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. S585.000 Sales (19,500 units * $30 per unit) Variable expenses Contribution margin Fixed expenses Net operating loss 409,500 175,500 180,000 $ (4,500) 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 $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 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 $60,000 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 75 cents per unit. Assuming no other changes, how many units would have to be sold each month to attain a target profit of $9,750? 5. Refer to the original data. By automating, the company could reduce variable expenses by S3 per unit. However, fixed expenses would increase by $72,000 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 26,000 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 26,000)?

Answer 1

1. Determination of the company's CM Ratio and Break-Even Sales. Contribution Margin Ratio : Contribution Margin Ratio = Contribution Margin Sales Contribution Margin Ratio = $ 175,500 $ 585,000 Contribution Margin Ratio = 30.00% Break-Even Point : Break-Even Point = Fixed Expenses CM Ratio Break-Even Point = - $ 180,000 $ 180,000 30% $ Break-Even Point (In $) = Break-Even Point (In Units) = 6,00,000 20,000 Units

2. Determination of the company's Net Operating Income. Particulars Amount ($) Sales 6,65,000 100% Less : Variable Expenses 4,65,500 70% Contribution 1,99,500 30% Less : Fixed Expenses 1,96,000 $ 180,000 + $ 16,000 Net Operating Income 3,500 With the current decision, there will be an increase in the Net Operating Income. 3. Determination of the company's Net Operating Income. Sales Units = 19,500 * 2 = 39,000 Units Sales Price = $ 30 * 90% = $ 27 Fixed Expenses = $ 180,000 + $ 60,000 = $ 240,000 Particulars Amount ($) Sales 10,53,000 Less : Variable Expenses 7,37,100 Contribution 3,15,900 Less : Fixed Expenses 2,40,000 Net Operating Income $ 75,900 The Revised Net Operating Income will be $ 75,900. "AAMA

4. Determination of Sales Units Original Variable Expenses = $ 30 * 70% = $ 21. Revised Variable Expenses = $ 21 + $ 0.75 = $ 21.75 Revised Contribution = $30 - $ 21.75 = $ 8.25 Contribution Margin Ratio = $ 8.25 / $ 30 = 27.5% $ Particulars Sales Less : Variable Expenses Contribution Less : Fixed Expenses Net Operating Income Amount ($) 6,90,000 5,00,250 1,89,750 1,80,000 9,750 4 Since, the variable expenses has increased, contribution ratio has decreased. Sales in Units can be determined by calculating contribution. Contribution = Net Operating Income + Fixed Expenses. Sales in Units can be determined by dividing the Contribution with CM Ratio and then dividing by Sales Price per Unit. Therefore, Sales in Units = $ 690,000 / $ 30 = 23,000 Units. Which means that the company shall sell 23,000 units @ $ 30 when the variable expense is $ 21.75 to earn an Net Operating Income of $ 9,750.