Question

Northwood Company manufactures basketballs. The company has a ball that sells for $35. At present, the ball is manufactured in a small plant that relies heavily on direct labor workers. Thus, variable expenses are high, totaling $21.00 per ball, of which 60% is direct labor cost.

Last year, the company sold 54,000 of these balls, with the following results:

Sales (54,000 balls)	$	1,890,000
Variable expenses		1,134,000
Contribution margin		756,000
Fixed expenses		630,000
Net operating income	$	126,000

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 $2.80 per ball. If this change takes place and the selling price per ball remains constant at $35.00, 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, $126,000, 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 89%. 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, $126,000, 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 54,000 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

Unit selling price = 1890000/54000= 35
Unit variable cost = 1396500/57000 = 24.5
1a
CM ratio =(35-21)/35= 40%
b
Degree of operating leverage = Contribution margin/ Net operating income = 756000/126000=6
2
Revised variable expenses = 21+2.8 = $23.8
CM ratio =(35-23.8)/35= 32%
Break even point = 630000/(35-23.8)= 56250
3
Units to be sold =(630000+126000)/(35-23.8)= 67500
4
Selling price = 23.8/(1-0.4)=$39.67
5
Revised variable expenses = 21*0.6 = $12.6
CM ratio =(35-12.6/)35= 64%
Revised fixed cost = 630000*1.89 = 1190700
Break even point =1190700/(35-12.6)= 53156
6a
Units to be sold = (1190700+126000)/(35-12.6)= 58781
b-1
Sales	1890000
Variable expenses	680400
Contribution margin	1209600
Fixed expenses	1190700
Net operating income	18900
b-2
Degree of operating leverage = 1209600/18900=64