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 x $30 per unit) Variable expenses Contribution margin Fixed expenses Net operating loss $ 396,000 198,000 198,000 220,500 $ (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 increase unit sales and the total sales by $88,000 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 $31,000 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 $4,100? 5. Refer to the original data. By automating, the company could reduce variable expenses by $3 per unit. However, fixed expenses would increase by $50,000 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 20,800 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 20,800 units)?

Answer 1

Req 1 :
Contribution margin per unit = Contribution margin / Units sold = 198000 / 13200 =	15
CM ratio = Contribution margin / Sales = 198000 / 396000 =	50%
Break-even point in units = Fixed expenses / Contribution margin per unit = 220500 / 15 =	14700
Break-even point in dollars = Fixed expenses / Contribution margin ratio = 220500 / 50% =	441000

Req 2 :
Increase in Contribution margin ( Increase in sales * Contribution margin ratio = 88000 * 50% )	44000
(-) Increase in advertising budget	6800
Increase (decrease) in net operating income	37200

Net operating income increases

by

37200

Req 3 :
Revised selling price = Current selling price * ( 1 - % reduction ) = 30 * ( 1 - 10% ) =	27
Current unit variable cost = Variable expenses / Units sold = 198000 / 13200 =	15
Revised fixed costs = Current fixed costs + Increase in advertising expense = 220500 + 31000 =	251500
Revised sales units = Current sales units * 2 = 13200 * 2 =	26400
Sales ( 26400*27 )	712800
(-) Variable expenses ( 26400*15 )	396000
Contribution margin	316800
(-) Fixed expenses	251500
Net operating Income (loss)	65300
Revised net operating Income (loss)	65300

Req 4 :
Revised unit variable cost = Current unit variable cost + 0.70 = 15 + 0.70 =	15.70
Units sales to attain target profit = ( Target profit + Fixed expenses ) / ( Selling price - Unit variable cost ) = ( 4100 + 220500 ) / ( 30 - 15.70 ) =	15706

Req 5A :
Current unit variable cost = Variable expenses / Units sold = 198000 / 13200 =	15
Revised unit variable cost = 15 - 3 =	12
Revised fixed expenses = 220500 + 50000 =	270500
Contribution margin per unit = Selling price - Unit variable cost = 30 - 12 =	18
CM ratio = Contribution margin per unit / Selling price = 18 / 30 =	60%
Break-even point in unit sales = Fixed costs / Contribution margin per unit = 270500 / 18 =	15028
Break even point in dollar sales = Fixed costs / CM ratio = 270500 / 60% =	450833

Req 5B :
	Not automated	Automated
	Total	Per unit	%	Total	Per unit	%
Sales	624000	30.00	100.00%	624000	30.00	100.00%
Variable expenses	312000	15.00	50.00%	249600	12.00	40.00%
Contribution margin	312000	15.00	50.00%	374400	18.00	60.00%
Fixed expenses	220500			270500
Net operating income	91500			103900

Req 5C :

Answer : Yes

Explanation : If the company sells 20800 units, then the company will earn more net operating income if it automates its operations.