Due to erratic sales of its sole product—a high-capacity battery for laptop comp
ID: 2392616 • Letter: D
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
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 $6,800 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 $38,000 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 0.60 cents per unit. Assuming no other changes, how many units would have to be sold each month to attain a target profit of $4,900?
5. Refer to the original data. By automating, the company could reduce variable expenses by $3 per unit. However, fixed expenses would increase by $52,000 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)?
Sales (12,600 units × $30 per unit) $ 378,000 Variable expenses 189,000 Contribution margin 189,000 Fixed expenses 211,500 Net operating loss $ (22,500 )Explanation / Answer
PEM Inc
CM ratio = (contribution margin/sales) x100
Contribution margin = $189,000
Sales = $378,000
CM Ratio = (189,000/378,000) x 100 = 50%
Break-even point in unit sales –
Break-even point in unit sales = fixed cost/contribution margin per unit
Contribution margin per unit = $189,000/12,600 units = $15
Fixed cost = $211,500
Break-even point in units sales = 211,500/15 = 14,100 units
Break-even point in dollar sales –
Break-even point in dollar sales = fixed cost/CM ratio
= $211,500/50% = $423,000
increase in fixed cost (advertising budget) = $6,800,
revised fixed cost = 211,500 + 6,800 = $218,300
Increase in monthly sales = $86,000
Revised sales = $378,000 + $86,000 = $464,000
Contribution margin = 50% of sales = $464,000 x 50% = $232,000
Net operating income = contribution margin – fixed cost
= $232,000 - $218,300 = $13,700
Original net operating income = ($22,500)
Revised net operating income = $13,700
Change = 13,700 – (22,500) = 13,700 + 22,500 = $36,200
Hence, net operating income increased by $36,200.
Sales price reduced by 10%, = $30 -10% $30 = $27
Revised fixed cost (with increased advertising expenditure) = $211,500 + $38,000 = $249,500
Revised unit sales = 2 x 12,600 = 25,200 units
Revised contribution margin = revised sales – revisedvariable cost
Revised sales = $27 x 25,200 units = $680,400
Revised variable cost = $15 x 25,200 units = $378,000
Revised CM= 680,400 – 378,000 = $302,400
Revised CM per unit = $302,400/25,200 units= $12 per unit
Revised net income = Revised CM – Revised fixed expenses
= $302,400 - $249,500 = $52,900
Hence, revised net income = $52,900
Revised variable cost = $15 + $0.60 = $15.60 per unit
Revised CM per unit = $30 - $15.60 = $14.40
Fixed expenses = $211,500
Target income = $4,900
Desired sales units = (fixed expenses + target profit)/CM per unit
= (211,500 + 4,900)/14.40 = 15,028 units
Hence, the company needs to produce and sell 15,028 units to reach the target profit of $4,900.
Break-even point in unit sales -
Revised variable cost = $15 - $3 = $12 per unit
New CM per unit = $30 - $12 = $18
New CM ratio = new CM per unit/sales price per unit
= (18/30) x 100 = 60%
Revised Fixed expenses = 211,500 + 52,000 = $263,500
Break-even point in unit sales = fixed expenses/CM per unit
= $263,500/$18 = 14,639 units
Break-even point in dollar sales = fixed expenses/CM ratio
= 263,500/60% = $439,167
5B
Contribution margin income statements
Automation
No Automation
Per Unit
Total
Percentage
Per Unit
Total
Percentage
Sales units
20,900
20,900
Sales
$30
$627,000
100%
$30
$627,000
100%
Variable cost
$12
$250,800
40%
$15
$313,500
50%
Contribution margin
$18
$376,200
60%
$15
$313,500
50%
Fixed expenses
$263,500
42.00%
$211,500
33.70%
Net Income
$112,700
18.00%
$102,000
16.30%
5c.
Yes, we recommend the company adopt automation.
Automation resulted in increase in net income by $10,700 (112,700 – 102,000). Though automation increases fixed expenses by $52,000 it causes a reduction of $3 per unit in variable costs and increase in net income by $10,700. Hence, automation is recommended.
Contribution margin income statements
Automation
No Automation
Per Unit
Total
Percentage
Per Unit
Total
Percentage
Sales units
20,900
20,900
Sales
$30
$627,000
100%
$30
$627,000
100%
Variable cost
$12
$250,800
40%
$15
$313,500
50%
Contribution margin
$18
$376,200
60%
$15
$313,500
50%
Fixed expenses
$263,500
42.00%
$211,500
33.70%
Net Income
$112,700
18.00%
$102,000
16.30%