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 52,000 of these balls, with the following results: Sales (52,000 balls) $ 1,300,000 Variable expenses 780,000 Contribution margin 520,000 Fixed expenses 321,000 Net operating income $ 199,000 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, $199,000, 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, $199,000, as last year? b. Assume the new plant is built and that next year the company manufactures and sells 52,000 balls (the same number as sold last year). Prepare a contribution format income statement and compute the degree of operating leverage. check_circle
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 52,000 of these balls, with the following results:
| Sales (52,000 balls) | $ | 1,300,000 |
| Variable expenses | 780,000 | |
| Contribution margin | 520,000 | |
| Fixed expenses | 321,000 | |
| Net operating income | $ | 199,000 |
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, $199,000, 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, $199,000, as last year?
b. Assume the new plant is built and that next year the company manufactures and sells 52,000 balls (the same number as sold last year). Prepare a contribution format income statement and compute the degree of operating leverage.
Expert Answer
Answers:
1)
a) Contribution margin ratio
= (Contribution margin / Sales) x 100
= ($520,000 / $1,300,000) x 100
= 40%
Break-even point (in units)
= Fixed expenses/ (Contribution margin / Number of units)
= $321,000 / ($520,000/ 52,000 units)
= $321,000 / 10
= 32,100 units
(b)
Degree of operating leverage
= (Contribution margin / Net Operating Income) x 100
= ($520,000/ $199,000) x 100
= 261.30%
2)
| Particulars | Per Unit | Amount |
| Sales | $25 | 1,300,000 (52,000 x $25) |
| Less: Variable Expenses | $18 (780000/52,000 units +3) | (936,000) (52,000 x$18) |
| Contribution Margin | $7 (364000 / 52,000 units) | 364,000 |
| Less: fixed Expenses | (321,000) | |
| Net Operating income | 43,000 |
Revised Contribution Margin ratio:
= (Revised Contribution margin / Revised Sales) x 100
= ($364,000 / $1,300,000) x 100
= 28%
Break-even point (in units)
= Fixed expenses / (Contribution margin / Number of units)
= $321,,000 / ($364,000/52,000 units)
=$ 321,000 / 7
= 45,857 units
3.
Target sales (in units)
= (Target profit+ Fixed expenses) / Revised contribution per unit
= ($199,000+ $321,000) / $7 per unit
= $520,000 / $7 per unit
= 74,286 units
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- Refer to the data in question h) above.
- If the new plant is built, how many balls will have to be sold next year to earn the same profit (€90,000) as last year?
- 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
profit and loss account and compute the degree of operating leverage. - Top management is confident that with a more intense sales effort and with a more creative advertising programme, the sales could be increased by 50% next year. What would be the expected percentage increase in profit? Use the degree of operating leverage to compute your answer.
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