Question

Northwood Company manufactures basketballs. The company has a ball that sells for $32. At present, the ball is manufactured in a small plant that relies heavily on direct labor workers. Thus, variable expenses are high, totaling $22 per ball, of which 69% is direct labor cost. Last year, the company sold 30,000 of these balls, with the following results: Sales (30,000 balls) $ 960,000

Variable expenses 660,500

Contribution margin 300,000

Fixed expenses 210,000

Net operating income $ 90,000

Required: 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 31.25%, but it would cause fixed expenses per year to DOUBLE. If the new plant is built, what would be the company’s new break-even point in balls? (Do not round intermediate calculations.) 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? (Do not round intermediate calculations.) b-1. 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 (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

5 - Computation of Break even point when variable cost slashed by 31.25% and fixed cost will be double -

Break even point = fixed cost / (sellin gprice per unit - variable cost per unit)

so proposed fixed cost = existing fixed cost * 2 = 210000*2 = 420000

variable cost = existing variable cost *(1-.3125)

= 22*(1-0.3125)

= 22*0.6875

= 15.125

BEP = 420000/(32-15.125)

= 420000/16.875

= 24888.89 or 24889 units

6 - compuation of units sold to earn the profit of 90000 same as last year -

Unit sold = (Desired profit + Fixed cost) / (Selling price per unit - variable cost per unit)

= (90000+420000)/(32 - 15.125)

= 510000/16.875

= 30222.22 or 30223 units

b-1 preparation of contribution format income statement -

	Particulars	Amt.$
	Sales (32*30000)	960000
less	variable cost (15.125*30000)	453750
	Contribution Margin (sales - variable cost)	506250
less	fixed cost	420000
	Operating margin	86250

b-2

Degree of Operating Leverage = % change in sales / % change in EBIT

		Proposed	Exisiting
	Particulars	Amt.$
	Sales (32*30000)	960000	960000
less	variable cost (15.125*30000)	453750	660000
	Contribution Margin (sales - variable cost)	506250	300000
less	fixed cost	420000	210000
	Operating margin	86250	90000

% change in Sales = 0

% chaneg in EBIT = (90000-86250)/86250 = 4.34%

DOL = 0%/4.34

= 0

Please comment in case of any doubt.