Question

Northwood Company manufactures basketballs. The company has a ball that sells for $49. At present, the ball is manufactured in a small plant that relies heavily on direct labor workers. Thus, variable expenses are high, totaling $34.30 per ball, of which 70% is direct labor cost. Last year, the company sold 58,000 of these balls, with the following results: Sales (58,000 balls) $ 2,842,000 Variable expenses 1,989,400 Contribution margin 852,600 Fixed expenses 705,600 Net operating income $ 147,000

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. (Round "Degree of operating leverage" to 2 decimal places.)

2. Due to an increase in labor rates, the company estimates that next year's variable expenses will increase by $4.90 per ball. If this change takes place and the selling price per ball remains constant at $49.00, 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, $147,000, as last year? Round your answer to the nearest whole unit.)

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? (Round your answer to 2 decimal places.)

Answer 1

1(a) CM ratio = Contribution margin/Sales = $852600/$2842000 = 30%

Break-even point in balls = Fixed expenses/Contribution per unit = $705600/($49 - $34.30) = $705600/$14.70 = 48000

1(b) Operating leverage = Contribution/Net operating income = $852600/$147000 = 5.80

2. CM ratio = Contribution margin/Sales = [$49 - ($34.30 + $4.90)]/$49 = [$49 - $39.20]/$49 = $9.80/$49 = 20%

Break-even point in balls = Fixed expenses/Contribution per unit = $705600/$9.80 = 72000

3. Number of balls to be sold = (Fixed expenses + Required net operating income)/Contribution per unit = ($705600 + $147000)/$9.80 = $852600/$9.80 = 87000

4. Selling price per ball = $56.00

CM ratio = Contribution margin/Sales = 30%

Variable expense/Sales = 70%

$39.20/Sales = 70%

Sales = $39.20/70% = $56