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 41,000 of these balls, with the following results:

 

     Sales (41,000 balls)$1,435,000    Variable expenses 861,000     Contribution margin 574,000    Fixed expenses 420,000     Net operating income$154,000   

 

Required:1-a.
Compute the CM ratio and the break-even point in balls. (Do not round intermediate calculations.)
  

  

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 variable expenses will increase by $2.80 per ball next year. If this change takes place and the selling price per ball remains constant at $35.00, what will be the new CM ratio and break-even point in balls? (Do not round intermediate calculations.)
  

  

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, $154,000, 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, 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 30%, but it would cause fixed expenses per year to double 76%. 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.)
  

  

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, $154,000, as last year? (Do not round intermediate calculations.)
  

 

b-1.
Assume the new plant is built and that next year the company manufactures and sells 41,000 balls (the same number as sold last year). Prepare a contribution format income
statement
  

 

b-2.Compute the degree of operating leverage. (Round your answer to 2 decimal places.)  

Answer 1

1a.

Sales Price=$35

Variable Expense=$21

Unit Contribution Margin =35-21=$14

Contribution Margin Ratio =Contribution Margin/Sales =14/35=0.4

Break Even Point in balls =Fixed Costs/Unit Contribution Margin=420000/14=30,000

1b.Operating Leverage =Quantity *(Price-Unit Variable Cost)/(Quantity *(Price-Unit Variable Cost)-Fixed Costs)

Operating Leverage =Contribution Margin/Profit=574000/154000=3.727273

2.NEW CM Ratio and Break Even Point:

Sales Price=$35

Variable Expense=$21+2.80=$23.80

Unit Contribution Margin =35-23.80=$11.20

Contribution Margin Ratio =Contribution Margin/Sales =11.20/35=0.32

Break Even Point in balls =Fixed Costs/Unit Contribution Margin=420000/11.20=37,500

3.Net operating Profit Required =$154000

Number of balls to be sold for contribution of 154000=154000/11.20=13,750

Break Even Point =37,500

Total Number of Balls Required to be sold=37500+13750=51,250

Net Operating Profit for this sales=51250*(35-23.80)-420000=$154,000

4.Sales Price for CM ratio=0.4

Assume Sales Price =X

Unit Contribution =(X-23.80)

CM ratio=Unit Contribution/Sales Price =(X-23.80)/X=0.4

X-23.80=0.4X

0.6X=23.80

X=23.80/0.6=39.67

New Sales Price =$39.67

Contribution Margin Ratio=(39.67-23.8)/39.67=0.4