Question

Northwood Company manufactures basketballs. The company has a ball that sells for $35. At present, the ball is manufactured in a small plant that relies heavily on direct labor workers. Thus, variable expenses are high, totaling $21.00 per ball, of which 60% is direct labor cost. Last year, the company sold 41,000 of these balls, with the following results: Sales (41,000 balls) $ 1,435,000 Variable expenses 861,000 Contribution margin 574,000 Fixed expenses 420,000 Net operating income $ 154,000 .

Required: 1-a. Compute last year's CM ratio and the break-even point in balls. (Do not round intermediate calculations.) 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 $2.80 per ball. If this change takes place and the selling price per ball remains constant at $35.00, what will be next year's CM ratio and the break-even point in balls? (Do not round intermediate calculations.)

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, $154,000, 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 76%. 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 "Unit sales to break even" to the nearest whole unit.)

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, $154,000, as last year? (Do not round intermediate calculations. Round your answer to the nearest whole unit.) b-1. Assume the new plant is built and that next year the company manufactures and sells 41,000 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

Answer to Part 1-a.

CM Ratio = Contribution Margin / Sales * 100
Contribution Margin = Sales – Variable Cost
Contribution Margin = $35 - $21 = $14

CM Ratio = 14 / 35 * 100
CM Ratio = 40%

Break Even Point (in Balls) = Fixed Cost / Contribution Margin per Unit
Break Even Point (in Balls) = 420,000 / 14
Break Even Point (in Balls) = 30,000 Balls

Answer to Part 1-b.

Degree of operating Leverage = Contribution Margin / Operating Income
Degree of operating Leverage = 574,000 / 154,000
Degree of operating Leverage = 3.73

Answer to Part 2.

CM Ratio = Contribution Margin / Sales * 100
Contribution Margin = Sales – Variable Cost
Expected Variable Cost per Unit = $21 + $2.80 = $23.80
Contribution Margin = $35 - $23.80 = $11.20

CM Ratio = 11.20 / 35 * 100
CM Ratio = 32%

Break Even Point (in Balls) = Fixed Cost / Contribution Margin per Unit
Break Even Point (in Balls) = 420,000 / 11.20
Break Even Point (in Balls) = 37,500 Balls

Answer to Part 3.

Profit = Contribution Margin – Fixed Cost
Let the Number of Units to be sold be “X” Units
$154,000 = ($11.20 * X) - $420,000
$574,000 = $11.20 * X
X = 51,250 Balls.

Therefore, 51,250 Balls must be sold to earn a Net Operating Income of $154,000, if Variable Expense per unit increased by $2.80 per unit.

Answer to Part 4.

CM Ratio = Contribution Margin / Sales * 100
Desired CM ratio = 40%
Let the Selling Price per Ball be “$X”
40 = (X – 23.80) / X * 100
40X = 100X – 2,380
2,380 = 60X
X = $39.67

Therefore, the Company must charge $39.67 per ball to earn main the CM ratio of 40%.