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 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, $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

C Amount А 1 Req 1(a) 2 Sales 3 Less: Variable expenses 4 Contribution Margin Per Unit 11,00,000.00 $ 25.00 6,60,000.00 $ 15.00 4,40,000.00 $ 10.00 Req 4 Variable expenses CM Margin 7,92,000.00 40% 5 13,20,000.00 Sales Variable exp/(1-CM%) Selling Price per ball 30.00 Req 5 Sales Less: Variable expenses Contribution Margin 11,00,000.00 $ 25.00 3,96,000.00 $ 9.00 7,04,000.00 $ 16.00 CM Ratio = CM/Sales 64.00% 3.58 Fixed Expenses Break even Point (in balls) (Fixed Exp./CM Per ball) 6,34,000.00 39625 Balls 6 CM Ratio = CM/Sales 40.00% 7 8 Fixed Expenses 3,17,000.00 9 Break even Point (in balls) 31700 Balls 10 (Fixed Exp./CM Per ball) 11 12 Req 1(b) 13 Degree of Operating Leverage Contribution margin 14 Operating Income 15 16 Degree of Operating Leverage 17 18 19 Req2 20 Sales 11,00,000.00 $ 25.00 21 Less: Variable expenses 7,92,000.00 $ 18.00 22 Contribution Margin 3,08,000.00 $ 7.00 23 24 CM Ratio = CM/Sales 28.00% 25 26 Fixed Expenses 3,17,000.00 27 Break even Point (in balls) 45286 Balls 28 (Fixed Exp./CM Per ball) 29 30 Req3 31 Breakeven Units with desired Profit (Fixed Exp + Desired Profit)/CM Per ball 32 (317000+123000)/7 33 Breakeven Units with desired Profit 62857 Balls 34 Req 6 (a) Breakeven Units with desired Profit (Fixed Exp + Desired Profit)/CM Per ball (634000+123000)/16 Breakeven Units with desired Profit 47313 Balls Req 6 (b) Sales Less: Variable expenses Contribution Margin Fixed Expenses Net Operating Income 11,00,000.00 $ 25.00 3,96,000.00 $ 9.00 7,04,000.00 $ 16.00 6,34,000.00 70,000.00 $ 1.59 Degree of Operating Leverage Contribution margin Operating Income Degree of Operating Leverage 10.06

Amount 1100000 660000 =B2-B3 Per Unit =B2/44000 =B3/44000 =B4/44000 Reg 4 Variable expenses CM Margin 792000 0.4 =F2/(1-F3) 1 Req 1a) 2 Sales 3 Less: Variable expenses 4 Contribution Margin 5 6 CM Ratio = CM/Sales 7 8 Fixed Expenses 9 Break even Point (in balls) 10 (Fixed Exp./CM Per ball) Sales Variable exp/(1-CM%) =B4/B2 Selling Price per ball =F5/44000 317000 =B8/04 Balls Req5 Sales Less: Variable expenses Contribution Margin 12 Req 1(b) 13 Degree of Operating Leverage 14 1100000 =660000*0.6 =F11-F12 =F11/44000 =F12/44000 =F13/44000 Contribution margin Operating Income 15 CM Ratio = CM/Sales =F13/F11 =B4/123000 Fixed Expenses Break even Point (in balls) (Fixed Exp./CM Per ball) =317000*2 =F17/13 16 Degree of Operating Leverage 17 18 19 Req2 20 Sales 21 Less: Variable expenses 22 Contribution Margin 23 24 CM Ratio = CM/Sales 25 26 Fixed Expenses 27 Break even Point (in balls) 28 (Fixed Exp./CM Per ball) 1100000 -44000*C21 =B20-B21 =B20/44000 18 =B22/44000 Req 6 (a) =B22/B20 Breakeven Units with desired Profit (Fixed Exp + Desired Profit)/CM Per ball (634000+123000)/16 Breakeven Units with desired Profit (634000+123000)/16 Balls 317000 =B26/C22 Balls 29 Req 6 (b) Sales Less: Variable expenses Contribution Margin Fixed Expenses Net Operating Income 1100000 =660000*0.6 =F28-F29 =317000*2 =F30-F31 =F28/44000 =F29/44000 =F30/44000 32 =F32/44000 30 Req3 31 Breakeven Units with desired Profit (Fixed Exp + Desired Profit)/CM Per ball (317000+123000)/7 33 Breakeven Units with desired Profit =(317000+123000)/7 34 35 Balls Degree of Operating Leverage Contribution margin Operating Income Degree of Operating Leverage =F30/F32

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