Question

Northwood Company manufactures basketballs. The company has a ball that sells for $49. At present, the ball is manufactured in a small plant that relies heavily on direct labor workers. Thus, variable expenses are high, totaling $34.30 per ball, of which 70% is direct labor cost.

Last year, the company sold 58,000 of these balls, with the following results:

Sales (58,000 balls)	$	2,842,000
Variable expenses		1,989,400
Contribution margin		852,600
Fixed expenses		705,600
Net operating income	$	147,000

Required:

1-a.	Compute last year's CM ratio and the break-even point in balls. (Do not round intermediate calculations. Round up your final break even answers to the nearest whole number.)

  

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 next year's variable expenses will increase by $4.90 per ball. If this change takes place and the selling price per ball remains constant at $49.00, what will be next year's CM ratio and the break-even point in balls? (Do not round intermediate calculations. Round up your final break even answers to the nearest whole number.)

  

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, $147,000, 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 (as computed in requirement 1a), 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 increase by 86%. 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. Round up your final break even answers to the nearest whole number.)

  

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, $147,000, as last year? (Do not round intermediate calculations. Round up your final answer to the nearest whole number.)

b-1.	Assume the new plant is built and that next year the company manufactures and sells 58,000 balls (the same number as sold last year). Prepare a contribution format income statement. (Do not round your intermediate calculations.)

b-2.	Compute the degree of operating leverage. (Do not round intermediate calculations and round your final answer to 2 decimal places.)

Answer 1

(1a) CM ratio last year = Contribution/sale

   852600/2842000 = 30%

BEP(in balls) = Fixed cost/contribution pu

FC = 705600

Contribution pu = 852600/58000 balls = 147

BEP = 705600/147 = 4800 balls.

(1b) Degree of Operating Leverage last year = Contribution margin/operating income

     = 852600/147000 = 5.8

(2) VC per ball increase by 4.9

CM Ratio = Contribution pu/sale pu

Contribution pu = SP – VC

SP = 49

VC = 34.3+4.9 = 39.2

Contribution = 49-39.2 = 9.8

Ratio = 9.8/49 = 20%

BEP(in balls) = Fixed cost/contribution pu

FC = 705600

Contribution pu =9.8

    BEP = 705600/9.8 = 72000 balls

(3) Let ‘x’ be the total balls sold

[(SP – VC) * x] – FC = Operating income

(49 – 39.2) * x – 705600 = 147000

x = 87000 balls

(4) Last year CM ratio = 30%

   VC per unit this year = 39.2

CM ratio = contribution pu/SP pu

      Let x be the SP pu

(x – 39.2)/x = 30%

X = 56

(5) New VC pu = 34.3 * 70% = 24.01

New FC = 705600 * 186% = 1312416

New contribution pu = 49 – 24.01 = 24.99

CM ratio = 24.99/49 = 51%

BEP = 1312416/(49-24.01) = 52518 units

(6a) Target profit = 147000

Let x be the units sold

(49 – 24.01) * x – 1312416 = 147000

X = 58400 units

(6bi)

Sale (58000 * 49)	2842000
(-) VC (24.01 * 58000)	1392580
Contribution	1449420
(-) FC	1312416
Net Operating Income	137004

(6bii) Degree of operating leverage = Contribution margin/operating income

= 1449420/137004 = 10.58