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 62,000 of these balls, with the following results: Sales (62,000 balls) Variable expenses Contribution margin Fixed expenses Net operating income $1,550,000 930,000 620,000 426,000 $ 194,000 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, $194,000, 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, $194,000, as last year? b. Assume the new plant is built and that next year the company manufactures and sells 62,000 balls (the same number as sold last year). Prepare a contribution format income statement and compute the degree of operating leverage.

Answer 1

62000 Balls Sales Variable Expenses contribution Margin Fixed cost Net operating income Per unit 1550000 25 930000 620000 426000 194000 10 40% 42600 Balls 3.20 Times Question 1 CM Ratio ( contribution/Sales) (10/25) BEP In Units (Fixed Cost/CM Per unit) (426000/10) Operating Leverage 620000/194000 Question 2 IF Variable cost increase by $3 New CM (25-18) CM Ratio (7/25) Break Even Point in Units 426000/7 Question 3 Ball To Sell to Attain the 194000 profit Number of Balls (426000+194000)/7 28.00% 60857 Balls 88571 Balls

30 852000 25/ 64.00% 53250 Balls Question 4 Selling Price (18/(1-40%) Question 5 Variable Cost will Reduce by 40% (15*40%) Fixed cost will be double (426000*2) selling Price Variable Cost Contribution Margin CM Ratio ( contribution/Sales) BEP In Units (Fixed Cost/CM Per unit) Question 6 Ball To Sell to Attain the 194000 profit Number of Balls Contribution Margin Income Statement Sales 1550000 Variable Expenses 558000 contribution Margin 992000 Fixed cost 852000 Net operating income 140000 Degree of Operating Leverage = 992000/140000 65375 Balls 7.09 Times