Question

volts Company manufactures and sells a telephone answering machine. The company’s contribution format profit and loss account for the most recent year is given below:

                                                              Total        Per unit      % of sales

Sales (20,000 units)                          ₤1,200,000        ₤60          100%

Less variable expenses                           900,000       ₤45            ?%

Contribution margin                               300,000       ₤15            ?%

Less fixed expenses                                240,000

Profit                                                      ₤60,000

Management is anxious to improve the company’s profit performance and has asked for several items of information.

Required:

1. Compute the company’s Contribution/margin ratio and variable expense ratio.

2. Compute the company’s break-even point in both units and sales pound. Use the equation method.

3. Assume that sales increase by ₤400,000 next year. If cost behaviour patterns remain unchanged, by how much will the company’s profit increase. Use the CM ratio to determine your answer.

4. Refer to the original data. Assume that next year management wants the company to earn a minimum profit of ₤90,000. How many units will have to be sold to meet this target figure?.

5. Refer to the original data. Compute the company’s margin of safety in both pound and percentage form.

6. In an effort to increase sales and profits, management is considering the use of a higher-quality speaker. The higher-quality speaker would increase variable costs by ₤3 per unit, but management could eliminate one quality inspector who is paid a salary of ₤30,000 per year. The sales manager estimates that the higher-quality speaker would increase annual sales by at least 20%

(a) Assuming that changes are made as described above, prepare a projected profit and loss account for next year. Show data on a total, per unit, and percentage basis.

(b) Compute the company’s new break-even point in both units and pounds of sales. Use the CM method.

(c) Would you recommend that the changes be made?

Answer 1

1. Contribution Margin Ratio=0.25 and the Variable expense ratio=0.75(see note below)

Note:

Contribution 3,00,000 pounds and variable expenses=900000 pounds

             Contribution Margin Ratio=Contribution/Total Revenue=300,000/12,00,000=0.25

               Variable expense ratio=Total variable expenses/total sales=900000/1200000=0.75

2. Company’s Break Even point(units)= 16000 units

Company’s Break Even point(pounds) = 96000 pounds(note below)

Note:

Company’s Break Even point(units)= Fixed Cost /Contribution per unit=240000pounds/15pound per unit=16000 units

Company’s Break Even point(pouns)=16000 units*60 pounds/unit= 96000 pounds

3. The profit increases by 100,000 pounds

New sales=16,00,000 pounds

Using the CM ratio we find Total Contribution=0.25 (1600,000)=400,000 pounds

Therefore 400000-240000=160000 pounds

4. Number of units to be sold=22000 units(Note)

Note:

Target Profit=90000 pounds

Fixed cost=240000 pounds

Therefore contribution=330000 pounds

Using the CM ratio we get sales=330000/0.25=1320000 pounds

Selling price per unit=60 pound

Therefore number of units=1320000/60=22000 units