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 (12,600 units x $40 per unit) - $504,000Variable expenses - 252,000Contribution margin - 252,000Fixed expenses - 282,000Net operating loss - $(30,000)1. Compute the company's CM ration and its break-even point in both sales and dollar sales.2. The president believes that a $6,600 increase in the monthly advertising budget, combined with an intensified effort by the sales staff, will result in an $85,000 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 $33,000 in the monthly advertising budget, will double unit sales. What will the new contribution format income statement look like if these changes are adopted?

Answer 1

Unit Cost = $40

Unit Contribution Margin = 252000/12600 = $20

Unit Variable Expenses = 252000/12600 = $20

Part 1:

CM ratio = 504000/252000 = 50%

For Break Even Quantity (BEQ) , profit = 0

`\therefore` Profit = (Unit CM * BEQ) - Fixed Expenses

0 = (20 * BEQ) - 282000

BEQ = 282000/20

BEQ = 14100 units

Break Even Sales (BES) will then be,

BES = Quantity * Unit Cost

BES = 14100 * 40

BES = $564000

Part 2:

Using incremental contribution margin approach:

Increased Sales * CM ratio = 85000 * 50% = $42500

Increased Advertising Cost = $6600

Increase in monthly net operating income = 42500 - 6600 = $35900

Hence, net profit will be

Profit = 35900 - 30000

Profit = $5900

Part 3:

New unit cost = 40 - (40 * 10%) = $36

New number of units = 2 * 12600 = 25200 units

New Sales = 36 * 25200 = $907200

New Variable Expenses = 20 * 25200 = $504000

New Contribution Margin = 907000 - 504000 = $403000

New Fixed Expenses = 282000 + 33000 = $315000

Net Operating Income

= New Sales -(New Variable Expenses + New Fixed Expenses)

Net Operating Income = 907000 - (504000 + 315000)

Net Operating Income = $88000