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 (13,400 units × $30 per unit)	$	402,000
Variable expenses		241,200
Contribution margin		160,800
Fixed expenses		178,800
Net operating loss	$	(18,000	)

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 $6,500 increase in the monthly advertising budget, combined with an intensified effort by the sales staff, will result in an $86,000 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 $35,000 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 $5,000?

5. Refer to the original data. By automating, the company could reduce variable expenses by $3 per unit. However, fixed expenses would increase by $53,000 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 20,900 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 20,900)? yes or no

Answer 1

Requirement 1: Compute contribution margin ratio, break-even point in dollars and units as follows

Contribution margion ratio:

Particulars	Total	Per Unit	% of Sales
Sales Revenue	$402,000	$30	100%
Deduct: Variable Expenses (241,200 ÷ 13,400)	$241,200	$18	60%
Contribution Margin per Unit and Ratio	$160,800	$12	40%

Break-even point in sales dollars:

Particulars	Amount
Fixed costs	$178,800
÷ Contribution margin ratio	40%
Break-even point in dollars	$447,000

Break-even point in units:

Particulars	Amount
Fixed costs	$178,800
÷ Contribution Margin Per Unit	$12
Break-even point in units	14,900

Requirement 2: Compute the increase or decrease in operating income as follows

Particulars	Amount
Incremental Contribution Margin
(86,000 increased sales × 40%)	$34,400
Deduct: Incremental costs	($6,500)
Increase in monthly operating income	$27,900

Requirement 3: Compute revised net operating income as follows

Particulars	Amount
Sales Revenue (13,400 × 2) × ($30 × (1−10%)	$723,600
Deduct: Variable Expenses (13,400 × 2) × $18	$482,400
Contribution Margin	$241,200
Deduct: Fixed Costs ($178,800 + $35,000)	$213,800
Net Operating Income	$27,400

Requirement 4: Compute required units sales as follows

Particulars	Total
Total Fixed Costs	$178,800
Add: Target Profit	$5,000
	$183,800
÷   Contribution Margin Per Unit	$11.50
Required unit sales	15,983

Note: compute contribution margin per unit as follows

Particulars	Total
Sales Revenue per Unit	$30.00
Deduct: Variable Cost per Unit ($18 + $0.50)	$18.50
Contribution Margin per Unit	$11.50

Requirement 5a: Compute contribution margin ratio, break-even point in dollars and units as follows

Contribution margion ratio:

Particulars	Per Unit	% of Sales
Sales Revenue per Unit	$30	100%
Deduct: Variable Cost Per Unit ($18 − $3)	$15	50%
Contribution Margin per Unit and Ratio	$15	50%

Break-even point in sales dollars:

Particulars	Amount
Total Fixed costs ($178,800 + $53,000)	$231,800
÷ Contribution margin ratio	50%
Break-even point in dollars	$463,600

  Break-even point in units:

Particulars	Amount
Total Fixed costs ($178,800 + $53,000)	$231,800
÷ Contribution Margin Per Unit	$15
Break-even point in units	15,453

  Requirement 5b: Prepare contrbution margin income statements as follows

P Inc
Contribution Margin Income Statement
Not Automated
Particulars	Total	Per Unit	% of Sales
Sales Revenue (20,900 units × $30 per unit)	$627,000	$30	100%
Deduct: Variable Expenses (20,900 units × $18 per unit)	$376,200	$18	60%
Contribution Margin	$250,800	$12	40%
Fixed Costs	$178,800
Net Operating Income	$72,000
P Inc
Contribution Margin Income Statement
Automated
Particulars	Total	Per Unit	% of Sales
Sales Revenue (20,900 units × $30 per unit)	$627,000	$30	100%
Deduct: Variable Expenses (20,900 units × $15 per unit)	$313,500	$15	50%
Contribution Margin	$313,500	$15	50%
Fixed Costs ($178,800 + $53,000)	$231,800
Net Operating Income	$81,700

Requirement 5c: Yes, the company should automate its operations as this would lead to increased operating income of $81,700