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 40,000 of these balls, with the following results:

Sales (40,000 balls) $1,000,000

Variable expenses 600,000

Contribution margin 400,000

Fixed expenses 265,000

Net operating income $135,000

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, $135,000, 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, $135,000, as last year?

b. Assume the new plant is built and that next year the company manufactures and sells 40,000 balls (the same number as sold last year). Prepare a contribution format income statement and Compute the degree of operating leverage.

Answer 1

• All working forms part of the answer

Requirement 2
A	Current Sale price	$                    25.00
B	Increased variable expenses	$                    18.00
C=A-B	Unit Contribution margin	$                       7.00
D=C/A	CM Ratio	28%
E	Fixed expenses	$        2,65,000.00
F = E/C	Break Even point in Balls	37857
Requirement 3
A	Target net income	$        1,35,000.00
B	Fixed expenses	$        2,65,000.00
C=A+B	Total contribution margin required	$        4,00,000.00
D	Unit Contribution margin	$                       7.00
E=C/D	No. of balls to be sold to earn target income	57143
Requirement 4
A	Current Sale price	$                    25.00
B	Current Variable expense	$                    15.00
C=A-B	Current unit contribution margin	$                    10.00
D=C/A	CM ratio required if Variable expenses increases	40%
E = 100% - D	Increased variable expenses =	60%
F	Increased variable expenses	$                    18.00
G = F/E	Selling price to earn same CM Ratio	$                    30.00
Requirement 5
A	Current Sale price	$                    25.00
B	Decreased variable expense	$                       9.00
C=A-B	Current unit contribution margin	$                    16.00
D=C/A	CM ratio required if Variable expenses increases	64%
E = 265000 x 2	Increased Fixed cost	$       5,30,000.00
F = E/C	Break Even point In balls	33125
Requirement 6
A	Target net income	$        1,35,000.00
B	Fixed expenses	$        5,30,000.00
C=A+B	Total contribution margin required	$        6,65,000.00
D	Unit Contribution margin	$                    16.00
E=C/D	No. of balls to be sold to earn target income	41563

Requirement 6 [b]
A	Sales	40000	$                 25.00	$    10,00,000.00
B	Variable cost	40000	$                    9.00	$      3,60,000.00
C=A-B	Contribution margin	40000	$                 16.00	$      6,40,000.00
D	Fixed expenses			$      5,30,000.00
E=C-D	Net Operating Income			$      1,10,000.00
A	Contribution margin	$        6,40,000.00
B	Net Operating Income	$        5,30,000.00
C=A/B	Degree of operating Leverage	1.20754717