Question

Northwood Company manufactures basketballs. The company has a ball that sells for $42. At present, the ball is manufactured in a small plant that relies heavily on direct labor workers. Thus, variable expenses are high, totaling $32.00 per ball, of which 76% is direct labor cost.

Last year, the company sold 30,000 of these balls, with the following results:

Sales (30,000 balls)	$	1,260,000
Variable expenses		960,000
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 $42.00, 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 23.81%, 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.

Answer 1

Req 1.
CM peerr unit:
Contribution			300000
Divide: Number of units			30000
CM per unit			10
Selling price per unit (1260000/30000):				42
CM ratio= CM per unit / Selling price *100
	10 /42 *100 = 23.81%
break even units: Fixed cost/ CM per unit
		210000 /10 = 21000 units
Break even in $: Fixed cost / CM ratio
		210000 /23.81% = $ 882000
Req 2.
Selling price			42
Less: Revised VC ratio			35
CM per unit			7
CM ratio = CM per unit/ Selling price *100
	7/ 42 *100 = 16.67%
Break even units:
Fixed cost		210000
Divide: Cm per unit		7
Break even units:		30000
Rreq 3.
Desired Income		90000
Add: Fixed cost		210000
Desired contribution		300000
Divide: Cm per unit		7
target sales units		42857	units
Req 4.
CM ratio of last year = 23.81%
VC ratio = 100 -23.81 = 76.19%
Revised VC per unit = 35
Revised Selling price = 35 / 76.19% = 45.94 per unit
Req 5.
Selling price			42
Less: Revsied VC (32-23.81%)			24.38
CM per unit			17.62
CM ratio = Cm per unit/ Sselling price *100
	17.62 /42 *100 = 41.95%
Break even units = Revised Fixed cost / Cm per unit
		420000 / 17.62 = 23837 units
Req 6.
Desired Income		90000
Add: Fixed cost		420000
Desired contribution		510000
Divide: Cm per unit		17.62
target sales units		28945	units
Contribution margin Income Statement (30000 units)
Sales revenue (30000*42)			1260000
Less: variable cost (30000*24.38)			731400
Contrbution margin			528600
Less: Fixed cost			420000
Net Income			108600
Degree of Operating leverage = Contribution/ Income
			528600 /108600 = 4.87 times