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 $25.20 per ball, of which 60% is direct labor cost. Last year, the company sold 47,000 of these balls, with the following results: Sales (47,000 balls) Variable expenses Contribution margin Fixed expenses Net operating income $ 1,974,000 1,184,400 789,600 588,000 $ 201,600 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 $3.36 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, $201,600, 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? Complete this question by entering your answers in the tabs below.

Answer 1

Answer 1.

Contribution Margin per unit = Selling Price per unit - Variable Cost per unit
Contribution Margin per unit = $42.00 - $25.20
Contribution Margin per unit = $16.80

Contribution Margin Ratio = Contribution Margin per unit / Selling Price per unit
Contribution Margin Ratio = $16.80 / $42.00
Contribution Margin Ratio = 40%

Breakeven Point in balls = Fixed Expenses / Contribution Margin per unit
Breakeven Point in balls = $588,000 / $16.80
Breakeven Point in balls = 35,000

Degree of Operating Leverage = Contribution Margin / Net Operating Income
Degree of Operating Leverage = $789,600 / $201,600
Degree of Operating Leverage = 3.92

Answer 2.

Selling Price per unit = $42.00

Variable Cost per unit = $25.20 + $3.36
Variable Cost per unit = $28.56

Fixed Expenses = $588,000

Contribution Margin per unit = Selling Price per unit - Variable Cost per unit
Contribution Margin per unit = $42.00 - $28.56
Contribution Margin per unit = $13.44

Contribution Margin Ratio = Contribution Margin per unit / Selling Price per unit
Contribution Margin Ratio = $13.44 / $42.00
Contribution Margin Ratio = 32%

Breakeven Point in units = Fixed Expenses / Contribution Margin per unit
Breakeven Point in units = $588,000 / $13.44
Breakeven Point in units = 43,750

Answer 3.

Contribution Margin per unit = $13.44
Fixed Expenses = $588,000
Target Profit = $201,600

Required Sales in units = (Fixed Expenses + Target Profit) / Contribution Margin per unit
Required Sales in units = ($588,000 + $201,600) / $13.44
Required Sales in units = 58,750

Answer 4.

Variable Cost per unit = $28.56
Contribution Margin Ratio = 40%

Contribution Margin Ratio = (Selling Price per unit - Variable Cost per unit) / Selling Price per unit
0.40 = (Selling Price per unit - $28.56) / Selling Price per unit
0.40 * Selling Price per unit = Selling Price per unit - $28.56
0.60 * Selling Price per unit = $28.56
Selling Price per unit = $47.60