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 (13,300 units × $30 per unit)	$	399,000
Variable expenses		239,400
Contribution margin		159,600
Fixed expenses		177,600
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 $6,900 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’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 cents per unit. Assuming no other changes, how many units would have to be sold each month to attain a target profit of $4,400?

5. Refer to the original data. By automating, the company could reduce variable expenses by $3 per unit. However, fixed expenses would increase by $51,000 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 20,700 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 20,700)?

Answer 1

1. Given information -

		Total	per unit
	No. of units sales	13300
	Sales (13300 units x 30 per unit)	399000	30
less	variable expenses	239400	18
	contribution margin	159600	12
less	fixed cost	177600	13.35
	net operating income/-loss	-18000	-1.35

contribution margin = (Sales - variable cost)/sales *100

= (399000-239400)/399000*100

= 159600/399000*100

= 40%

Break even sales (in units) = fixed cost / (selling price per unit - variable cost per unit)

= 177600/(30-18)

= 177600/12

= 14800 units

Break even in dollar sales = BEP in units * selling price per unit

= 14800*30

= 444000

2. Sales value will increase by $ 90000 by increase in advertising expense from 6900. advertising expense is a fixed cost so fixed cost will increase by 6900 which would now is 177600+6900 =184500 and sales would increase to 399000+90000 = 489000.

No. of units increase = 13300+90000/30

= 13300+3000

= 16300

		Total	per unit
	No. of units sales	16300
	Sales (16300 units*30 per unit)	489000	30
less	variable expenses (18*16300)	293400	18
	contribution margin	195600	12
less	fixed cost	184500	11.32
	net operating income/-loss	11100	0.68

Increase /-decrease in net operating income = income after changes - previous income (income in given information in part 1)

= 11100 - (-18000)

= 29100

3. Now selling price would reduced by 10% it now becomes = 30*.90 = 27 per unit & advertising budget would increase by 35000 so now fixed expenses would be = 177600+35000 = 212600

unit sales will be double, previously it was 13300 units which would now become = 13300*2 = 26600 units

Computation of Net income /-loss in given condition -

		Total	per unit
	No. of units sales	26600
	Sales (26600units x 27 per unit)	718200	27
less	variable expenses	478800	18
	contribution margin	239400	9
less	fixed cost	212600	7.99
	net operating income/-loss	26800	1.01

4. Now marketing department thinks that a fancy new package for the laptop computer battery would grow sales. due to this change the packaging cost will increase by 0.50/unit. so now variable cost will become 18+0.50 = 18.5

and company wants to earn net income = 4400

so BEP for desired income = (fixed cost + desired income)/(selling price per unit - variable cost per unit)

= (177600+4400)/(30-18.5)

= 182000/11.5

= 15826.09 units

5. now variable expense would become = 18-3 = 15 & fixed expense would become = 177600+51000 = 228600

in that case (a) contribution margin ratio = sales price per unit - variable cost per unit/sales price per unit*100

= (30-15)/30*100

= 15/30*100

= 50%

BEP in units = Total new fixed cost / (selling price per unit - variable cost per unit)

= 228600/(30-15)

= 228600/15

= 15240 units

in dollar sales = 15240*30 = 457200

(b.) preparation of contribution income statement with two columns one is without automation & one with automation -

		Not automation	NA/Per unit	% basis	automation	A/per unit	% basis
	No. of units sales	20700			20700
	Sales (20700 units x 30 per unit)	621000	30		621000	30
less	variable expenses (20700*18,for automation20700*15)	372600	18	60.00%	310500	15	50.00%
	contribution margin	248400	12	40.00%	310500	15	50.00%
less	fixed cost	177600	8.58	28.60%	228600	11.04	36.81%
	net operating income/-loss	70800	3.42	11.40%	81900	3.96	13.19%

(c) yes company should automate its operation as net income would be higher in above case.

Please check with your answer and let me know.