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 $35. At present, the ball is manufactured in a small plant that relies heavily on direct labor workers. Thus, variable expenses are high, totaling $21.00 per ball, of which 60% is direct labor cost. Last year, the company sold 54,000 of these balls, with the following results: Sales (54,000 balls) $ 1,890,000 Variable expenses 1,134,000 Contribution margin 756,000 Fixed expenses 630,000 Net operating income $ 126,000 Required:

1-a. Compute the CM ratio and the break-even point in balls. (Do not round intermediate calculations.)

1-b. Compute the the degree of operating leverage at last year’s sales level. (Round your answer to 2 decimal places.)

2. Due to an increase in labor rates, the company estimates that variable expenses will increase by $2.80 per ball next year. If this change takes place and the selling price per ball remains constant at $35.00, what will be the new CM ratio and break-even point in balls? (Do not round intermediate calculations.)

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, $126,000, as last year? (Do not round intermediate calculations. Round your answer to the nearest whole unit.)

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, what selling price per ball must it charge next year to cover the increased labor costs? (Do not round intermediate calculations. Round your answer to 2 decimal places.)

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%, but it would cause fixed expenses per year to increase by 89%. If the new plant is built, what would be the company’s new CM ratio and new break-even point in balls? (Do not round intermediate calculations.)

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, $126,000, as last year? (Do not round intermediate calculations.)

b-1. Assume the new plant is built and that next year the company manufactures and sells 54,000 balls (the same number as sold last year). Prepare a contribution format income statement (Do not round your intermediate calculations.) b-2. Compute the degree of operating leverage. (Do not round intermediate calculations and round your final answer to 2 decimal places.)

Explanation / Answer

(‘1-a)

CM Ratio

Particulars

Amount

Selling Price Per unit

35

Less: Variable Cost per unit

21

Contribution Margin per unit

14

CM Ratio

( CM per unit/ Sales price per unit )

40 %

Break Even Point in Balls

Particular

Amount

Fixed Expense

630,000

CM per unit

14

BEP in balls

( Fixed Expense/ CM per unit)

45,000 balls

(‘1-b)

Degree of Operating Leverage = Contribution Margin/ Operating Income

Degree of Operating Leverage = 756,000/126,000 = 6 times

(‘2)

Particulars

Amount

Sales Price per unit

35

Variable cost

23.80

Contribution margin

11.20

CM Ratio

32 %

Fixed Expense

630,000

BEP in balls

56,250 balls

(‘3) Desired number of balls to be sold

Desired units to be sold = ( Desired net income + Fixed Expense )/ CM per unit

Sales in units = (126,000+630,000)/ 11.20

Sales in units = 67,500 units

(‘4) Desired sales price to maintain CM ratio

Desired CM ratio = 40 %

Hence variable cost ratio = 60 %

Variable Cost = 23.80

Sales Price = 23.80/60 %

Sales Price = $ 39.67

(‘5)

Particulars

Amount

Sales Price

35

Variable Cost ( 21 x 60 %)

12.60

Contribution Margin

22.40

CM Ratio

64 %

Fixed Expense (630,000 x1.89)

1190,700

BEP in balls

53,156.25

( say 53,157 balls )

Particulars

Amount

Selling Price Per unit

35

Less: Variable Cost per unit

21

Contribution Margin per unit

14

CM Ratio

( CM per unit/ Sales price per unit )

40 %

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