000 235,800 157,200 175,200 $ (18,000)

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 $6,900 increase in the monthly advertising budget, combined with an intensified effort by the sales staff, will result in an $81,000 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 $0.80 per unit. Assuming no other changes, how many units would have to be sold each month to attain a target profit of $4,900?

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 20,900 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 20,900)?

Answer 1

1.CM Ratio = Contribution Margin/Sales

= 157200/393,000

= 40%

Break even point in unit sales = Fixed costs/Contribution Margin per unit

= 175,200/12

= 14,600 units

Dollar sales = 175,200/40%

= $438000

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

= 81,000*40% - 6,900

= $25,500

3.Net operating Income = 26,200*(27-18) – 175,200-32,000

= $28,600

4.Target Profit = $4,900

Fixed costs = 175,200

Target Contribution Margin = $180,100

Units required to be sold = 180,100/(30-18-0.8)

= 16,080.36 units

5.CM Ratio = (30-15)/30 = 50%

Break even point in unit sales = (175,200+57,000)/15 = 15,480 units

Dollar sales = 232200/50%

= $464,400

b.

	Without Automation			With Automation
	Per unit	Total	%	Per unit	Total	%
Sales	30	627,000	100.00%	30	627,000	100.00%
Variable expenses	18	376,200	60.00%	15	313,500	50.00%
Contribution Margin	12	250,800	40.00%	15	313,500	50.00%
Fixed Expenses	8.38277512	175,200	27.94%	11.11	232,200	37.03%
Net operating income	3.61722488	75,600	12.06%	3.88995	81,300	12.97%

Yes, should automate