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 per ball, of which 60% is direct labor cost.

Last year, the company sold 30,000 of these balls, with the following results:

Sales (30,000 balls)	$	750,000
Variable expenses		450,000
Contribution margin		300,000
Fixed expenses		210,000
Net operating income	$	90,000

Required:

1-a.	Compute the CM ratio and the break-even point in balls.

  

1-b.	Compute the the degree of operating leverage at last year

Answer 1

Concepts and reason

Cost Volume Profit (CVP) Analysis: CVP analysis is one of the techniques of decision making to achieve the targeted profits by changing different variables. The analysis observes the relationships among cost, volume of output, and profit which provides the basis for the manager to take effective steps about the future profits.

Contribution margin: It is the difference between the sales revenue and total variable costs. The amount of contribution margin is contributed to cover fixed costs and provide operating income.

Breakeven analysis: This is one of the techniques of decision accounting which determines the particular level of activity where the total costs and the total revenues of a firm are equal. The relationship between cost, profit and sales volume provides the basis for the manager to take effective steps about the future profits. The breakeven analysis uses the contribution margin approach.

Fundamentals

Sales revenue: Sales revenue is the total income earned by an organization by selling goods or rendering services.

Fixed costs: These are the costs which remain constant throughout the process of manufacturing or for the services rendered. They are incurred irrespective of number of units produced.

Operating income: It is the income earned from primary operations of a business. It explains the profitability of the company accurately and is also called as operating margin. Operating income is determined as the difference between sales revenue and cost of sales plus operating expenses.

Contribution margin per unit: It is the excess of revenue per unit over the variable costs per unit. It is calculated as the difference between the sales per unit and variable costs per unit.

Contribution margin ratio: The contribution margin ratio is the ratio of contribution margin to total sales.

Use the following formula to calculate contribution margin ratio:

Breakeven point: The breakeven point is a point where revenue of the company equals the total cost incurred. In other words, the point of sales at which there is no profit or loss is called as Break Even Point (BEP). Hence, at the point of breakeven, the profit of any company will be zero.

Use the following formula to calculate breakeven points in units:

Operating Leverage: Operating leverage forecast the changes in company’s operating income because of changes in sales volume based on the company’s cost structure.

Degree of operating leverage: Degree of operating leverage is a ratio that measures the effects of changes of operating income when sales volume changes.

Use the following formula to calculate degree of operating leverage:

1-a.

Calculate the amount of contribution margin ratio as below:

Hence, the contribution margin ratio and breakeven point in units is 40%.

1-a.

Calculate the amount of breakeven point in units as below:

Hence, the breakeven point in units is 21,000 balls respectively.

1-b

Calculate the amount of degree of operating leverage as below:

Hence, the degree of operating leverage is 3.33.

Ans: Part 1-a.1

The amount of contribution margin ratio is 40%.

Part 1-a.2

The breakeven point in units is 21,000 balls.

Part 1-b

The degree of operating leverage is 3.33.