Question

Problem 6-20 CVP Applications: Break-Even Analysis; Cost Structure; Target Sales [LO6-1, LO6-3, LO6-4, LO6-5, LO6-6, LO6-8]

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 per ball, of which 60% is direct labor cost.

Last year, the company sold 30,000 of these balls, with the following results:

Sales (30,000 balls)	$	750,000
Variable expenses		450,000
Contribution margin		300,000
Fixed expenses		210,000
Net operating income	$	90,000

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 per ball. If this change takes place and the selling price per ball remains constant at $25, 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, $90,000, 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 1a), 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%, 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, $90,000, as last year?

b. Assume the new plant is built and that next year the company manufactures and sells 30,000 balls (the same number as sold last year). Prepare a contribution format income statement and compute the degree of operating leverage.

Answer 1

Price (7) (as last year's Cm Ratio = (sales per unit - Variable expenses per unit) & sales ver Price Unit = ($25-415) $25 - $10 & $25 = 0.40 or 40% point - Fixed cost contribution per Unit Break-even Contribution margin Per Unit = velling Price per Unit - Variable expenses per unit = $25 - $15 Break-even point = $210,000 - $10 = 21,000 balls (1b) 12 Degree of operating Leverage = contribution margin Net Income = $ 300,000 - $90,000 = 3.33 Contribution Margin = Selling Price per Unit - Variable expenses per unit) selling Price Per Unit Variable expenses increase by & 3 per ball, so xpenses = ($15 + $3) per ball = $ 18 per ball variable expenses = ($15 t.

Now, Cm Ratie = ($25 - $18) - $25 I $7 - $25 = 0.20 or 28% Break even Point = Pixed cost contribution margin Per Unit Contribution Margin Per Unit = sales per unit - Variable expenses per unit) a $25 – $18 z $ 7. Νου, Breakeven Point = $ 210,000 & $7 = 30,000 balls (3) Desired sales (Balls) = fixed cost & Desired Profit Contribution per Unit = ($ 210,000 + $ 90,000) = $ 7 = $300,000 - $7 = 42,857 balls approx. & Contribution per unit is calculated above in parte 4 Let selling price an So contribution margin = x x 40% (calculated in = 0.40 x part la)

Contribution Margin per Unit = selling Price per unit- Variable expenses per unit 0.40 n - n - ($15+ $3) 0.40 n = a- $18 x -0.4on – $18 0.6on = $ 18 x = $ 18 0.60 = $30 per unit to be charged So selling Price = $30 per unit to be charged & variable expenses slashed by 40% Variable expenses per unit = $15-($15x40%) = $15 - $6 3 $9 fixed cost per year to double, so fixed cost = $210,000 & 2 = $420,000 CM Ratio a selling Price per Unit - variable expen Selling Price per unit = ($25 - $9) $25 = $ 16 - $25 = 0.64 or 64%

Break even point (balls) = fixed cost contribution per Unit Contribution per unit a sales per unit - variable expense per unit) - $25- $9 2 $16 Now, Break even point (balls) = $420,000 - $16 2 26,250 balls Gas Desired sales = fixed cost + Desired Profit Contributien der Unit = ($420,000 + $ 90,000) - $16 (calculated above in part s) - $510,000 & $16 = 31,875 balls (6b) i T Sales $750,000 Less: Variable expenses $270,000 Contribution margin less: fixed cost Net Income $ 480,ooo $ 420,000 $ 60,000

Calculation: Sales - 30,000 balls & $25 - $750,000 Variable expenses = 30,000 balls & $9 (calculated in part 5) $ 270,000 6b) ii) Degree of operating levarage & Contribution Margin Net income = $ 480,000 = $ 60,000