Question

Problem 5-22 CVP Applications: Contribution Margin Ratio; Break-Even Analysis; Cost Structure (L05-1 LO5-3, LO5-4, LO5-5, LO5-6) 333 points Due to erratic sales of its sole product 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. $399,00 Sales (15,300 units X $30 per unit) Variable expenses Contribution margin Fixed expenses Net operating loss 159,600 122.600 (18,000) References 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 56,300 increase in the monthly advertising budget, combined with an intensified effort by the sales staff, will result in an $88,000 increase in monthly sales. 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 $39,000 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 $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 20,800 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)?

Answer 1

Selling Price per unit = $30
Variable costs per unit = Variable expenses / 13,300 units = $239,400 / 13,300 units = $18 per unit.
Contribution margin per unit = Selling price per unit - Variable costs per unit = $30 - $18 = $12 per unit.

1. Company's CM ratio = Contribution margin per unit / Selling price per unit = $12 / $30 = 40%
Break point in unit sales = Fixed expenses / Contribution margin per unit = $177,600 / $12 per unit = 14,800 units.
Break point in dollar sales = Break point in unit sales * Selling price per unit = 14,800 units * $30 per unit = $444,000.

2. Increase in contribution due to increase in monthly advertising budget = Amount of increase in sales * Contribution margin ratio = $88,000 * 40% = $35,200
Change in fixed expenses = $6,300
Change in operating income = Increase in contribution margin - Change in fixed expenses = $35,200 - $6,300 = $28,900.
If the president is right then, the monthly operating income will increase by $28,900.

3. New selling price = $30 - 10% = $27 per unit
Variable expenses per unit = $18 per unit.
New Contribution margin per unit = $27 - $18 = $9 per unit.
Unit sales = Old unit sales * 2 = 13,300 units * 2 = 26,600 units.
New Contribution margin = Contribution margin per unit * 26,600 units = $9 per unit * 26,600 units = $239,400
New fixed expenses = Old fixed expenses + $39,000 = $177,600 + 39,000 = $216,600
Revised net operating income = New Contribution margin - New fixed expenses = $239,400 - $216,600 = $22,800

4.Target profit = $4,100
Revised variable cost per unit = $18 per unit + Increase in packaging costs = $18 + $0.7 = $18.70 per unit.
Revised contribution margin = Selling price per unit - Revised variable costs per unit = $30 - $18.70 = $11.30 per unit
Units to be sold to achieve target profit = ( Fixed expenses + Target profit ) / Revised Contribution margin per unit = ( $177,600 + 4,100 ) / $11.30 = 16,079.65 or 16,080 units.