Question

Problem 6-20 CVP Applications: Break-Even Analysis; Cost Structure; Target Sales [LO6-1, LO6-3, LO6-4, LO6-5, LO6-6, LO6-8]

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 30,500 of these balls, with the following results:

Sales (30,500 balls)	$	775,000
Variable expenses		465,000
Contribution margin		310,000
Fixed expenses		212,000
Net operating income	$	98,000

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, $98,000, 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, $98,000, as last year?

b. Assume the new plant is built and that next year the company manufactures and sells 30,500 balls (the same number as sold last year). Prepare a contribution format income statement and compute the degree of operating leverage.

Answer 1

Req 1
	CM Ratio			40.00%
	Unit Sales to break even			21200
	Degree of operating leverate			0.32
	CM ratio = contribution /sales
		310,000/775000
		40.00%
	BEP(units) = fixed cost/contribution margin per unit
		212000/10
		21200
	Degree of operating leverage = contribution/net income
			310000/98000
			0.32
Req 2	CM Ratio			28.00%
	Unit Sales to break even			30286
	CM ratio = contribution /sales
		7./25
		28.00%
	BEP(units) = fixed cost/contribution margin per unit
		212000/7
		30286
Req 3
	Number of balls			44286
	BEP(units) =( fixed cost+ target income)/contribution margin per unit
		(212000+98000)/7
		44286
Req 4	selling price			30.00
	CM ratio = 40%
	selling price per unit be x
	variable cost per unit is 18
	so selling price should be =
	40%              = (x-18)/x
	.40x                  = (x -18)
	x                         =18/.6
	x                         =		30.00
Req 5	Selling price per unit				25
	New variable cost		(15*60%)		9
	Contribution per unit				16
	fixed expense   = 212000*200%=				424000
	contribution margin ratio				64.00%
	unit sales to break-even				26500	balls
Req 6A	number of balls				32625	balls
	(424000+98000)/16
Req6B	Contribution income statement
	Sales	(30500*25)			762500
	Variable expenses (30500*9)				274500
	Contribution margin				488000
	Fixed expenses				424,000
	Net operating income				64,000
	Degree of operating leverage					7.63
	(contribution margin/net income)