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 32,000 of these balls, with the following results:

Sales (32,000 balls)	$	800,000
Variable expenses		480,000
Contribution margin		320,000
Fixed expenses		211,000
Net operating income	$	109,000

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, $109,000, as last year?

b. Assume the new plant is built and that next year the company manufactures and sells 32,000 balls (the same number as sold last year). Prepare a contribution format income statement and Compute the degree of operating leverage.

Answer 1

5) Variable expense per unit = 15*60% = 9 per unit

Selling price per unit = 25 per unit

Fixed cost = 211000*2 = $422000

New CM ratio = (25-9)/25 = 64%

New break even point in balls = 422000/16 = 26375 Balls

6a) Desired Sales unit = (422000+109000)/16 = 33187.50 Balls

6b) Contribution margin income statement

Sales (32000*25)	800000
Variable cost (32000*9)	288000
Contribution margin	512000
Fixed cost	422000
Net operating income	90000

Degree of operating leverage = 512000/90000 = 5.69 Times