Question

Due to erratic sales of its sole product—a high-capacity battery for laptop computers—PEM, Inc., has been experiencing difficulty for some time. The company’s contribution format income statement for the most recent month is given below:

	Total (Tk.)	Per Unit	Percent of Sales
Sales (19,500 units)	5,85,000	30	100%
Variable Expense	4,09,500	21	? %
Contribution Margin	1,75,500	9	? %
Fixed Expenses	1,80,000
Net Operation Income	(4,500)

Required:

1. Compute the company’s CM ratio and its break-even point in both units and dollars.
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.
3. If the president 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.)
4. 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 cause unit sales to double. What will the new contribution format income statement look like if these changes are adopted?
5. Refer to the original data. The Marketing Department thinks that a fancy new package for the laptop computer battery would help 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 earn a profit of $9,750?
6. Refer to the original data. By automating certain operations, the company could reduce variable costs by $3 per unit. However, fixed costs would increase by $72,000 each month.

1. Compute the new CM ratio and the new break-even point in both units and dollars.
2. 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.)
3. Would you recommend that the company automate its operations? Explain.

Answer 1

Answer 1.

Contribution Margin Ratio = Contribution Margin per unit / Selling Price per unit
Contribution Margin Ratio = $9.00 / $30.00
Contribution Margin Ratio = 30%

Breakeven Point in unit sales = Fixed Expenses / Contribution Margin per unit
Breakeven Point in unit sales = $180,000 / $9.00
Breakeven Point in unit sales = 20,000

Breakeven Point in dollar sales = Fixed Expenses / Contribution Margin Ratio
Breakeven Point in dollar sales = $180,000 / 0.30
Breakeven Point in dollar sales = $600,000

Answer 2.

Increase in Sales = $80,000
Increase in Fixed Expenses = $16,000

Increase in Net Operating Income = Increase in Sales * Contribution Margin Ratio - Increase in Fixed Expenses
Increase in Net Operating Income = $80,000 * 0.30 - $16,000
Increase in Net Operating Income = $8,000

Answer 3.

Selling Price per unit = $30.00 - 10% * $30.00
Selling Price per unit = $27.00

Fixed Expenses = $180,000 + $60,000
Fixed Expenses = $240,000

Number of units sold = 2 * 19,500
Number of units sold = 39,000

Net Operating Income (Loss) = Number of units sold * (Selling Price per unit - Variable Cost per unit) - Fixed Expenses
Net Operating Income (Loss) = 39,000 * ($27.00 - $21.00) - $240,000
Net Operating Income (Loss) = -$6,000

Answer 4.

Variable Cost per unit = $21.00 + $0.75
Variable Cost per unit = $21.75

Contribution Margin per unit = Selling Price per unit - Variable Cost per unit
Contribution Margin per unit = $30.00 - $21.75
Contribution Margin per unit = $8.25

Required Unit Sales = (Fixed Expenses + Target Profit) / Contribution Margin per unit
Required Unit Sales = ($180,000 + $9,750) / $8.25
Required Unit Sales = 23,000

Answer 5-a.

Variable Cost per unit = $21.00 - $3.00
Variable Cost per unit = $18.00

Fixed Expenses = $180,000 + $72,000
Fixed Expenses = $252,000

Contribution Margin per unit = Selling Price per unit - Variable Cost per unit
Contribution Margin per unit = $30.00 - $18.00
Contribution Margin per unit = $12.00

Contribution Margin Ratio = Contribution Margin per unit / Selling Price per unit
Contribution Margin Ratio = $12.00 / $30.00
Contribution Margin Ratio = 40%

Breakeven Point in unit sales = Fixed Expenses / Contribution Margin per unit
Breakeven Point in unit sales = $252,000 / $12.00
Breakeven Point in unit sales = 21,000

Breakeven Point in dollar sales = Fixed Expenses / Contribution Margin Ratio
Breakeven Point in dollar sales = $252,000 / 0.40
Breakeven Point in dollar sales = $630,000

Answer 5-b.

Sales Variable expense Contribution margin Fixed expense Net operating income $ $ $ $ $ PEM, Inc. Contribution Income Statement Not Automated Total Per Unit % 780,000 $ 30.00 100.00% 546,000 $ 21.00 70.00% 234,000 $ 9.00 30.00% 180,000 54,000 $ $ $ $ $ Automated Total Per Unit 780,000 $ 30.00 468,000 $ 18.00 312,000 $ 12.00 252,000 60,000 % 100.00% 60.00% 40.00%

Answer 5-c.

Yes, company should automate its operations