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.

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