Question

Question 5

Due to erratic sales of its sole product – a high-capacity battery for laptop
computers – Johane Ltd has been experiencing difficulty for some time. The
company’s contribution income statement for the most recent month is
given below:
Sales (19,500 units * $30 per unit) $585,000
Variable expenses 409,500
Contribution 175,500
Fixed Expenses 180,000
Operating Loss $(4500)
Required:
a. Compute the company’s CM ratio and its break-even point in both units and
dollars.
b. 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 net operating income or loss? (Use the
incremental approach in preparing your answer.)
c. 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 cause units sales to double. What will the new contribution format
income statement look like if these changes are adopted?
d. The Marketing Department thinks that a fancy new package for the laptop
computers 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?
e. By automating certain operations, the company would reduce variable costs
by $3 per unit. However, fixed costs would increase by $72,000 each month.

Answer 1

Answer: a. CM ratio = Contribution / Sales = $175,500 / $585,000 = 0.3 or 30% Break-even point in units = Fixed Expenses / CM per unit = $180,000 / ($30*0.3) = 20,000 units Break-even point in dollars = Break-even point in units Selling price per unit = 20,000 units $30 = $600,000

b. Increase in sales = $80,000 Increase in advertising budget = $16,000 Net increase in sales - increase in advertising budget = $80,000 - $16,000 = $64,000 Increase in contribution = Increase in sales CM ratio = $64,000 0.3 = $19,200 New net operating income = Old net operating income + increase in contribution - increase in advertising budget = -$4,500 + $19,200 - $16,000 = -$1,300 (still a loss)

c. New selling price = Old selling price (1 - 0.1) = $30 (1 - 0.1) = $27 New unit sales = Old unit sales 2 = 19,500 units 2 = 39,000 units New sales = New unit sales New selling price = 39,000 units $27 = $1,053,000 New variable expenses = Old variable expenses 2 + increased advertising budget = $409,500 2 + $60,000 = $879,000 New contribution = New sales - New variable expenses = $1,053,000 - $879,000 = $174,000 New operating loss = New contribution - Fixed expenses = $174,000 - $180,000 = -$6,000 (still a loss)

d. New variable cost per unit = Old variable cost per unit + increase in packaging cost = $30 - $30*0.3 + $0.75 = $22.75 Units to be sold to earn a profit of $9,750 = (Fixed expenses + desired profit) / CM per unit = ($180,000 + $9,750) / ($30 - $22.75) = 25,300 units

e. New variable cost per unit = Old variable cost per unit - reduction in variable cost = $22.75 - $3 = $19.75 New fixed costs = Old fixed costs + increase in fixed costs = $180,000 + $72,000 = $252,000 New break-even point in units = New fixed costs / CM per unit = $252,000 / ($30 - $19.75) = 20,200 units.

Explanation: