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 $42. At present, the ball is manufactured in a small plant that relies heavily on direct labor workers. Thus, variable expenses are high, totaling $32.00 per ball, of which 76% is direct labor cost. Last year, the company sold 30,000 of these balls, with the following results Sales (30,000 balls) Variable expenses Contribution margin Fixed expenses $ 1,260,000 960,000 300,00 210,000 Net operating income $90,000 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 $42.00, 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, $90,000, 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 23.81%, 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, $90,000, as last year? b. Assume the new plant is built and that next year the company manufactures and sells 30,000 balls (the same number as sold last year). Prepare a contribution format income statement and Compute the degree of operating leverage

Explanation / Answer

Solution:

Part 1(a) Last Year CM Ratio and Break Even Point in balls

CM Ratio = Contribution Margin / Sales x 100

= $300,000 / $1,260,000 x 100

= 23.81%

Break Even Point in balls

Break Even Point is the level of sales at which costs are equal to sales revenue and profit is zero. In other words, at break even point contribution margins are equal to total fixed cost.

Break Even Point (in balls) = Total Fixed Cost / Contribution Margin Per Unit

Here,

Total Unit Variable Cost =$32 per ball

Contribution Margin Per Unit = Unit Selling Price $42 – Total Unit Variable Cost $32 = $10 per unit

Total Fixed Costs = $210,000

Break Even Point (in balls) = Total Fixed Cost $210,000 / Contribution Margin Per Unit 10

= 21,000 Units

Break Even Point in balls = 21,000 Balls

Part 1(b) – degree of operating leverage

Degree of Operating Leverage = Contribution Margin / Net Operating Income

= $300,000 / 90,000

= 3.333 times

Part 2 – Next Year’s CM Ratio and Break Even Point in balls

CM Ratio

New Variable Cost per unit = Old $32 + Increase $3 = $35

New Contribution Margin per unit = Unit Selling Price $42 – New Variable Cost per unit $35 = $7 per unit

CM Ratio = Contribution Margin Per Unit $7 / Selling Price per unit 42 x 100

= 16.67%

Break Even Point in balls

Break Even Point (in balls) = Total Fixed Cost $210,000 / New Contribution Margin Per Unit 7

= 30,000 Balls

Part 3 –

Number of balls to be sold to earn $90,000 = (Total Fixed Costs + Desired Profit) / CM Per Unit

= ($210,000 + $90,000) / 7

= 42,857 balls

Part 4 –

Increase in Variable Cost = $3 per ball

Last Year CM Ratio (as per part 1a) = 23.81%

CM Ratio is 23.81%, it means variable cost percentage to sales = 100% - 23.81% = 76.19%

Total Variable Cost per unit = $35 per ball

Selling Price Per Ball would be = New Variable Cost per unit / Variable Cost Percentage to sales

= $35 / 76.19%

= $45.94

Selling Price would be $45.94 Per Ball to get same CM Ratio as last year.

Hope the above calculations, working and explanations are clear to you and help you in understanding the concept of question.... please rate my answer...in case any doubt, post a comment and I will try to resolve the doubt ASAP…thank you

Pls ask separate question for remaining parts.

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