Question

Last year, the company sold 60,000 of these balls, with the following results: Sales (60,000 balls) Variable expenses Contribution margin Fixed expenses Net operating income $ 1,500,000 900,000 600,000 375,000 $ 225,000 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, $225,000, 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, $225,000, as last year? b. Assume the new plant is built and that next year the company manufactures and sells 60,000 balls (the same number as sold last year). Prepare a contribution format income statement and compute the degree of operating leverage.

Answer 1

	Total	Per unit
Sales	1500000	25
VC	900000	15
Contribution	600000	10
FC	375000	6.25
Net operating income	225000	3.75

1. a) CM ratio = Contribution Margin / Sales x 100 = 600000 / 1500000 x 100 = 40%

BEP in balls = Fixed cost / Contribution per unit = 375000 / 10 = 37500 balls

b) Degree of Operating Leverage = Contribution Margin / Operating Income

= 600000 / 225000 x 100 = 266.67%

2. If the variable expenses are increased by $3 then the Contribution = 25-18 = $7 per unit

New CM ratio = 7 /25 x 100 = 28 %

New BEP in balls = 375000 / 7 = 53571 units

3. Number of balls to be sold to make a profit of 225000 = (Fixed cost + Target profit) / Contribution per unit

= (375000 + 225000 ) / 7 = 85715 units

4. What selling price must be charged to mainatin same CM ratio as last year

  Here Variable cost is increased by 20% (3/15x100)

So Selling price also should increase by 20% (25 x 20% = $5)  

Selling price must be increased by $5 so that the new selling price will be 30 to maintain the same CM ratio

If Selling price is 30 new Contribution = 30 - 18 =12

New CM ratio = 12 / 30 x 100 = 40%

5. If the new plant is built

New variable cost = 15 x 60% = $9

Contribution = 25 - 9 = $16

CM ratio = 16 / 25 x 100 = 64%

New BEP = Fixed cost / Contribution per unit

Fixed cost will double, so the new FC = 2 x 375000 = $750000

BEP = 750000 / 16 = 46875 units

6. a) Number of balls will have to sell to get a profit of $225000

= Fixed cost + Target profit / contributin per unit

= 750000 + 225000 / 16 = 60938 units

b). Income statement

	$
Sales 60000 x 25	1500000
Variable cost 60000 x9	540000
Contribution	960000
Fixed cost 375000 x2	750000
Net operating income	210000

Degree of Operating Leverage = Contribution Margin / Operating Income

= 960000 / 210000 x 100 = 457%