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 $49. At present, the ball is manufactured in a small plant that relies heavily on direct labor workers. Thus, variable expenses are high, totaling $34.30 per ball, ofwhich 70% is direct labor cost Last year, the company sold 58,000 of these balls, with the following results s 2,842,000 1,989,400 Sales (58,000 balls) Variable expenses Contribution margin 852,600 705,600 Fixed expenses Net operating income $147,000 Required: 1-a. Compute the CM ratio and the break-even point in balls. (Do not round intermediate calculations.) CM Ratio 30 % Unit sales to break even 48,000 balls 1-b. Compute the the degree of operating leverage at last year's sales level. (Round your answer to 2 decimal places.) egree of operating everage 5.80 2. Due to an increase in labor rates, the company estimates that variable expenses will increase by $4.90 per ball next year. If this change takes place and the selling price per ball remains constant at $49.00, what will be the new CM ratio and break-even point in balls? (Do not round intermediate calculations.) CM Ratio 20 % Unit sales to break even 72,000 balls

Explanation / Answer

Solution:

1-a. Compute the CM ratio and the break-even point in balls. Selling price $49 100% Variable expenses $34.30 70% Contribution margin $14.70 30% Profit = Unit CM × Q Fixed expenses $0 = $14.70 × Q $705,600 $14.70 Q = $705,600 Q = $705,600 ÷ $14.70 Q = 48,000 balls Alternative solution: Fixed expenses Unit sales to break even = Unit contribution margin $705,600 = 48,000 balls 14.70 1-b. Compute the degree of operating leverage at last year's sales level. The degree of operating leverage is: Degree of operating leverage = Contribution margin Net operating income $852,600 = 5.80 $147,000 2. Due to an increase in labor rates, the company estimates that variable costs will increase by $4.90 per ball next year. If this change takes place and the selling price per ball remains constant at $49, what will be the new CM ratio and break-even point in balls? The new CM ratio will be: Selling price $49 100% Variable expenses $39.20 80% Contribution margin $9.80 20% The new break-even point will be: Profit = Unit CM × Q Fixed expenses $0 = $9.80 × Q $705,600 $9.80 Q = $705,600 Q = $705,600 ÷ $9.80 Q = 72,000 balls Alternative solution: Fixed expenses Unit sales to break even = Unit contribution margin $705,600 = 72,000 balls 9.80 3. Refer to the data in (2) above. If the expected change in variable costs takes place, how many balls will have to be sold next year to earn the same net operating income ($147,000) as last year? Profit = Unit CM × Q Fixed expenses $147,000 = $9.80 × Q $705,600 $9.80 Q = $705,600 + $147,000 Q = $852,600 ÷ $9.80 Q = 87,000 balls Alternative solution: Unit sales to attain target profit = Target profit + Fixed expenses Unit contribution margin $147,000+$705,600 = 87,000 balls 9.80 Thus, sales will have to increase by 15,000 balls (87,000 balls, less 72,000 balls currently being sold) to earn the same amount of net operating income as last year. The computations above and in part (2) show the dramatic effect that increases in variable costs can have on an organization. The effects on Northwood Company are summarized below Present Expected Combination margin ratio 30% 20% Break-even point (in balls) 48,000 72,000 Sales (in balls) needed to earn a $147,000 profit 72,000 87,000 Note that if variable costs do increase next year, then the company will just break even if it sells the same number of balls (72,000) as it did last year. 4. Refer again to the data in (2) above. The president feels that the company most 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? The contribution margin ratio last year was 30%. If we let P equal the new selling price, then: P = $39.20 + 0.30P 0.70P = $39.20 P = $39.20 ÷ 0.70 Price (P) = $56 To verify: Selling price $56 100% Variable expenses $39.20 70% Contribution margin $16.80 30% Therefore, to maintain a 30% CM ratio, a $4.90 increase in variable costs would require an increase in the selling price. 5. Refer to the original data. The company is discussing the construction of a new, automated manufacturing plant. The new plant would slash variable costs per ball by 30%, but it would cause fixed costs per year to increase by 86%. If the new plant is built, what would be the company's new CM ratio and new break-even point in balls? Selling price $49 100% Variable expenses $24.01 49% Contribution margin $24.99 51% Profit = Unit CM × Q Fixed expenses $0 = $24.99 × Q $705,600 + 86% x $705,600 $24.99 Q = $705,600 + $606,816 Q = $1,312,416 ÷ $24.99 Q = 52,518 balls Alternative solution: Unit sales to break even = 86% increase on Fixed expenses + Fixed expenses Unit contribution margin $705,600 + 86% x $705,600 24.99 $705,600 + $606,816 24.99 $1,312,416 = 52,518 balls 24.99 6.Refer to the information in part (5) above: a. If the new plant is built, how many basketballs will have to be sold next year to earn the same net operating income $147,000 as last year? Profit = Unit CM × Q Fixed expenses $147,000 = $24.99 × Q $705,600 + 86% x $705,600 $24.99 Q = $705,600 + $147,000 + $606,816 Q = $1,459,416 ÷ $24.99 Q = 58,400 balls Alternative solution: Unit sales to attain target profit = Target profit + Fixed expenses Unit contribution margin $705,600 + $147,000 + $606,816 24.99 $1,459,416 = 58,400 balls 24.99 b-1.Assume the new plant is built and that next year the company sells 58,000 basketballs (the same number as sold last year). Prepare a contribution format income statement. Northwood Company Contribution Income Statement Sales (58,000 balls) @ $49 $        2,842,000 Variable expenses @ 49% 1,392,580 Contribution margin @ 51% 1,449,420 Fixed expenses 705,600 Net operating income $            743,820 b-2.Compute the degree of operating leverage. The degree of operating leverage is: Degree of operating leverage = Contribution margin Net operating income $1,449,420 = 1.95 $743,820

Related Questions

Navigate

• Browse (All)
• Browse N
• Subjects

---

---

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