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 labor workers. Thus, variable costs are high, totaling $15 per ball.

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

Sales (30,000 standard balls) $750,000

Less variable expenses 450,000

Contribution margin 300,000

Less fixed expenses 210,000

Net income $ 90,000

Required 1. Compute (a) the CM ratio and the break-even point in balls, and (b) the degree of operating leverage at last years level of sales.

2. Due to an increase in labor 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 (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 net income ($90,000) as last year?

4. 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 companys new CM ratio and new break-even point in balls?

5. Refer to the data in (4) above.

a. If the new plant is built, how many balls will have to be sold next year to earn the same net income ($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 income statement and compute the degree of operating leverage.

c. If you were a member of top management, would you

have voted in favor of constructing the new plant? Explain.

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