Question

Memofax, Inc. produces memory enhancement software for computers. Sales have been very erratic, with some months showing a profit and some months showing a loss. The company's contribution format income statement for the most recent month is given below: Sales (18,000 units at $25 per unit) Less: Variable expenses $450,000 270,000 Contribution margin Less: Fixed expenses 180,000 188,000 Net operating loss $ (8,000) Required: 1. Compute the company's CM ratio and its break-even point in both units and dollars. Contribution margin ratio Break-even point in units Break-even point in dollars 2. The sales manager feels that an $20,000 increase in the monthly advertising budget, combined with an intensified effort by the sales staff, will result in a $130,000 increase in monthly sales. If the sales manager is right, what will be the effect on the company's monthly net operating income or loss? (Use the incremental approach in preparing your answer.)

Answer 1

Solution to the above problem is as under:

1)

Memofax Inc Income Statement
Particulars	Amount (in $)
Sales (18000 units at $25 per unit)	450000
Less: Variable Expenses	270000
Contribution Margin	180000
Less: Fixed Expenses	188000
Net Operating Loss	-8000

Computation of Contribution Margin Ratio:

Contribution Margin Ratio (in percentage)=Contribution Margin (Total Sales Revenue-Variable Expenses)/Sales X 100

= (180000/450000)*100 = 40

Computation of Break Even Point (in Units)

Break Even Point (in units)= Fixed Cost/Contribution Margin per Unit (i.e Sale Price per unit-Variable Cost per unit)

=188000/10=18800

Break Even Point (In Dollars)=Sale price per Unit*Break Even Point in units

=25*18800=$470000

2) Statement showing Company's Net Operating Income/Loss (Using Incremental Approach)

Particulars	Amount
Increase in Sales Revenue	130000
Less: Increase in Variable Expenses	0
Increase in Contribution Margin	130000
Increase in Fixed Cost (Marketing/Advertising)	20000
Incremental Net Operating Income	110000

Note: Assuming Monthly increase of Advertising budget to be fixed and not variable in nature.

3) As per the recommendation of the President of Company

Memofax Inc Income Statement

Particulars	Amount (in $)
Sales (36000 units at $ 22.5 per unit)	810000
Less: Variable Expenses	270000
Contribution Margin	540000
Less: Fixed Expenses (including Advertising)	273000
Net Operating Income/(Loss)	267000

4)

Memofax Inc Income Statement
Particulars	Amount (in $)
Sales	500000
Less: Variable Expenses	310000
Contribution Margin	190000
Less: Fixed Expenses	188000
Net Operating Loss	2000
Units Sold	20000
Sale price per unit	25
Variable Expenses (including packaging cost) per unit	15.5

Thus 20000 units must be sold every month to earn a profit of $2000 and to cover the new package cost.

5) Income Statement of Memofax Inc when the process are automated

Memofax Inc Income Statement
Particulars	Amount (in $)
Sales (18000 units at $25 per unit)	450000
Less: Variable Expenses	135000
Contribution Margin	315000
Less: Fixed Expenses	248500
Net Operating Profit / (Loss)	66500

Computation of Contribution Margin Ratio:

Contribution Margin Ratio (in percentage)=Contribution Margin (Total Sales Revenue-Variable Expenses)/Sales X 100

= (315000/450000)*100 = 70

Computation of Break Even Point (in Units)

Break Even Point (in units)= Fixed Cost/Contribution Margin per Unit (i.e Sale Price per unit-Variable Cost per unit)

=248500/17.5=14200

Break Even Point (In Dollars)=Sale price per Unit*Break Even Point in units

=25*14200=$355000

b) Comparative Income Statement

Particulars	Non-Automated		Automated
	Total	Per Unit	Total	Per Unit
Sales (25000 Units)	625000	25	625000	25
Less: Variable Expenses (25000 Units)	375000	15	187500	7.5
Contribution Margin	250000		437500
Less: Fixed Expenses	188000	7.52	248500	9.94
Net Operating Income/(Loss)	62000		189000