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 52,000 of these balls, with the following results:Sales (52,000 balls) $ 1,300,000Variable expenses 780,000Contribution margin 520,000Fixed expenses 321,000Net operating income $ 199,000Required: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, $199,000, 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, $199,000, as last year?b. Assume the new plant is built and that next year the company manufactures and sells 52,000 balls (the same number as sold last year). Prepare a contribution format income statement and compute the degree of operating leverage.

Answer 1

1)

Contribution margin ratio = Contribution margin / sales = $520000/$1300000 = 40%

Contribution margin per unit =$25-$15= $10per unit

Breakeven sales units = Fixed cost / contribution margin per unit = $321000/10 = 32100units

Degree of operating leverage = Contribution margin / Net operating income = $520000/ $199000 = 2.61

2)

New variable cost per unit =  $15 + $3 = $18 per unit

New contribution margin per unit = $25 - $18 = $7 per unit

New contribution margin ratio = $7 / $25  =28%

New breakeven point in units = $321000 / $7 = 45857 units

3)

Number of units to be sold to earn target income = (Fixed cost + Target profit) / contribution margin per unit

= ($321000 + $199000 ) / $7 = 74285 units

4)

Variable cost per unit = $18 per unit

Required contribution margin ratio = 40%

Required variable cost ratio = 60%

New selling price per unit = $18 / 60% = $30 per unit

5)

New variable cost per unit = $15 * 60% = $9 per unit

New contribution margin per unit = 25- $9 = $16 per unit

New fixed costs = $321000*2 = $642000

New CM ratio = $16/$25 = 64%

New breakeven point = $642000 / $ 16 = 40125 units

6)

a) Number of units to be sold to earn target income = (Fixed cost + Target profit) / contribution margin per unit

= ($642000 + $ 199000) / $16

= 52563 units

b)

6b)	Northwood company
	Contribution margin income statement
	Particular	Amount
	Sales (52000*$25)	$1300000
	Variable cost (52000 * $9)	$468000
	Contribution margin	$832000
	Fixed expenses	$642000
	Net operating Income	$190000

Degree of operating leverage = Contribution / Net operating Income

= 832000 / 190000

= 4.38