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) Variable expenses Contribution margin Fixed expenses Net operating loss $ 384,000 192,000 192,000 214,500 $ (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 $7,000 increase in the monthly advertising budget, combined with an intensified effort by the sales staff, will result in an $90,000 increase in monthly sales. If the president is right, what will be the increase (decrease) in the company 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 $40,000 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 $4,500? 5. Refer to the original data. By automating, the company could reduce variable expenses by $3 per unit. However, fixed expenses would increase by $57,000 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 20,500 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 wel as in total, for each alternative.) c. Would you recommend that the company automate its operations (Assuming that the company expects to sell 20,500)?

Answer 1

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PEM Inc.
Calculation of Variable expense per unit	Amount $	Note
Variable expenses	192,000.00	A
Units sold	12,800.00	B
Variable expense per unit	15.00	C=A/B
Answer 1	Amount $
Sales	384,000.00	D
Contribution margin	192,000.00	E
CM ratio	50.00%	F=E/D
Units sold	12,800.00	See B
Contribution margin per unit	15.00	G=E/B
Fixed expense	214,500.00	H
Break even units	14,300.00	I=H/G
Sell price	30.00	J
Break even $	429,000.00	K=I*J
Answer 2
Increase in sales	90,000.00	L
CM ratio	50.00%	See F
Increase in Contribution margin	45,000.00	M=L*F
Less: Advertising expense	7,000.00
Increase in net operating income	38,000.00
Answer 3
Current Sell price	30.00	See J
Reduction by 10%	3.00	N=J*10%
Revised Sell price	27.00	O=J-N
Current Sales units	12,800.00	See B
Increase by 100%	12,800.00	P=B*100%
Revised Sales units	25,600.00	Q=B+P
Income statement	Amount $
Sell Price	27.00	See O
Less: Variable expenses	15.00	See C
Contribution per unit	12.00	R
Units sold	25,600.00	See Q
Contribution margin	307,200.00	S=R*Q
Less: Fixed expense	214,500.00
Less: Advertising expense	40,000.00
Operating Income	52,700.00
Answer 4
Current Contribution per unit	15.00
Less: packaging costs	0.70
Revised Contribution per unit	14.30	T
Target Profit	4,500.00
Add: Fixed expense	214,500.00
Target Contribution	219,000.00	U
Revised Contribution per unit	14.30	See T
Units to be sold	15,314.69	V=U/T
Workings for Answer 5
Current Variable cost per unit	15.00
Reduction by	3.00
Revised Variable cost per unit	12.00	W
Current Fixed costs	214,500.00
Increase by	57,000.00
Revised Fixed costs	271,500.00	X
Answer 5 a	Amount $	Note
Sell price	30.00	See J
Less: Variable expenses	12.00	See W
Contribution margin per unit	18.00	Y
CM ratio	60.00%	Z=Y/J
Fixed expense	271,500.00	See X
Break even units	15,083.33	AA=X/Y
Break even $	452,500.00	AB=AA*J

Answer 5 b	Not Automated	Automated	Note
Sell Price	30.00	30.00	See J
Less: Variable expenses	15.00	12.00	See C, W
Contribution per unit	15.00	18.00	AC
Units sold	20,500.00	20,500.00	AD
Contribution margin	307,500.00	369,000.00	AE=AC*AD
Less: Fixed expense	214,500.00	271,500.00	See H, X
Operating Income	93,000.00	97,500.00
Increase in Operating Income by		4,500.00

Answer 5 c

If automation is done then operating income will increase by $ 4,500 so yes the company should automate its operations.