P3–17 Various CVP questions: break-even point; cost structure; target sales Time allowed: 60 minutes Northwood Company manufactures basketballs. The company has a standard ball that sells for £25. At present, the standard ball is manufactured in a small plant that relies heavily on direct labour workers. Thus, variable costs are high, totalling £15 per ball.

Last year, the company sold 30,000 standard balls, with the following results:

Required 1 Compute

(a) the CM ratio and the break-even point in balls (b), and the degree of operating leverage at last year’s level of sales.
2 Due to an increase in labour rates, the company estimates that variable costs will increase by £3 per ball next year. If this change takes place and the selling price per ball remains constant at £25, what will be the new CM ratio and break-even point in balls?
3 Refer to the data in Question 2 above. If the expected change in variable costs takes place, how many balls will have to be sold next year to earn the same profit (£90,000) as last year?
4 Refer again to the data in Question 2 above. The managing director feels that the company must raise the selling price on the standard balls. If Northwood Company wants to maintain the same CM ratio as last year, what selling price per ball must it charge next year to cover the increased labour costs?
5 Refer to the original data. The company is discussing the construction of a new, automated plant to manufacture the standard balls. The new plant would slash variable costs per ball by 40%, but it would cause fixed costs to double in amount per year. 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 Question 5 above.
7

(a) 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?

(b) 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.

(c) If you were a member of top management, would you have voted in favour of constructing the new plant? Explain.

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Sales (30,000 standard balls) Less variable expenses Contribution margin Less fixed expenses Profit 750,000 450,000 300,000 210,000 90,000