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:

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

Required:

1-a.	Compute last year's CM ratio and the break-even point in balls. (Do not round intermediate calculations. Round up your final break even answers to the nearest whole number.)

  

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 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? (Do not round intermediate calculations. Round up your final break even answers to the nearest whole number.)

  

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? (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 (as computed in requirement 1a), 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 80%. 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. Round up your final break even answers to the nearest whole number.)

  

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, $144,000, as last year? (Do not round intermediate calculations. Round up your final answer to the nearest whole number.)

b-1.	Assume the new plant is built and that next year the company manufactures and sells 59,000 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.)

Answer 1

1(a) contribution margin ratio = contribution margin/sales

= $849600/$2124000

= 0.4 or 40%

1(a) break even point (units)

Contribution margin per unit = contribution margin/sales units

= $849600/59000

= $14.4 per unit of ball

Break even point (units) = fixed expenses/contribution margin per unit

= $705600/$14.4

= 49000 units of balls

1(b) degree of operating leverage = contribution margin/net operating income (EBIT)

= $849600/$144000

= 5.9

(2) Next year's variable expenses = sale units x (variable expense per unit + additional variable expenses)

= 59000 x ($21.60 + $2.88)

= 59000 x $24.48

= $1444320

Next year's contribution margin = $2124000 - $1444320 = $679680

Next year's contribution margin ratio = $679680/$2124000

= 0.32 or 32%

(2) Next year's break even point (units) = $705600/$11.52

= 61250 units of balls

Where, Contribution margin per unit = $679680/59000 = $11.52 per unit of ball

(3) for the sake of easy computation let's take,

net operating income + fixed expenses = fixed expenses for the purpose of break even point (units) computation

Therefore, break even point (units) = ($705600+$144000)/$11.52

= $849600/$11.52

= 73750 units of ball

(4) calculation of new selling price per unit of ball

As, we have variable expenses as per point (2), i.e $1444320

And our desired contribution margin ratio is 40% as per (1)

Therefore, variable expenses are 60% of sales

Therefore, sales = variable expenses / 60%

Therefore, sales = $1444320/0.6 = $2407200

Therefore, selling price per unit = sales/sales units

= $2407200/59000

= $40.8 per unit is the new selling price.

From the above mentioned data,