Question

CILOR my 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 42,000 of these balls, with the following results: Sales (42,000 balls) Variable expenses Contribution margin Fixed expenses Net operating income $ 1,050,000 630,000 420,000 266,000 $ 154,000 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, $154,000, 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 la), 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

Answer 1

Solution 1:

• Contribution margin ratio = Contribution margin / sales = $420,000 / $1050,000 = 40%
• Contribution margin per unit = $25 - $15 = $10 per unit
• Breakeven sales units = Fixed cost / contribution margin per unit = $266,000 / 10 = 26,600 units
• Degree of operating leverage = Contribution margin / Net operating income = $420,000 / $154,000 = 2.73

Solution 2:

• New variable cost per unit =  $15 + $3 = $18 per ball
• New contribution margin per unit = $25 - $18 = $7 per unit
• New contribution margin ratio = $7 / $25  =28%
• New breakeven point in balls = $266,000 / $7 = 38,000 units

Solution 3:

• Nos of balls to be sold to earn target income = (Fixed cost + Target profit) / contribution margin per unit
• = ($266,000 + $154,000) / $7 = 60,000 units

Solution 4:

• Variable cost per unit = $18 per unit
• Required contribution margin ratio = 40%
• required variable cost ratio = 60%
• New selling price per unit = $18 / 60% = $30 per unit

Solution 5:

• New variable cost per unit = $15 * 60% = $9 per unit
• New contribution margin per unit = $25- $9 = $16 per unit
• New fixed costs = $266,000*2 = $532,000
• New CM ratio = $16/$25 = 64%
• New breakeven point = $532,000/ $16 = 33,250 units

Solution 6a:

• Nos of balls to be sold to earn target income = (Fixed cost + Target profit) / contribution margin per unit
• = ($532,000 + $154,000) / $16 = 42875 units

Solution 6b:

• Contribution margin Income Statement

Particulars	Amount in $
Sales (42000 *25)	1,050,000
Variable Cost(42000*9)	(3,78,000)
Contribution margin	6,72,000
Fixed Expense	532,000
Net operating income	1,40,000
Degree of Operating Leverage=Contribution/Net operating Income = $6,72,000/$1,40,000	4.8