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:

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.

Sales (30,000 balls) $ 1,260,000 Variable expenses 960,000 Contribution margin 300,000 Fixed expenses 210,000 Net operating income $ 90,000

Explanation / Answer

Req 1 CM Ratio 23.81% Unit Sales to break even 21000 Degree of operating leverate 3.33 CM ratio = contribution /sales 300,000/1,260,000 23.81% BEP(units) = fixed cost/contribution margin per unit 210,000/(42-32) 21000 Degree of operating leverage = contribution/net income 300,000/90000 3.33 Req 2 CM Ratio 16.67% Unit Sales to break even 30000 CM ratio = contribution /sales (10-3)/42 16.67% BEP(units) = fixed cost/contribution margin per unit 210000/7 30000 Req 3 Number of balls 42857 BEP(units) =( fixed cost+ target income)/contribution margin per unit (210000+90000)/7 42857 Req 4 selling price 45.94 CM ratio = 23.81% selling price per unit be x variable cost per unit is 35 so selling price should be = 23.81%              = (x-35)/x .2381x                  = (x -35) x                         =35/.7619 x                         = 45.94 Req 5 Selling price per unit 42 New variable cost (32*.7619 24.3808 Contribution per unit 17.6192 contribution margin ratio 41.95% unit sales to break-even 23838 balls 420,000/41.95%) Req 6A number of balls 28946 balls (420000+90000)/17.6192 Req6B Contribution income statement Sales (30,000*42) 1260000 Variable expenses (30000*24.3808)) 731424 Contribution margin 898579.2 Fixed expenses 420,000 Net operating income 478,579 Degree of operating leverage 1.88 (contribution margin/net income)

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