Question

Problem 6-20 CVP Applications: Break-Even Analysis; Cost Structure; Target Sales [LO6-1, LO6-3, LO6- 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 direct labor cost. Last year, the company sold 36,000 of these balls, with the following results: $ Sales (36,800 balls) Variable expenses Contribution margin Fixed expenses Net operating income 900,000 540,000 360.ee 263.ee 97,000 $ 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. $97.000. 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 balis? 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. $97.000. as last year? b. Assume the new plant is built and that next year the company manufactures and sells 36.000 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. Red Reg 2 Req Rug Rogs ROGA Rua 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

Answer 1

1) Contribution margin per unit= $25.00-15.00= $10.00

CM ratio= Contribution margin*100/Sales

= $10*100/25= 40%

Unit sales to break even= Fixed cost/Contribution margin per unit

= $263000/10= 26300 balls

Degree of operating leverage= Contribution margin/Net operating income

= $360000/97000= 3.71

CM ratio	40	%
Unit sales to break even	26300	balls
Degree of operating leverage	3.71

2) New variable expenses= $15+3= $18

New contribution margin= $25-18= $7

CM ratio= Contribution margin*100/Sales

= $7*100/25= 28%

Unit sales to break even= Fixed cost/Contribution margin per unit

= $263000/7= 37571 balls

CM ratio	28	%
Unit sales to break even	37571	balls

3) Units required to earn a net operating income of $97000= (Fixed costs+Net operating income)/Contribution margin per unit

= ($263000+97000)/7

= 51429 balls

Number of balls

51429

4) Selling price= Variable expense+Contribution margin

Let selling price= x

Contribution margin= 40% of x= 0.4x

x= Variable expense+0.4x

x-0.4X= $18

0.6x= $18

x= $18/0.6= $30

So, the Selling price= x= $30

Selling price

$30

5) New variable expenses= $15*60%= $9

New contribution margin= $25-9= $16

New fixed expenses= $263000*2= $526000

CM ratio= Contribution margin*100/Sales

= $16*100/25= 64%

Unit sales to break even= Fixed cost/Contribution margin per unit

= $526000/16= 32875 balls

CM ratio	64	%
Unit sales to break even	32875	balls

6-a) Units required to earn a net operating income of $97000= (Fixed costs+Net operating income)/Contribution margin per unit

= ($526000+97000)/16= 38938 balls

Number of balls

38938

b)

Northwood Company
Contribution Income Statement
Sales (36000*$25)	$900000
Variable expenses (36000*$9)	324000
Contribution margin	576000
Fixed expenses	526000
Net operating income	$50000
Degree of operating leverage (576000/50000)	11.52

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