Question Completion:
Due to erratic sales of its sole product - a high capacity battery for laptop computers - PEM, Inc., has been experiencing difficulties for some time. The contribution format income statement for the most recent month is given as follows:
Sales (19,500 units at $30 per unit) $585,000
Variable expenses 409,500
Contribution margin 175,500
Fixed expenses 180,000
Net operating margin ($4,500)
Answer:
PEM, Inc.
a1) New CM ratio = 40%
a2) Break-even point in unit sales and dollars sales
i) Break-even point in unit sales = Fixed Expenses/Contribution per unit
= $237,000/$12
= 19,750 units
ii) Break-even point in dollars sales = Fixed Expenses/Contribution margin ratio
= $237,000/0.4
= $592,500
b. Contribution format income statements, based on sales of 20,800 units:
Without With
Automation Automation
Sales (20,800 units at $30 per unit) $624,000 $624,000 (20,800 * $30)
Variable expenses (20,800 at $21) 436,800 374,400 (20,800 * $18)
Contribution margin (20,800 * $9) 187,200 249,600 (20,800 * $12)
Fixed expenses 180,000 237,000
Net operating margin $7,200 $12,600
c) I would recommend that the company should automate its operations. It will generate more net operating margin, equal to $5,400 ($12,600 - $7,200), when it automates than when it does not, assuming that it expects to sell 20,800 units.
Explanation:
a) Data and Calculations:
Variable expenses reduction = $3 per unit
Old variable expenses per unit = $21 ($409,500/19,500)
New variable expenses per unit = $18 ($21 - $3)
New variable expenses = $351,000 ($18 * 19,500)
New Contribution Margin per unit = $12 ($30 - $18)
New Contribution margin ratio = $12/$30 * 100 = 0.4 or 40%
Old Fixed Expenses = $180,000
New Fixed Expenses = $237,000 ($180,000 + $57,000)
