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 $36. At present, the ball is manufactured in a small plant that relies heavily on direct labor workers. Thus, variable expenses are high, totaling $21.60 per ball, of which 60% is direct labor cost.

Last year, the company sold 59,000 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 $2.88 per ball. If this change takes place and the selling price per ball remains constant at $36.00, 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, $144,000, 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?

Sales (59,000 balls) $ 2,124,000 Variable expenses 1,274,400 Contribution margin 849,600 Fixed expenses 705,600 Net operating income $ 144,000

Explanation / Answer

Units 59000 Particulars Total PU Sales 2124000 36.00 Variable Cost 1274400 21.60 Total Variable Cost 21.60 Contribution Margin 849600 14.40 Direct Labor Cost(60%) 12.96 Fixed Expenses 705600 Balance VC 8.64 Net Operating Income 144000 1 Contribution Margin Ratio 40.00% (CM/Sales) Break Even Point in Units 49000 (Fixed Cost/CM) Degree of Operating Leverage 5.90 (CM/Net Operating Income) 2 Particulars Total Sales 36.00 Variable Cost 24.48 (21.60+2.88) Contribution Margin 11.52 Fixed Expenses 705600 Contribution Margin Ratio 32.00% (CM/Sales) Break Even Point in Units 61250 (Fixed Cost/CM) 3 Net Operating Income 144000 Fixed Expenses 705600 Total Required Contribution 849600 Contribution Margin 11.52 Required Units to be sold 73750 (849600/11.52) 4 Particulars Total Total Sales 36.00 X Variable Cost 21.60 24.48 Contribution Margin 14.40 X-24.48 (X-24.48)/X=40% (X-24.48)=40%(X) (X-24.48)=0.40X X-0.40X=24.48 0.60X=24.48 X=24.48/0.60 X=40.80 Particulars Total Sales 40.80 Variable Cost 24.48 Contribution Margin 16.32 Contribution Margin Ratio 40.00%

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