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 (13,200 units * $30 per unit) Variable expenses Contribution margin Fixed expenses Net operating loss $ 396,000 237,600 158, 400 176,400 $ (18,000) 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 $6,400 increase in the monthly advertising budget, combined with an intensified effort by the sales staff, will increase unit sales and the total sales by $88,000 per month. If the president is right, what will be the increase (decrease) ir 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 $32,000 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 per unit. Assuming no other changes, how many units would have to be sold each month to attain a target profit of $4,300? 5. Refer to the original data. By automating, the company could reduce variable expenses by $3 per unit. However, fixed expenses would increase by $54,000 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 20,400 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 20,400 units)?

Answer 1

1.
CM ratio = 40%
Break-even point in units sales = 14,700 units
Break-even point in dollar sales = $441,000

Explanation:

It is given,
Contribution Margin = $158,400
Sales = $396,000
Fixed expenses = $176,400
Selling price per unit = $30
Contribution margin per unit = Contribution Margin / Units sold
= $158,400 / 13,200 = $12
Variable expenses per unit = Variable expense / Units sold
= $237,600 / 13,200 = $18

CM ratio = CM / Sales
= $158,400 / $396,000 = 0.4 = 40%

Break-even point in unit sales = Fixed expenses/ Contribution margin per unit
= $176,400 / $12 = 14,700 units

Break-even point in dollar sales = Fixed expenses/ Contribution margin ratio
= $176,400 / 40% = $441,000

2.
Increased by $28,800.

Increase in company's monthly net operating income = $28,800.

Explanation:

Increase in sales = $88,000
Increase in contribution margin = Increase in sales × CM ratio = $88,000 × 40% = $35,300
Increase in Fixed expenses (monthly advertising) = $6,400

Increase in net operating income = $35,200 - $6,400 = $28,800

3.
Revised net operating income = $29,200

Explanation:

New selling price per unit = $30 - 10% reduction = $27
New sales unit = Double = 13,200 × 2 = 26,400
New fixed expense = $176,400 + $32,000 = $208,400

New contribution margin per unit = New selling price per unit - Variable expense per unit
= $27 - $18 = $9

New contribution margin = New sales unit × New contribution margin per unit
= 26,400 × $9 =$237,600

New net operating income = =$237,600 - $208,400 = $29,200

4.
Unit sales to attain target profit = 15,851

Explanation:

Target profit = $4,300
Increase in variable expenses = $0.60 per unit

New variable expense per unit = $18 + $0.60 = $18.60

Selling price per unit = $30
Fixed expense = $176,400

New contribution margin per unit = Selling price per unit - New variable expense per unit = $30 - $18.60 = $11.40

Units to attain target profit = (Fixed expense + Target profit) / New contribution margin per unit
= ($176,400 + $4,300) / $11.40 = 15,851 units

5. a.
CM ratio = 50%
Break-even point in units sales = 15,360 units
Break-even point in dollar sales = $460,800

New variable expense per unit = $18 - $3 = $15
New fixed expense = $176,400 + $54,000 = $230,400

New Contribution Margin per unit = Sales price per unit - New variable expense per unit = $30 - $15 = $15

New CM ratio = CM per unit / Selling price per unit
= $15 / $30 = 0.5 = 50%

Break-even point in unit sales = Fixed expenses/ Contribution margin per unit
= $230,400 / $15 = 15,360 units

Break-even point in dollar sales = Fixed expenses/ Contribution margin ratio
= $230,400 / 50% = $460,800

b.
Contribution income statement:

Sales Variable Expenses Contribution Margin Fixed expenses Net Income PEM, Inc. Contribution Income Statement Not Automated Automated Total Per unit % Total Per unit $612,000 $30 100% $612,000 $30 $367,200 $18 60% $306,000 $15 $244,800 $12 40% $306,000 $15 $176,400 $230,400 $68,400 $75,600 % 100% 50% 50%

Units sold = 20,400 units

Sales is taken ad 100%

c. It is recommended that company should automate its operation. If the company produces 20,400 units, it would generate more income than when it is not automated.