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 (19,500 units $30 per unit) Variable expenses Contribution margin Fixed expenses Net operating loss $ 585,000 409,500 175,500 180,000 $ (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 $3 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

Solution:

5	Computation of Net Income Assuming that operations are Automated
	Particulars				Amount      $
	Sales (19,500 units * $30)				585,000
	Variable Expense (19,500 * $18)				351,000
	Contribution Margin $ 12 per unit				234,000
	Fixed Expenses ($180,000 + $72,000)				252,000
	Net Operating Loss				-18,000

5A	Contribution Margin or CM Ratio			= (Contribution Margin / Sales) *100
				= (234,000 / 585,000) * 100
				= 40 %
	Break Even Point in unit Sales			= (Fixed Expenses / CM per unit)
				= ($252,000 / $12)
				= $21,000
	Break Even Point in dollar Sales			= (Fixed Expense / CM Ratio)
				= ($252,000 / 40%)
				= ( $630,000

5B	PEM, Inc.
	Contribution Income Statement
	Particulars			Not Automated			Automated
				Total   $	per unit	%	Total   $	per unit	%
	Sales (26,000 units * $30)			780,000	$ 30	100%	780,000	$ 30	100%
	Variable Expense			546,000	21	70%	468,000	18	60%
	Contribution Margin			234,000	9	30%	312,000	12	40%
	Fixed Expenses			180,000			252,000
	Net Operating Loss			54,000			60,000