Question

Problem 6-20 CVP Applications: Break-Even Analysis; Cost Structure; Target Sales (LO6-1, LO6-3, LOG- 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 $15.00 per ball, of which 60% is direc 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 $ 1,250,000 750,000 500,000 320,000 180,000 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, $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 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, wha 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 yea 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.

Answer 1

As From part 1 to Part 4 are correct, I have only done the remaining parts.

5) New variable cost per unit= ($750000/50000)*60%= $9 per unit

Selling price per unit= $1250000/50000= $25

New fixed costs= $320000*2= $640000

Contribution margin per unit= Selling price per unit-New variable cost per unit

= $25-9= $16 per unit

Contribution margin ratio= Contribution margin*100/Sales

= $16*100/25= 64%

Break even point in balls= Fixed cost/Contribution margin per unit

= $640000/16= 40000 balls

CM ratio	64	%
Unit sales to break even	40000	balls

6-A) Break eve point in balls= (Fixed cost+Target income)/Contribution margin per unit

= ($640000+180000)/16= 51250 balls

Number of balls

51250

B)

Northwood Company
Contribution Income Statement
Sales (50000*$25)	$1250000
Variable expenses (50000*$9)	-450000
Contribution margin	800000
Fixed expenses	-640000
Net operating income	$160000
Degree of operating leverage (800000/160000)	5