Problem 5-20 CVP Applications: Break-Even Analysis; Cost Structure; Target Sales

Question

Problem 5-20 CVP Applications: Break-Even Analysis; Cost Structure; Target Sales [LO5-1, LO5-3, LO5- 4, LO5-5, LO5-6, LO5-8] 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 38,000 of these balls, with the following results Sales (38,000 balls) Variable expenses Contribution margin Fixed expenses Net operating income $ 950,000 570,000 380,000 264,000 $ 116,000 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, $116,000, 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, $116,000, as last year? b. Assume the new plant is built and that next year the company manufactures and sells 38,000 balls (the same number as sold last year). Prepare a contribution format income statement and Compute the degree of operating leverage

Explanation / Answer

1.

(a) Contribution margin ratio = Contribution margin / sales

= $380,000 / $950,000

= 0.4

Contribution margin per unit = selling price per unit - Variable expenses per unit

= $25 - $15

= $10

Breakeven point in balls = Fixed expenses / Contribution margin per unit

= $264,000 / $10

= 26,400 balls

(b) Degree of operating leverage = Contribution margin / Net operating income

= $380,000 / $116,000

= 3.28 times

2.

Contribution margin per ball = Selling price per ball - Variable expenses per ball

= $25 - $18

= $7

Contribution margin ratio = Contribution margin per ball / Selling price per ball

= $7 / $25

= 0.28

Breakeven point in balls = Fixed expenses / Contribution margin per ball

= $264,000 / $7

= 37,714 balls

3.

Balls to be sold = (fixed costs + desired net opertaing income) / contribution margin per ball

= ($264,000 + $116,000) / $7

= 54,286 balls

4.

Contribution margin ratio last year = 0.4

(selling price per ball - variable expenses per ball) / selling price per ball = 0.4

Selling price per ball - $18 = 0.4*Selling price per ball

Selling price per ball = $30

5.

Variable expenses per ball = $15 - ($15*40%) = $9

Contribution margin per ball = Selling price per ball - Variable expenses per ball

= $25 - $9

= $16

Contribution margin ratio = Contribution margin per ball / Selling price per ball

= $16/$25

= 0.64

Fixed expenses = $264,000 * 2 = $528,000

Breakeven point in balls = Fixed expenses / Contribution margin per ball

= $528,000 / $16

= 33,000 balls

6.

a. Balls to be sold = (fixed expenses + desired net opertaing income) / contribution margin per ball

= ($528,000 + $116,000) / $16

= 40,250 balls

b.

Contribution margin income statement

Sales (38,000 balls * $25 per ball) $950,000 Variable expenses (38,000 balls * $9 per ball) $342,000 Contribution margin $608,000 Fixed expenses $528,000 Net operating income $80,000

Related Questions

Navigate

• Browse (All)
• Browse P
• Subjects

---

---

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.