Question

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 44,000 of these balls, with the following results: Sales (44,000 balls) Variable expenses Contribution margin Fixed expenses Net operating income $ 1,100,000 660,000 440,000 317,000 $ 123,000 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, $123,000, 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 co 1a), what selling price per ball must it charge next year to cover the 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, $123,000, as last year? b. Assume the new plant is built and that next year the company manufactures and sells 44,000 balls (the same number as sold last year). Prepare a contribution format income statement and compute the degree of operating leverage.

Answer 1

Answer 1)

CM ratio = (Contribution Margin / Sales) x 100

= ($440000 / 1100000) x 100 = 40%

BEP in units = Fixed Cost / Contribution margin per unit

= $317000 / ($440000/44000) = 31700 units i.e. 31700 balls

Degree of operating leverage = Contribution Margin / Operating income

= $440000 / $123000 = 3.57724 r/o 3.58

Answers 2)

Total variable expense per unit on increase in variable expenses = $15 + $3 = $18

Contribution margin per ball = Selling price per ball - Contribution per ball = $25 - $18 = $7

CM ratio = (Contribution Margin per ball / Selling price per ball) x 100 = ($7 / $25) x 100 = 28%

BEP in units = Fixed Cost / Contribution margin per unit = $317000 / $7 = 45286 units

Answers 3)

Sales in units required to maintain same amount of net operating income

= (Fixed Cost + Net operating income) / Contribution margin per ball

= ($317000 + $123000) / $7

= 62857 balls

Answers 4)

CM ratio = (Selling price per ball - Variable expense per ball) / Selling price per ball

0.4 = (Selling price per ball - $18) / Selling price per ball

0.4 x Selling price per ball = Selling price per ball -$18

$18 = 1 Selling price per ball - 0.4 Selling price per ball

$18 = 0.6 Selling price per ball

Therefore, Selling price per ball = $18 / 0.6 = $30