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 30,000 of these balls, with the following results:
Sales (30,000 balls) $ 750,000
Variable expenses 450,000
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.
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, $90,000, 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, $90,000, as last year?
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.
Please show as many details as possible- Thank you!

Answer 1

Particulars	Amount
Sales price	25
Less: Variable cost	(15)
Contribution	10
Less: Fixed cost
Profit

CM ratio = 300000/750000 = 40%

Break even point = fixed cost / contribution per unit = 210000/10 = 21000 balls

Operating ratio = FC/VC = 210000/450000 = 46.67%

2.

Particulars	Amount
Sales price	25
Less : VC	(18)
Contribution margin	7

CM ratio = 7/25 = 28%

Breakeven = fixed cost / contribution P.u. = 210000/7 = 30000 units

3. Number of balls to be sold = (Fixed cost+profit required)/Contribution P.u. = (210000+90000)/7 = 42,858 balls

4. CM ratio = 40%

Let Sales price be x. Contribution is x - 18.

x-18/x = 0.4

x-18 = 0.4x

0.6x = 18

X = 30

Required SP is 30.

4.

Particulars	Amount
Sales price	25
Less: VC	(7.5)
Contribution P.u.	17.5

CM ratio = 17.5/25 = 70%

Breakeven = 210000*2/17.5 = 24000 balls

6. a) required sales = (Fixed cost + Profit) / contribution P.u.

= (420000+90000)/17.5 = 29143 balls

b)

Particulars	Amount
Sales (30000*25)	750000
Less: VC (30000*7.5)	(225000)
Contribution	525000
Less: FC	(420000)
Profit	105000

Operating leverage = FC/VC = 420000/225000 = 1.87