Metro International manufactures two products – plasma TV and high quality laptop. Plasma TV sells for \$800 and high quality laptop for \$1200. Company sells its products through its own stores and other outlets. Total fixed expenses of Metro International are \$132,000 per month. Variable expenses and monthly sales data are given below:

 Plasma TV Laptop Variable expenses per unit \$480 \$240 Monthly sales in units 200 Units 80 Units

Required:

1. Prepare a contribution margin format income statement showing dollars and percent columns for products and for the company as a whole.
2. Compute the break-even point in dollars and margin of safety.
3. Metro International is considering to manufacture another product – an inverter. The addition of new product will not effect the fixed cost of the company. The variable expenses to manufacture and sell an inverter will be \$1,200. If the new product is sold for \$1,600 the monthly expected sales are 40 inverters.
(a). Prepare a new contribution margin income statement.
(b). Compute the new break-even point and margin of safety of the company.
4. The president is unable to understand the increase in break-even sales because the new product has increased the sales revenue and contribution margin without any increase in fixed costs. Explain to the president the reason of increase in break-even sales.

## Solution:

(1) Contribution margin format income statement:

 Plasma TV Laptop Total Sales 160,000 100% 96,000 100% 256,000 100% Less variable expenses 96,000 60% 19,200 20% 115200 45% ——– —– ——– —– ——– —– 64,000 40% 76,800 80% 140,800 55% ——– —– ——– —– —– Less fixed expenses 132,000 ——– Net operating income 8,800 ——–

(2) Computation of break-even point (BEP) and margin of safety (MOS):

BEP = Total fixed cost / CM ratio

\$132,000 / 0.55

\$240,000

The break-even point of Metro international in dollars is \$240,000. At this point, the company will neither earn any profit nor suffer any loss.

MOS = Total sales – Break-even sales

\$256,000 – 240,000

\$16,000

or

16,000 / 256,000 = 0.0625 or 6.25%

The margin of safety is \$16,000. It means that if the sales are reduced by \$16,000, the Metro International will break-even.

(3). Addition of new product – inverter:

(a). Contribution margin income statement:

 Plasma TV Laptop Inverter Total Sales 160,000 100% 96,000 100% 64,000 100% 320,000 100% Less variable expenses 96,000 60% 19,200 20% 48,000 75% 163,200 51% ——– —– ——– —– ——– —– ——– —– 64,000 40% 76,800 80% 16,000 25% 156,800 49% ——– —– ——– —– ——– —– —– Less fixed expenses 132,000 ——– Net operating income 24,800 ——–

(b). Break-even point and margin of safety after the addition of new product:

BEP = 132,000 / 0.49

\$269,388

MOS = \$320,000 – \$269,388

\$50,612

(4). Explanation to the president:

The reason of increase in break-even point is the change in sales mix (introduction of new product – inverter). In spite of the fact that it has increased the sales revenue and total contribution margin, it has reduced overall CM ratio of the company from 55% to 49%. The reduction in overall CM ratio has increased break-even point of Metro International.