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 40,000 of these balls, with the following results: Sales (40,000 balls) Variable expenses Contribution margin Fixed expenses Net operating income $1,000,000 600,000 400,000 265,000 $ 135,000 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, $135,000, 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 bullt, how many balls will have to be sold next year to earn the same net operating income, $135,000, as last year? b. Assume the new plant is built and that next year the company manufactures and sells 40,000 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. Reg 1 Reg 2 Reg 3 Reg 4 Reg 5 Reg 6 Reg 6B

Answer 1

Q 1)

CM Ratio %	Contribution Margin / Total Sales	10/25	40.00%
Unit sales to breakeven	Fixed Expenses/Contribution Margin per unit	265000/10	26500
Degree of Operating Leverage	(Sales - Variable Cost)/(Sales - Variable Cost-Fixed Cost)	400000/135000	2.96

Q 2)

CM Ratio %	Contribution Margin / Total Sales	7/25	28.00%
Unit sales to breakeven	Fixed Expenses/Contribution Margin per unit	265000/7	37857
Degree of Operating Leverage	(Sales - Variable Cost)/(Sales - Variable Cost-Fixed Cost)	280000/15000	18.67

Q 3)

Particulars	Price per unit
Sales	$                                                                                        25.00
Variable Costs	$                                                                                        18.00
Contribution margin (Sales - variable cost)	$                                                                                          7.00

Number of balls to be sold to achieve net operating income of 135000

=(Target Operating Income + Fixed Costs)/Contribution Margin per unit

(135000+265000)/7

57143

Q 4)

Selling price

=Variable Cost per unit/(1- CM Ratio %)

18/(1-40%)

30

Q 5)

CM Ratio %	Contribution Margin / Total Sales	16/25	64.00%
Unit sales to breakeven	Fixed Expenses/Contribution Margin per unit	530000/16	33125

Q 6 A)

Number of balls to be sold to achieve net operating income of 135000

=(Target Operating Income + Fixed Costs)/Contribution Margin per unit

(135000+530000)/16

41563

Q 6 B)

Particulars	Price per unit	Units	Amount
Sales	$                                                          25.00	40,000.00	$ 1,000,000.00
Variable Costs	$                                                            9.00	40,000.00	$    360,000.00
Contribution margin (Sales - variable cost)	$                                                          16.00	40,000.00	$    640,000.00
Fixed Expenses			$    530,000.00
Net Operating Income			$    110,000.00

Degree of Operating Leverage

(Sales - Variable Cost)/(Sales - Variable Cost-Fixed Cost)

640000/110000

5.82