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 (13,500 units × $30 per unit)	$	405,000
Variable expenses		202,500
Contribution margin		202,500
Fixed expenses		225,000
Net operating loss	$	(22,500	)

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 $6,800 increase in the monthly advertising budget, combined with an intensified effort by the sales staff, will result in an $85,000 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 $39,000 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 0.60 cents per unit. Assuming no other changes, how many units would have to be sold each month to attain a target profit of $4,400?

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

	contribution margin per unit=			202500/13500
				15
1)	CM ratio = contribution/sales
		202500/405000
		50.00%
	BEP(units) = total fixed cost/contribution margin per unit
		225000/15
		15000
	BEP(dollars) = 15000*30
		450000
	CM ratio			50%
	Break even point in units			15000
	Break even point in dollars			450000
2)	increase in contribution			(85000*50%)		42500
	less : increase in advertising budget					6,800
	increase in net income					35,700
	increases by		35,700
3)	units = 13500*2 =		27000 units ; selling price = 30*90%=$27
		Contribution Income statement
	Sales	(27000*27)			729000
	Variable expense		(27000*15)		405000
	Contribution margin				324000
	Fixed expenses		(225000+39000)		264,000
	Net income				60,000
4)	New contribution margin = 15-.60
			14.4
	BEP(units) = (total fixed cost+target profit)/contribution per unit
		(225000+4400)/14.4
		15930.56
	Sales units		15,931
5)
	CM ratio = contribution/sales
		18/30
		60.00%
	BEP(units) = total fixed cost/contribution margin per unit
		(225000+57000)/18
		15667
	BEP(dollars) =		282000/60%
		470000
	CM ratio			60%
	Break even point in units			15667
	Break even point in dollars			470000
			20900
b)			Not Automated			Automated
			total	per unit	%	total	per unit	%
	Sales		627000	30	100%	627000	30	100%
	Variable expenses		313500	15	60%	250800	12	50%
	Contribution margin		313500	15	40%	376200	18	50%
	Fixed expenses		225,000			282,000
	Net operating income		88,500			94,200
c)		yes