Question

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 54,000 of these balls, with the following results: Sales (54,000 balls) $ 1,350,000 Variable expenses 810,000 Contribution margin 540,000 Fixed expenses 372,000 Net operating income $ 168,000 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, $168,000, 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, $168,000, as last year? b. 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 and Compute the degree of operating leverage.

Answer 1

Solution 1
	Per unit	Total for 54000 unit
Sale	25	1,350,000
variable cost	15	810,000
Contribution	10	540,000
Fixed expense		372,000
Net Income		168,000
Contribution ratio	=10/25	40.00%
Break even sale	372000/40%	930,000
Break even Unit	930000/25	37,200
Operating leverage	Contribution/Net Income
Operating leverage	540000/168000	3.21
Solution 2
	Per unit	Total for 54000 unit
Sale	25	1,350,000
variable cost	18	972,000
Contribution	7	378,000
Fixed expense		372,000
Net Income		6,000
Contribution ratio	=7/25	28.00%
Break even sale	372000/28%	1,328,571
Break even Unit	1328571/25	53,143
Solution 3
Fixed cost		372,000
Required profit		168,000
Total		540,000
Requried sale price	540000/28%	1,928,571
Requried sale Unit	1928571/25	77,143
Solution 4
Variable cost	18
Required Contribution ratio	40.00%
Required Sale price=	18/(1-40%)	30
Required Sale price=	30
Solution 5
	Per unit
Sale	25
variable cost- (15-40%)	9
Contribution	16
Contribution ratio=	16/25	64.00%
Fixed expense - 2*372000		744,000
Break even sale	744000/64%	1,162,500
Break even Unit	1162500/25	46,500
Solution 6
Net Profit req.	168,000
Fixed expense	744,000
Total	912,000
Contribution ratio	64%
Sale Price required	912000/64%	1,425,000
Sold units	1425000/25	57,000
Solution 7
	Per unit	Total for 54000 unit
Sale	25	1,350,000
variable cost	9	486,000
Contribution	16	864,000
Fixed expense		744,000
Net Income		120,000
Operating leverage=	Contribution/Net Income
	864000/120000	7.200