Zoltrixound company manufactures high quality speakers for desktop and laptop computers. Last month Zoltrixound suffered a loss of $18,000. The income statement of the last month is as follows:

Sales (13,500 units × $40) 540,000
Less variable expenses 378,000
———
Contribution margin 162,000
Less fixed expenses 180,000
———
Net operating loss $(18,000)
———

 Required:

  1. Compute the break-even point and contribution margin ratio of Zoltrixound company?
  2. Sales department feels that if monthly advertising budget is increased by $16000, the sales will be increased by $140,000. Show the effect of this change.
  3. If sales price is reduced by 20% and monthly advertising expenses are increased by $70,000, the unit sales are expected to increase by 100%. Show the effect of this change by preparing a new income statement of Zoltrixound company.
  4. The Zoltrixound wants to make the packing of  its product more attractive. The new packing would increase cost by $1.20 per unit. Assuming no other changes, compute the number of units to be sold to earn a net operating income of $9,000.
  5. The company is planning to purchase a new machine. The installation of  new machine will increase fixed cost by $236,000 and decrease unit variable expenses by 50%.
    (a). Compute the CM ratio and break-even point if the new machine is installed.
    (b). Company expects a sale of 20,000 units for the next month. Prepare two income statement, one assuming that the machine is not installed and one assuming that it is installed.
    (c) Should the company install new machine. Give your recommendations.

Solution:

(1) Computation of CM ratio and break-even point:

CM ratio = $162,000 / $540,000

=0.3 or 30%

Break-even point = $180,000 / $12

=  15,000 units or $600,000

(2) Effect of increase in advertising budget by $16,000 and sales by $140,000:

Increase in sales revenue $140,000
Less increase in expenses:
Variable (3,500* units × $28**) 98,000
Fixed (monthly advertising budget) $16,000 $114,000
——– ———-
$26,000
———-

If sales are increased by $140,000, the company will earn a profit of $8,000 ($26,000 – $18,000) rather than suffering a loss.

*$140,000 /$40 = 3,500 units

**$378,000 /$13,500 = $28

(3) Effect of reduction in sales price by 20%, increase in monthly advertising budget by $70,000 and increase in unit sales by 100%:

Sales (27,000 units × $32 ) $864,000
Less variable expenses (27,000 units × $28 ) $756,000
———-
Contribution margin $108,000
Less fixed expenses $250,000
———-
 Net operating loss $(142,000)
———-

(4) Computation of the number of units to be sold to earn $9,000:

($180,000 + $9,000) / $10.8*

17,500 Units

*The variable expenses in original income statement are $28. The new packing will increase variable expenses and reduce contribution margin per unit by $1.20 as shown below:

[$40 – ($28 + $1.20)] = $10.8

(5) Installation of new machine:

(a).

Computation of new CM ratio:

351,000 / 540,000

0.65%

Break-even point:

416,000 / $26

16,000 units

or

16,000 units × $40 = $640,000

(b).

If new machine is not installed:

Sales (20,000 units × $40) 800,000
Less variable expenses (20,000 units × $28) 560,000
———–
Contribution margin 240,000
Less fixed expenses 180,000
———–
Net operating income 60,000
———–

If new machine is installed:

Sales (20,000 units × $40) 800,000
Less variable expenses (20,000 units × $14) 280,000
———–
Contribution margin 520,000
Less fixed expenses ($180,000 + $236,000) 416,000
———–
Net operating income 104,000
———–

(c). If only the monthly net operating income is considered, Zoltrixound should purchase and install the new machine because it will generate more net operating income . Decrease in variable expenses are more than the increase in fixed expenses if 20,000 units are produced.

Decrease in variable expenses: (20,000 units × $14) =  280,000

Increase in fixed expenses: $236,000

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