Question

Northwood Company manufactures basketballs. The company has a ball that sells for $38. At present, the ball is manufactured in a small plant that relies heavily on direct labor workers. Thus, variable expenses are high, totaling $28.00 per ball, of which 74% is direct labor cost.

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

Sales (30,000 balls)	$	1,140,000
Variable expenses		840,000
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 $38.00, 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 26.32%, 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 Ratio			26.32%
		Unit Sales to break even			21000
		Degree of operating leverate			3.33
		CM ratio = contribution /sales
			300,000/1,140,000
			26.32%
		BEP(units) = fixed cost/contribution margin per unit
			210,000/10
			21000
		Degree of operating leverage = contribution/net income
				300,000/90,000
				3.33
	Req 2	CM Ratio			18.42%
		Unit Sales to break even			30000
		CM ratio = contribution /sales
			Jul-38
			18.42%
		BEP(units) = fixed cost/contribution margin per unit
			210,000/7
			30000
	Req 3
		Number of balls			42857
		BEP(units) =( fixed cost+ target income)/contribution margin per unit
			(210,000+90000)/7
			42857
	Req 4	selling price			42.07
		CM ratio = 26.32%
		selling price per unit be x
		variable cost per unit is 31
		so selling price should be =
		26.32%              = (x-31)/x
		26.32x              = 100x -3100
		x                        = 3100/(100-26.32)
		x                         =		42.07
	Req 5	Selling price per unit				38
		New variable cost		(28*73.68%)		20.6304
		Contribution per unit				17.3696
		contribution margin ratio				45.71%
		unit sales to break-even				24180	balls
		(420,000/44.71%)
	Req 6A	number of balls				29362	balls
		(420,000+90000)/17.3696
	Req6B	Contribution income statement
		Sales (30,000*38)				1140000
		Variable expenses (30000*20.6304)				618912
		Contribution margin				521088
		Fixed expenses				420,000
		Net operating income				101,088
		Degree of operating leverage					5.15
		(contribution margin/net income)