Question

Seved Help Problem 5-20 CVP Applications: Break-Even Analysis; Cost Structure; Target Sales (LO5-1, LO5-3, LOS- 4, LO5-5, LO5-6, LO5-8) Northwood Company manufactures basketballs. The company has a ball that sells for $25. At present, the ball is manufactured in a small plant that relies heavily on direct labor workers. Thus, variable expenses are high, totaling $15.00 per ball, of which 60% is direct labor cost Last year, the company sold 50,000 of these balls, with the following results: Sales (50,000 balls) Variable expenses Contribution margin Fixed expenses Net operating income $1,250,000 750,000 320.000 $ 180,000 500,00 Required: 1. Compute(a) last year's CM ratio and the break-even point in balls, and (b) the degree of operating leverage at last year's sales level. 2. Due to an increase in labor rates, the company estimates that next year's variable expenses will increase by $3.00 per ball. If this change takes place and the selling price per ball remains constant at $25.00, what will be next year's CM ratio and the break-even point in balls? 3. Refer to the data in (2) above. If the expected change in variable expenses takes place, how many balls will have to be sold next year to earn the same net operating income. $180,000, as last year? 4. Refer again to the data in (2) above. The president feels that the company must raise the selling price of its basketballs. If Northwood Company wants to maintain the same CM ratio as last year (as computed in requirement 10), what selling price per ball must it charge next year to cover the increased labor costs? 5. Refer to the original data. The company is discussing the construction of a new, automated manufacturing plant. The new plant would slash variable expenses per ball by 40.00%, but it would cause fixed expenses per year to double. If the new plant is built what would be the company's new CM ratio and new break-even point in balls? 6. Refer to the data in (5) above. a. If the new plant is built, how many balls will have to be sold next year to earn the same net operating income, $180,000, as last year? b. Assume the new plant is built and that next year the company manufactures and sells 50,000 balls the same number as sold last year). Prepare a contribution format income statement and compute the degree of operating leverage.

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Answer 1

Answer with working notes is given below

1 CM Ratio Units sales to Break even Degree of Operating Leverage 40.00% 32,000 2.78 CM Ratio per unit Sales Total $1,250,000 $750,000 $500,000 $25 $15 Variable cost Contribution $10 40.00% CM Ratio (Contribution/Sales) % Units sales to Break even Fixed Cost Contribution per unit 32,000 A/B $320,000 A $10B Degree of Operating leverage Contribution Net Operating Income 2.78 A/B $500,000 A $180,000 B 2 per unit $25 $18 Revised CM Ratio Selling price Variable cost Contribution CM Ratio (Contribution/Sales) % $7 28.00%| Units Unit Sales to Break even Fixed Cost Contribution per unit $320,000 45,714 Balls $7 3 Fixed Cost Net Operating income Total Target needed $320,000 $180,000 $500,000 A Contribution per unit $7B Number of Balls to be sold A/B 71,429 Balls ($500,000/$7) 4 Required CM Ratio Variable Cost ratio 40.00% 60.00% (1-CM Ratio) Variable cost Selling price to be charged $18.00 $30.00 (Variable cost/60%) 5 New CM Ratio Selling price Variable cost Contribution New CM ratio per unit $25 $9 $15-40% less $16B 64.00% $640,000 A Fixed expenses- Revised ($319,000 X 2) New Break even point in units (Fixed Cost/Contribution per unit) 40,000 A/B Fixed Cost- Revised Net Operating income Total Target needed $640,000 $180,000 $820,000 A Contribution per unit $16 B Units to be sold A/B 51,250 Balls ($820,000/$16) b Contribution Format Income Statement Sales $1,250,000 (50,000*$25) Less: Variable cost $450,000 (50,000*$9) Contribution $800,000 Less: Fixed Cost $640,000 Net Operating Income $160,000 Degree of Operating leverage Contribution Net Operating Income 5.00 A/B $800,000 A $160,000 B