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 (12,800 units × $30 per unit)	$	384,000
Variable expenses		192,000
Contribution margin		192,000
Fixed expenses		214,500
Net operating loss	$	(22,500	)

1. figure the company’s CM ratio and its break-even point in unit sales and dollar sales.

2. The president believes that a $6,400 increase in the monthly advertising budget, combined with an intensified effort by the sales staff, will result in an $85,000 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 $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 $0.50 per unit. Assuming no other changes, how many units would have to be sold each month to attain a target profit of $4,600?

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. figure the new CM ratio and the new break-even point in unit sales and dollar sales.

b. Assume that the company expects to sell 20,400 units next month. figure 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 20,400)?

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Answer 1

1.

• CM Ratio = Contribution / Sales = 192,000 / 384,000 = 50%
• Break-even point in units = Fixed Cost / Contribution per unit = 214,500 / (192,000/12,800) = 14,300 units
• Break-even point in dollars = 14,300 x 30 = $429,000

2. Net Operating Income will be: Contribution from additional $84,000 sales - Increase in expense + Income (Loss) as earlier = 50% x $84,000 - $6,400 - $22,500 = $13,100

3.

• 	Calculation	Result
  Sales	12800 x 2 x $30 x 90%	$ 691,200
  Variable expenses	12800 x 2 x $15	$ 384,000
  Contribution margin		$ 307,200
  Fixed expenses	214500 + 31000	$ 245,500
  Net operating income		$ 61,700

4.

• Contribution per unit = $15 - $0.50 = $14.50
• Fixed cost = $214,500
• Target profit = $4,600
• Target contribution = 214,500 + 4,600 = $219,100
• Units required = Target contribution / Contribution per unit = 219,100 / 14.50 = 15110.34 units = 15,111 units

5.
a) New CM ratio = ($15 + $3) / $30 = 60%
New Break-even point in units = New fixed cost / New contribution per unit = (214500 + 54000) / 18 = 14,917
New Break-even point in dollars = 14,917 x $30 = $447,510

b)

• 	Not Automated			Automated
  	Total	Per Unit	Percentage	Total	Per Unit	Percentage
  Sales	$ 612,000	30	100.00%	$ 612,000	30	100.00%
  Variable expenses	$ 306,000	15	50.00%	$ 244,800	12	40.00%
  Contribution margin	$ 306,000	15	50.00%	$ 367,200	18	60.00%
  Fixed expenses	$ 214,500	10.5147	35.05%	$ 268,500	13.1618	43.87%
  Net operating income	$ 91,500	4.48529	14.95%	$ 98,700	4.83824	16.13%

c) It is recommended to automate the operations as it will result in higher profits, as seen from the statement above.

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