Question

Problem 5-20 CVP Applications: Break-Even Analysis; Cost Structure; Target Sales [LO5-1, LO5-3, LO5- 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 46,000 of these balls, with the following results Sales (46,000 balls) Variable expenses Contribution margin Fixed expenses Net operating income $ 1,150,000 690,000 460,000 318,000 $ 142,000 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 $3.00 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, $142,000, 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 40.00%, 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, $142,000, as last year? b. Assume the new plant is built and that next year the company manufactures and sells 46,000 balls (the same number as sold last year). Prepare a contribution format income statement and compute the degree of operating leverage Complete this question by entering your answers in the tabs below Req 1 Req 2 Req 3 Req 4 Req 5 Req 6A Req 6B 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. (Round "Unit sales to break even" to the nearest whole unit and other answers to 2 decimal places.) CM Ratio Unit sales to break even Degree of operating leverage balls

Answer 1

Unit selling price	25	= 1150000/46000
Unit variable cost	15	= 690000/46000
1
CM ratio	40%	=(25-15)/25
Units sales to break even	31800	=318000/(25-15)
Contribution margin	460000
Divide by Net operating income	142000
Degree of operating leverage	3.24
2
Revised variable expenses	18	= 15+3
CM ratio	28%	=(25-18)/25
Units sales to break even	45429	=318000/(25-18)
3
Number of balls	65714	=(318000+142000)/(25-18)
4
Selling price	30	=18/(1-40%)
5
Revised variable expenses	9	=15*(1-40%)
Revised fixed cost	636000	=318000+318000
CM ratio	64%	=(25-9)/25
Units sales to break even	39750	=636000/(25-9)
6a
Number of balls	48625	=(636000+142000)/(25-9)
b
Sales	1150000	=46000*25
Variable expenses	414000	=46000*9
Contribution margin	736000
Fixed expenses	636000
Net operating income	100000
Degree of operating leverage	7.36	=736000/100000