Question

Northwood Company manufactures basketballs. The company has a ball that sells for $36. At present, the ball is manufactured in a small plant that relies heavily on direct labor workers. Thus, variable expenses are high, totaling $21.60 per ball, of which 60% is direct labor cost.

Last year, the company sold 59,000 of these balls, with the following results:

Sales (59,000 balls)	$	2,124,000
Variable expenses		1,274,400
Contribution margin		849,600
Fixed expenses		705,600
Net operating income	$	144,000

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 $2.88 per ball. If this change takes place and the selling price per ball remains constant at $36.00, 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, $144,000, 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?

Answer 1

	Units	59000
	Particulars	Total	PU
	Sales	2124000	36.00
	Variable Cost	1274400	21.60		Total Variable Cost	21.60
	Contribution Margin	849600	14.40		Direct Labor Cost(60%)	12.96
	Fixed Expenses	705600			Balance VC	8.64
	Net Operating Income	144000
1	Contribution Margin Ratio	40.00%	(CM/Sales)
	Break Even Point in Units	49000	(Fixed Cost/CM)
	Degree of Operating Leverage	5.90	(CM/Net Operating Income)
2	Particulars	Total
	Sales	36.00
	Variable Cost	24.48	(21.60+2.88)
	Contribution Margin	11.52
	Fixed Expenses	705600
	Contribution Margin Ratio	32.00%	(CM/Sales)
	Break Even Point in Units	61250	(Fixed Cost/CM)
3	Net Operating Income	144000
	Fixed Expenses	705600
	Total Required Contribution	849600
	Contribution Margin	11.52
	Required Units to be sold	73750	(849600/11.52)
4	Particulars	Total	Total
	Sales	36.00	X
	Variable Cost	21.60	24.48
	Contribution Margin	14.40	X-24.48
	(X-24.48)/X=40%
	(X-24.48)=40%(X)
	(X-24.48)=0.40X
	X-0.40X=24.48
	0.60X=24.48
	X=24.48/0.60
	X=40.80
	Particulars	Total
	Sales	40.80
	Variable Cost	24.48
	Contribution Margin	16.32
	Contribution Margin Ratio	40.00%