Problem 5-20 CUP Applications: Break-Even Analysis: Cost Structure; Target Sales
ID: 2544524 • Letter: P
Question
Problem 5-20 CUP Applications: Break-Even Analysis: Cost Structure; Target Sales Lo05-1, LO5-3, LO5- 4, LO5-5, LO5-6, LO5-8) Northwood Company manufactures basketballs. The company has a ball that sells for $34. At present, the ball is manufactured in a small plant that relies heavily on direct labor workers. Thus, variable expenses are high, totaling $24.00 per ball, of which 71% is direct abor cost. nts Last year, the company sold 30,000 of these balls, with the following results: s 1,e2e,880 720,80e Sales (3e,eee balls) Variable expenses Contribution margin Fixed expenses Net operating income 300) 00 21e,80e $ 90,000 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 $34.00, 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, $90,000, 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 29.41%, but it would cause fixed expenses per year to double, if the new parts bull, 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, $90,000, as last year? Prev 1012 ill Next >Explanation / Answer
Answer 1:
Part a:
Contribution Margin per Unit = Selling Price per Unit – Variable Expenses Per Unit
Contribution Margin per Unit = $34 - $24
Contribution Margin per Unit = $10
Contribution Margin Ratio = Contribution Margin per Unit / Selling Price *100
Contribution Margin Ratio = $10 / $34 *100
Contribution Margin Ratio = 29.41%
Part b:
Break Even Point in Balls = Fixed Expenses / Contribution Margin per Unit
Break Even Point in Balls = $210,000 / $10
Break Even Point in Balls = 21,000 balls
Part C:
Degree of Operating Leverages = Contribution Margin / Net Operating Income
Degree of Operating Leverages = $300,000 / $90,000
Degree of Operating Leverages = 3.33
Answer 2:
Part a:
New Variable Expenses = Old Variable Expenses + Increased Variable Expenses
New Variable Expenses = $24 + $3
New Variable Expenses = $27
New Contribution Margin per balls = Selling Price – New Variable Expenses
New Contribution Margin per balls = $34 - $27
New Contribution Margin per balls = $7
Contribution Margin Ratio =New Contribution Margin per Unit / Selling Price *100
Contribution Margin Ratio = $7 / $34 *100
Contribution Margin Ratio = 20.59%
Part b:
Break Even Point in Balls = Fixed Expenses / New Contribution Margin per Unit
Break Even Point in Balls = $210,000 / $7
Break Even Point in Balls = 30,000 balls
Answer 3:
Unit Sales to Attain Target Profit = (Fixed Expenses + Target Profit) / New Unit Contribution Margin
Units Sales to Attain Target Profit = (210,000 + $90,000) / $7 per balls
Unit Sales to Attain Target Profit = $300,000 / $7 per balls
Unit Sales to Attain Target Profit =42,857 balls
Answer 4:
Let the Selling Price be “$x”
Contribution Margin Ratio = 29.41%
Contribution Margin Ratio = (Sales – Variables Expenses) / Sales * 100
29.41 = ($x - $27) / $x * 100
29.41x = 100X - 2,700
2,700 = 70.59x
x = $38.25
Therefore, Selling Price should be $38.25 to maintain the CM ratio of 29.41%.