P5–20 Basics of CVP Analysis; Cost Structure [LO1, LO3, LO4, LO5, LO6]

Memofax, Inc., produces memory enhancement kits for fax machines. Sales have been very erratic, with some months showing a profit and some months showing a loss. The company’s contribution format income statement for the most recent month is given below:

Sales (13,500 units at $20 per unit)     $270,000

Variable expenses                                  189,000

Contribution margin                                 81,000

Fixed expenses                                                    90,000

Net operating loss                                  $(9,000)

Required:

1. Compute the company’s CM ratio and its break-even point in both units and dollars.

Check FigureBreak-even: 15,000 units

2. The sales manager feels that an $8,000 increase in the monthly advertising budget, combined with an intensified effort by the sales staff, will result in a $70,000 increase in monthly sales. If the sales manager 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 president is convinced that a 10% reduction in the selling price, combined with an increase of $35,000 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 company’s advertising agency thinks that a new package would help sales. The new package being proposed would increase packaging costs by $0.60 per unit. Assuming no other changes, how many units would have to be sold each month to earn a profit of $4,500?

5. Refer to the original data. By automating, the company could slash its variable expenses in half. However, fixed costs would increase by $118,000 per month.

a. Compute the new CM ratio and the new break-even point in both units and dollars.

b. Assume that the company expects to sell 20,000 units next month. Prepare two contribution format income statements, one assuming that operations are not automated and one assuming that they are.

c. Would you recommend that the company automate its operations? Explain.