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 (12,900 units * $20 per unit) Variable expenses Contribution margin Fixed expenses Net operating loss $ 258,000 129,000 129,000 144,000 $ (15,000) 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 $6,900 increase in the monthly advertising budget, combined with an intensified effort by the sales staff, will increase unit sales and the total sales by $84,000 per month. 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 $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 $0.70 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 crease by $58,000 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 20,300 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 20,300 units)?

Answer 1

1.

CM ratio = Contribution / Sales

= 129,000 / 258,000

= 0.5

Break even point = Fixed cost / Cm ratio

= 144,000 / 0.5

= 288,000

2.

Variable exp per unit = 129,000 / 12,900

= 10

New sale = 258,000 + 84,000

New fixed exp =144,000 + 6,900

No. of units Sales Variable expense Contribution Fixed expense Net income $ 17,100 $ 342,000 $ 171,000 $ 171,000 $ 150,900 $ 20,100

3.

New sale per unit = 20 - 10%

New fixed cost = 144,000 + 32,000

No. of units Sales Variable expense Contribution Fixed expense Net income $ 25,800 $ 464,400 $ 258,000 $ 206,400 $ 176,000 $ 30,400

4.

New variable exp per unit = 10 + 0.7

Contribution per unit = 20 - 10.7

= 9.3

Sales to earn desired profit = (Fixed cost + Desired profit) /  Contribution per unit

= (144,000 + 4,300) / 9.3

= 15946 units