Question

Due to erratic sales of its sole product—a high-capacity battery for laptop computers—PEM, Inc., has been experiencing difficulty for some time. The company’s contribution format income statement for the most recent month is given below:
Sales (13,200 units × $40 per unit) $528,000
Variable expenses 316,800
Contribution margin 211,200
Fixed expenses 235,200
Net operating loss $(24,000)
1. Compute the company’s CM ratio and its break-even point in both unit sales and dollar sales.
2. The president believes that a $6,800 increase in the monthly advertising budget, combined with an intensified effort by the sales staff, will result in an $89,000 increase in monthly sales. If the president is right, what will be the effect on the company’s monthly net operating income or loss?
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. What will the new contribution format income statement look like if these changes are adopted?
4. Refer to the original data. The Marketing Department thinks that a fancy new package for the laptop computer battery would help sales. The new package would increase packaging costs by $0.60 cents per unit. Assuming no other changes, how many units would have to be sold each month to earn a 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 $55,000 each month.
A. Compute the new CM ratio and the new break-even point in both unit sales and dollar sales.
CM ratio 45%
Break-even points in units 183
Break-even points in dollars 7,305

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.
C. Would you recommend that the company automate its operations?
1. Yes
2. No

Answer 1

Answer:

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

CM ratio = 211,200 / 528,000 = 39.96%

break even point in $ = 235,200 / 39.96% = $588,588

break even point in units = 588,588 / 40 = 14,714.7 ≈ 14,715 units

2. The president believes that a $6,800 increase in the monthly advertising budget, combined with an intensified effort by the sales staff, will result in an $89,000 increase in monthly sales. If the president is right, what will be the effect on the company’s monthly net operating income or loss?

total revenue = $617,000

variable expenses = $617,000 x 60.04% = $370,446.80

contribution margin = $246,553.20

fixed expenses = $242,000

operating profit = $4,553.20

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. What will the new contribution format income statement look like if these changes are adopted?

total revenue = $950,400

variable expenses = 26,400 x $24.016 = $634,022.40

contribution margin = $316,377.60

fixed expenses = $266,200

operating profit = $50,177.60

4. Refer to the original data. The Marketing Department thinks that a fancy new package for the laptop computer battery would help sales. The new package would increase packaging costs by $0.60 cents per unit. Assuming no other changes, how many units would have to be sold each month to earn a profit of $4,100?

variable expenses per unit = $24.016 + $0.60 = $24.616

contribution margin per unit = $40 - $24.616 = $15.384

break even point + $4,100 gains = 239,300 / 15.384 = 15,555.122 ≈ 15,556 units

5. Refer to the original data. By automating, the company could reduce variable expenses by $3 per unit. However, fixed expenses would increase by $55,000 each month.

a) contribution margin per unit = $18.984

break even point = 290,200 / 18.984 = 15,286.56 ≈ 15,287 units

break even point in $ = 15,287 x $40 = $611,480

b)                                           not automated                   automated

sales revenue                           $828,000                       $828,000

variable costs                           $497,131.20                    $435,031.20      

contribution margin                $330,868.80                  $392,968.80

fixed costs                                  $235,200                      $290,200

operating income                     $95,668.80                   $102,768.80

c) 2. No

In order for the automation process to be profitable, the number of sales units must increase a lot, and since the company is struggling to sell enough units, I doubt it will work.