Question

Problem 6-20 CVP Applications: Break-Even Analysis; Cost Structure; Target Sales [LO6-1, LO6-3, LO6-4, LO6-5, LO6-6, LO6-8]

Northwood Company manufactures basketballs. The company has a ball that sells for $25. At present, the ball is manufactured in a small plant that relies heavily on direct labor workers. Thus, variable expenses are high, totaling $15.00 per ball, of which 60% is direct labor cost.

Last year, the company sold 36,000 of these balls, with the following results:

Sales (36,000 balls)	$	900,000
Variable expenses		540,000
Contribution margin		360,000
Fixed expenses		263,000
Net operating income	$	97,000

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 $25.00, 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, $97,000, 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 40.00%, 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, $97,000, as last year?

b. Assume the new plant is built and that next year the company manufactures and sells 36,000 balls (the same number as sold last year). Prepare a contribution format income statement and compute the degree of operating leverage.

ANSWER 5-6B

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 40.00%, 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? (Round "CM Ratio" to 2 decimal places and "Unit sales to break even" to the nearest whole unit.)

	CM Ratio % Unit sales to break even balls

6.

If the new plant is built, how many balls will have to be sold next year to earn the same net operating income, $97,000, as last year? (Round your answer to the nearest whole unit.)

	Number of balls 6B. Assume the new plant is built and that next year the company manufactures and sells 36,000 balls (the same number as sold last year). Prepare a contribution format income statement and compute the degree of operating leverage. (Round "Degree of operating leverage" to 2 decimal places.) Northwood Company Contribution Income Statement 0 $0 Degree of operating leverage

Answer 1

1-a)	CM Ratio	40%	(Note 1)
	Break Even Points (In Balls)	26,300	(Note 2)
	Note 1:
	CM Ratio = (Contribution margin per unit / selling price *100)
	Selling Price	25
	Less: Variable cost per unit	15
	Contribution margin per unit	10
	CM Ratio	40%
	Note 2:
	Break Even Units = Total fixed cost / Contribution margin per unit
	Total Fixed cost	263,000
	Contribution margin per unit	10
	Break Even Points (In Balls)	26,300
1-b)	Degree of Operating leverage	3.71	(Note 3)
	Note 3:
	Degree of Operating leverage =Total Contribution margin / Net Operating income
	Total Contribution margin	360,000
	Net Operating Income	97,000
	Degree of Operating leverage	3.71
2)	CM Ratio	28%	(Note 4)
	Break Even Points (In Balls)	37,571	(Note 5)
	Note 4:
	Selling Price	25
	Less: Revised Variable cost per unit	18
	Contribution margin per unit	7
	CM Ratio	28%
	Note 5:
	Total Fixed cost	263,000
	Contribution margin per unit	7
	Break Even Points (In Balls)	37,571
3)	No. of Balls to be sold next year to earn same level of income	51,429	(Note 6)
	Note 6:
	Target Units = (Fixed cost + Target Income)/Contribution per unit
	Fixed cost + target Income	360,000
	Contribution margin per unit	7
	Target UNITS	51,429
4)	Target Selling Price to maintain same CM ratio	30	(Note 7)
	Variable cost per unit	18
	Required CM Ratio	40%
	Required Variable cost ratio (1-CM Ratio)	60%
	Selling Price (Variable cost / variable cost ratio)	30
5)	Break Even Points (In Balls)	32,875	(Note 8)
	Note 8:
	Selling Price	25
	Less: Variable cost per unit	9
	Contribution margin per unit	16
	Total Fixed cost	526,000
	Break Even Points (In Balls)	32,875
6)-a	Number of balls to be sold to earn same net income (if plant is made)	38,938	(Note 9)
	Fixed cost + target Income	623,000
	Contribution margin per unit	16.0
	Target UNITS	38,938
6)-b	Northwood Company
	Contribution Income statement
	Sales Revenue	973,438
	Less: Variable cost	350,438
	Contribution margin	623,000
	Less: Fixed cost	526,000
	Net Income	97,000
	Degree of Operating Leverage	6.42