Due to erratic sales of its sole product—a high-capacity battery for laptop computers—PEM, Inc., has been experiencing financial 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)$260,000 Variable expenses 156,000 Contribution margin 104,000 Fixed expenses 116,000 Net operating loss$(12,000) Required:1. Compute the company’s CM ratio and its break-even point in unit sales and dollar sales.2. The president believes that a $7,000 increase in the monthly advertising budget, combined with an intensified effort by the sales staff, will result in an $86,000 increase in monthly sales. If the president is right, what will be the increase (decrease) in the company’s monthly net operating income?

To get the contribution margin ratio, divide the contribution margin by the amount of sales. Since the CM is 104,000 and the sales is 260,000, you will get 40% CM ratio.

To compute the BEP in dollar sales, divide the fixed expenses by the CM ratio. So, 116,000 divided by 40% is 290,000.

To compute the BEP in units, divide the fixed expenses by the CM per unit. So, 116,000 divided by 8 is 14,500.

Requirement two:

Sales - 346,000

Less: Variable expenses - 156,000

Contribution Margin - 190,000

Less: Fixed Expenses - 123,000

Net Operating Income - 67,000

67,000 compared to (12,000) operating loss, there will be an increase of 55,000.

Explanation:

Since there will be an increase of 86,000 in peso sales, the sales will become 346,000. The contribution margin will increase to 190,000. With the 7,000 increase in fixed expenses, the net operating income will become 67,000. Compared from the 12,000 operating loss, the company will have a net increase of 55,000 in net operating income for the month.