Question

Northwood Company manufactures basketballs. The company has a ball that sells for $32. At present, the ball is manufactured in a small plant that relies heavily on direct labor workers. Thus, variable expenses are high, totaling $22.00 per ball, of which 69% is direct labor cost.

Last year, the company sold 30,000 of these balls, with the following results:

Sales (30,000 balls)	$	960,000
Variable expenses		660,000
Contribution margin		300,000
Fixed expenses		210,000
Net operating income	$	90,000

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.

CM RATIO = 31.25%

UNIT SALES TO BREAK EVEN = ? BALLS

DEGREE OF OPERATING LEVERAGE = ?

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 $32.00, what will be next year's CM ratio and the break-even point in balls?

CM RATIO = ?

UNIT OF SALES TO BREAK EVEN = ? 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?

NUMBER OF BALLS = ?

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?

SELLING PRICE = ?

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 31.25%, 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?

CM RATIO = ? %

UNIT OF SALES TO BREAK EVEN = ? 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?

NUMBER OF BALLS = ?

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.

NORTHWOOD COMPANY

CONTRIBUTION INCOME STATEMENT =

Answer 1

1.

CM Ratio	31.25%
Break even point (balls)	Fixed expenses / units contribution margin
=	210000 / 10
=	21000
Degree of operating leverage =	Contribution margin / Net operating income
=	300000 / 90000
=	3.33

Working:

	Units	Value	per unit	%
Sales	30000	960000	32.00	100.00%
Variable expenses		660000	22.00	68.75%
Contribution margin		300000	10.00	31.25%
Fixed expenses		210000
Net operating income		90000

2.

	Units	per unit
Sales	30000	32.00
Variable expenses		25.00
Contribution margin		7.00
Fixed expenses		210000
Net operating income
CM Ratio	21.88%
Break even point (balls)	Fixed expenses / units contribution margin
=	210000 / 7
=	30000

3.

Break even point (balls)	(Fixed expenses+target net income) / units contribution margin
=	(210000+90000) / 7
=	42857

4.

Orginal CM ratio =31.25%

Variable cost =100 - 31.25 = 68.75%

Present Variable cost in Dollars =$25.00

Proposed Selling Price = 25 / 68.75% = $36.36

5.

	Present	Proposed
Sales	32.00	32.00
Variable expenses	25.00	17.19
Contribution margin	7.00	14.81
Fixed expenses	210000	420000
New variable costs = 31.25% less than the original = 25.00 - 31.25% x 25.00
New fixed expenses to double from 210,000 to 420,000.
Break even point (balls)	Fixed expenses / units contribution margin
=	420000 / 14.81
=	28359

6.a.
Break even point (balls)	(Fixed expenses+target net income) / units contribution margin
=	(420000+90000) / 14.81
=	34436
6.b.
	Per unit	Value
Volume	30000
Sales	32.00	960000
Variable expenses	17.19	515625
Contribution margin	14.81	444375
Fixed expenses		420000
Net operating income		24375