Question

Exercise 6-18 Break-Even and Target Profit Analysis; Margin of Safety; CM Ratio [LO6-1, LO6-3, LO6-5, LO6-6, LO6-7]

Menlo Company distributes a single product. The company’s sales and expenses for last month follow:

	Total			Per Unit
Sales	$	300,000		$	20
Variable expenses		210,000			14
Contribution margin		90,000		$	6
Fixed expenses		76,200
Net operating income	$	13,800

Required:

1. What is the monthly break-even point in unit sales and in dollar sales?

2. Without resorting to computations, what is the total contribution margin at the break-even point?

3-a. How many units would have to be sold each month to attain a target profit of $28,200?

3-b. Verify your answer by preparing a contribution format income statement at the target sales level.

4. Refer to the original data. Compute the company's margin of safety in both dollar and percentage terms.

5. What is the company’s CM ratio? If sales increase by $93,000 per month and there is no change in fixed expenses, by how much would you expect monthly net operating income to increase?

Answer 1

1) monthly break-even point in unit = Fixed expenses / Contribution margin per unit

monthly break-even point in unit = $76,200 / $6 = 12,700 units

monthly break-even point in dollar sales = 12,700 * $20 = $254,000

2) total contribution margin at the break-even point = fixed expenses

total contribution margin at the break-even point = $76,200

3-a) units to be sold each month to attain a target profit of $28,200 = ($76,200 + $28,200) / $6

units to be sold each month to attain a target profit of $28,200 = $104,400 / $6

units to be sold each month to attain a target profit of $28,200 = 17,400 units

3-b) Per Unit $20 $14 Sales Variable expenses Contribution margin Fixed expenses Net operating income Total $348,000 $243,600 $104,400 $76,200 $28,200 $6

4) company's margin of safety in dollar terms = total dollar sales - break even dollar sales

company's margin of safety in dollar terms = $300,000 - $254,000

company's margin of safety in dollar terms = $46,000

company's margin of safety in percentage terms = $46,000 / $300,000

company's margin of safety in percentage terms = 15.33%

5) company’s CM ratio = contribution margin per unit / sales price per unit

company’s CM ratio = $6 / $20

company’s CM ratio = 30%

expected increase in net operating income = $93,000 * 30%

expected increase in net operating income = $27,900