Question

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 44,000 of these balls, with the following results:

Sales (44,000 balls)	$	1,100,000
Variable expenses		660,000
Contribution margin		440,000
Fixed expenses		317,000
Net operating income	$	123,000

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, $123,000, 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, $123,000, as last year?

b. Assume the new plant is built and that next year the company manufactures and sells 44,000 balls (the same number as sold last year). Prepare a contribution format income statement and compute the degree of operating leverage.

Answer 1

Answer 1

Sales	1100000
Variable Expenses	660000
Contribution Margin	440000
Fixed Expenses	317000
Net Operating Income	123000
CM Ratio (%) (CM/Sales*100)	40.00%
Breakeven Point (Fixed Cost/CM per unit)	31700
Degree of Operating Leverage (CM/Operating Income)	3.58

Asnwer 2

Sales	1100000
Variable Expenses	792000
Contribution Margin	308000
CM Ratio (%) (CM/Sales*100)	28.00%
Contribution Margin per unit	7
Fixed Expenses	317000
Breakeven Point (Fixed Cost/CM per unit)	45,285.71
Breakeven Point (rounded off)	45286

Answer 3

Fixed Cost	317000
Targeted Profit	123000
Contribution to be earned	440000
CM per unit	7
Target units to be sold	62,857.14

Answer 4

Revised Variable Cost	18
Original CM ratio	40%
Original Variable Cost Ratio	60%
Revised Selling Price ($) (Revised VC/VC%	30

Answer 5

Sales	25
Revised Variable Expenses	9
Contribution Margin	16
Revised Fixed Expenses	634000
CM Ratio (%) (CM/Sales*100)	64.00%
Breakeven Point (Fixed Cost/CM per unit)	39625

Answer 6(a)

Fixed Cost	634000
Targeted Profit	123000
Contribution to be earned	757000
CM per unit	16
Target units to be sold	47,312.50

Answer 6(b)

Income Statement as per Marginal Costing (Contribution Format)
Units Sold	44000
Sales ($25 per unit)	1100000
Variable Expenses ($9 per unit)	396000
Contribution Margin	704000
Fixed Expenses	634000
Net Operating Income	70000
Degree of Operating Leverage (CM/Operating Income)	10.06