Problem 5-22 Basics of CVP Analysis, Cost Structure [LO5-1, LO5-3, LO5-4, LO5-5,

ID: 2555706 • Letter: P

Question

Problem 5-22 Basics of CVP Analysis, Cost Structure [LO5-1, LO5-3, LO5-4, LO5-5, LO5-6] 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 (13,000 units $20 per unit) $260,000 Variable expenses 130,000 Contribution margin Fixed expenses 130,000 145,000 Net operating loss $ (15,000) Required: 1. Compute the company's CM ratio and its break-even point in both unit sales and dollar sales. CM ratio Break-even point in units Break-even point in dollars 2. The president believes that a $6,100 increase in the monthly advertising budget, combined with an intensified effort by the sales staff, will result in an $87,000 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.)

Explanation / Answer

Solution:

Part 1 –

CM Ratio = Contribution margin 130,000 / Sales 260,000 x 100 = 50%

Break Even Point in units = Total Fixed Cost /Contribution Margin Per Unit

Contribution Margin Per Unit = Contribution margin 130,000 / Total Units 13,000 Units = $10

Break Even Point in units = Total Fixed Cost 145,000 /Contribution Margin Per Unit 10 = 14,500 Units

Break Even point in dollars = Total Fixed Cost 145,000 / CM Ratio 50% = $290,000

Part 2 --- Effect on monthly net operating income or loss

Increase in Monthly Sales

$87,000

Increase in Monthly Contribution Margin

$43,500 (87,000*50%)

Less: Increase in Fixed Cost (Advertisement Exp)

($6,100)

Increase in Monthly Net Operating Income (43,500 – 6,100)

$37,400

Monthly Net Operating Income INCREASED by $37,400

Part 3 – New Contribution Format Income Statement

Sales (26,000 Units x $18)

$468,000

Variable Expenses (26,000 Units x $10)

$260,000

Contribution Margin

$208,000

Fixed Expense (145,000 + 31,000)

$175,000

Net Operating Income

$33,000

Note –

New Selling Price per unit = Old $20 – 10% decrease in old selling price 20 = 20 – 2 = $18

New Units Sales = Old 13,000 Units x Double 2 = 26,000 Units

Variable Expense Per Unit = Total Variable Expense from original data $130,000 / Total Units from original data 13,000 Units = $10 per unit

Part 4 –

New Variable Expenses per unit =Old $10 + Packing Cost $0.70 per unit = $10.70

Selling Price Per Unit = $20

Contribution Margin Per Unit = $20 – 10.7 = $9.30 per unit

Number of Units would have to be sold to earn a profit of $4,800 = (Total Fixed Expense + Target Profit) / Contribution Margin per unit

= ($145,000 + $4,800) */ 9.3

= $149,800 / 9.3

= 16,107.53 units or 16,108 Units

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Pls ask separate question for remaining parts.