3 Due to erratic sales of its sole product a high capacity b

3. 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 ( 19,500 units 3 $ 30 per unit) . . . . . . . . . $ 585,000

Variable expenses . . . . . . . . . . . . . . . . . . . . . .       409,500

Contribution margin . . . . . . . . . . . . . . . . . . . . .     175,500

Fixed expenses . . . . . . . . . . . . . . . . . . . . . . . .       180,000

Net operating loss . . . . . . . . . . . . . . . . . . . . . .     $ ( 4,500 )

Required:

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 $ 16,000 increase in the monthly advertising budget, combined with an intensified effort by the sales staff, will result in an $ 80,000 increase in monthly sales. If the president is right, what will be the effect on the company’s monthly net operating income or loss? ( Use the incremental approach in preparing your answer.)

3. Refer to the original data. The sales manager is convinced that a 10% reduction in the selling price, combined with an increase of $ 60,000 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 75 cents per unit. Assuming no other changes, how many units would have to be sold each month to earn a profit of $ 9,750?

5. Refer to the original data. By automating, the company could reduce variable expenses by $ 3 per unit. However, fixed expenses would increase by $ 72,000 each month.

a. Compute the new CM ratio and the new break- even point in both unit sales and dollar sales.

b. Assume that the company expects to sell 26,000 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? Explain.

Solution

As per policy first four questions will be answered.

PART 1

Total

  Per Unit

Percent of Sales

  Sales (13,500 units)

$

585,000   

$

30   

100

%

  Variable expenses

409,500   

21   

70

%

  Contribution margin

$

175,500   

$

9  

30

%

Variable expenses=(409500/19500)

Contribution margin = contribution margin per unit / sales price per unit = 9/30 = 30%

Unit sales to break even = fixed expenses / Unit contribution margin = 180000/9 = 20000 units

Dollar sales to break even = fixed expense / CM ratio = 180000/30% = $600000

PART 2

  Incremental contribution margin:

    $80,000 increased sales × 30% CM ratio

$

24,000   

  Less increased advertising cost

16,000   

  Increase in monthly net operating income

$

8,000   

Increases by 8000

PART 3

PEM Inc.

Contribution margin income statement

sales

1053000 ((19500*2)*(30*(1-10%))

Variable expenses

819000 (19500*2)*21

Contribution margin

234000

Fixed expenses

240000(180000+60000)

Net operating loss

(6000)

PART 4

Unit sales to attain target profit = Target profit + Fixed expenses/CM per unit = (9750+180000)/(30-(21+0.75)) = 23000 units

	Total	Per Unit	Percent of Sales
Sales (13,500 units)	$	585,000	$	30	100	%
Variable expenses		409,500		21	70	%
Contribution margin	$	175,500	$	9	30	%