Reference no: EM132566611

Question - Lily Flowers is President of Lily Recreation which manufactures recreational equipment. One of the company's products, a skateboard, sells for $37.50. The skateboards are manufactured in an antiquated plant that relies heavily on direct labor workers. The variable costs are high, totaling $22.50 per skateboard of which 60% is direct labor cost.

Over the past year the company sold 40,000 skateboards, with the following operating results:

Sales (40,000 skateboards) $1,500,000

Variable Expenses 900,000

Contribution Margin 600,000

Fixed Expenses 480,000

Net Operating Income 120,000

Management is anxious to maintain and perhaps even improve its present level of income from the skateboards.

Required -

1. Compute the Contribution Margin ratio and the break-even point in skateboards.

2. Due to an increase in labor rates, the company estimates that variable costs will increase by $3 per skateboard next year. If this change takes place and the selling price per skateboard remains constant at $37.50, what will be the new Contribution margin ratio and the new break-even point in skateboards?

3. Refer to the data in (2) above. If the expected change in variable costs takes place, how many skateboards will have to be sold next year to earn the same net operating income, $120,000, as last year?

4. Refer again to the data in (2) above. Lily has decided that the company may have to raise the selling price of its skateboards. If Lily Recreation wants to maintain the same Contribution Margin ratio as last year, what selling price per skateboard must it charge next year to cover the increased labor costs?

5. Refer to the original data. Lily is considering the construction of a new, automated plant. The new plant would slash variable costs by 40%, but it would cause fixed cost to increase by 90%. If the new plant is built, what would be the company's new Contribution Margin ratio and new break-even point in skateboards?

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

a. If the new plant is built, how many skateboards will have to be sold next year to earn the same net operating income, $120,000, as last year?

b. Assume that the new plant is constructed and that next year the company manufactures and sells 40,000 skateboards (the same number as sold last year). Provide a contribution format income statement.