Northwood Company manufactures basketballs. The company has a ball that sells fo

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 36,000 of these balls, with the following results:

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 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, $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.

Sales (36,000 balls) $ 900,000 Variable expenses 540,000 Contribution margin 360,000 Fixed expenses 263,000 Net operating income $ 97,000

Explanation / Answer

Req 1 CM Ratio 40.00% Unit Sales to break even 26300 Degree of operating leverate 3.71 CM ratio = contribution /sales 360,000/900,000 40.00% BEP(units) = fixed cost/contribution margin per unit 263,000/(25-15) 26300 Degree of operating leverage = contribution/net income 360,000/97000 3.71 Req 2 CM Ratio 28.00% Unit Sales to break even 37571 CM ratio = contribution /sales (10-3)/25 28.00% BEP(units) = fixed cost/contribution margin per unit 263,000/7 37571.43 Req 3 Number of balls 51429 BEP(units) =( fixed cost+ target income)/contribution margin per unit (263,000+97000)/7 51429 Req 4 selling price 30.00 CM ratio = 40% selling price per unit be x variable cost per unit is 18 so selling price should be = 40%              = (x-18)/x .40x                  = (x -18) x                         =18/.6 x                         = 30.00 Req 5 Selling price per unit 25 New variable cost (15*60%) 9 Contribution per unit 16 contribution margin ratio 64.00% unit sales to break-even 32875 balls (263000*2)/16 Req 6A number of balls 38938 balls (526000+97000)/16 Req6B Contribution income statement Sales (36000*25) 900000 Variable expenses (36000*9) 324000 Contribution margin 576000 Fixed expenses 526,000 Net operating income 50,000 Degree of operating leverage 11.52 (contribution margin/net income)

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