EXERCISE 5-18 Break-Even and Target Profit Analysis; Margin of Safety; CM Ratio

Question

EXERCISE 5-18 Break-Even and Target Profit Analysis; Margin of Safety; CM Ratio LO5-1, LO5-3, LO5-5, LO5-6, LOS-7 Menlo Company distributes a single product. The comppany's sales and expenses for last month follow: Total Per Sales Variable expenses Contribution margin Unit $450,000 $30 180,000 12 270,000 $18 Net operating income S 54,000 Required: 1. What is the monthly break-even point in unit sales and in dollar sales? 2. Without resorting to computations, what is the total contribution margin at the break-even point? 3. How many units would have to be sold each month to attain a target profit of $90,000? Verify your answer by preparing a contribution format income statement at the target sales level. 4. Refer to the original data. Compute the company's margin of safety in both dollar and percentage terms. 5. What is the company's CM ratio? If sales increase by $50,000 per month and there is no change in fixed expenses, by how much would you expect monthly net operating income to increase?

Explanation / Answer

Note: As per rule I am answering first 4 parts of this question.

Requirement – 1;

Break-even point (in units sales) = 12000 units

Break-even point (in dollar sales) = $360000

Explanation;

Break-even point (in units sales) = Fixed costs / (Sale price – Variable cost)

Fixed costs = $216000

Sale price = $30

Variable cost = $12

Now let’s put the values in above given formula;

Break-even point (in units sales) = $216000 / ($30 – $12)

= 12000 units

Break-even point (in dollar sales) = Break-even point (in units sales) *Sale price per unit

Break-even point (in dollar sales) = 12000 * $30 = $360000

Requirement – 2;

Total contribution margin at break-even point = $216000

Explanation;

Total contribution margin at break-even point = Break-even units sale * Contribution margin per unit

Break-even units sale = 12000

Contribution margin per unit = $18

Thus, Total contribution margin at break-even point (12000 * $18) = $216000

Requirement – 3;

Units to be sold for attaining target profit of $90000 = 17000 units

Income Statement

Sales (17000 * $30)

$510000

Less: Variable expenses (17000 * $12)

($204000)

Contribution margin (17000 * $18)

$306000

Less: Fixed expenses

($216000)

Net operating income

$90000

Thus answer is verified because it shows target profit of $90000

Explanation;

Units to be sold for attaining target profit of $90000 =

(Fixed expenses + Target profit) / Contribution margin per unit

$216000 + $90000 / $18 = 17000 units

Requirement – 4;

Margin of safety (in dollar) = $90000

Margin of safety (in %) = 20%

Explanation;

Margin of safety (in dollar) = Actual sale – Break even sale

Margin of safety $450000 – $360000 = $90000

Margin of safety (in %) = Actual sale – Break even sale / Actual sale

Margin of safety (in %) = $450000 – $360000 / $450000

Margin of safety (in %) = 20%

Income Statement

Sales (17000 * $30)

$510000

Less: Variable expenses (17000 * $12)

($204000)

Contribution margin (17000 * $18)

$306000

Less: Fixed expenses

($216000)

Net operating income

$90000

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