Question

T’s is thinking of cutting costs by switching to a different material supplier. Their variable material costs would decrease by 50% (only variable material costs – not all variable costs). The quality of the ingredients is lower, so T’s estimates that their additional fixed scrap costs related to the ingredient quality would be $1,000,000 per month. They would not change the pricing of their glue bottles.

A) Prepare a revised monthly Contribution Margin Income Statement to include the revenues, costs and profits of using the different raw material (ingredient) supplier. (At normal volume.)

B) What is the break-even point in units? (Show your calculations.)

C) What is the break-even point in sales dollars? (Show your calculations.)

D) If their sales end up decreasing because of the change in quality, how much of a reduction in sales (dollars and units) could Stuckie’s handle and still keep their net operating income the same as before the supplier change? Show your data in a Contribution Margin Income Statement.

E) What are the potential impacts – both Qualitative and Quantitative – of the material supplier change? If you had to make the decision of whether to switch suppliers or not, what would you do? Why?

T's produces white school glue. Their glue bottles are primarily sold at department stores across the country. The cost of manufacturing and marketing their glue, at their normal factory volume of 20,000,000 bottles of glue per month, is shown in the table below. T's sells their glue bottles for $1.50 each. T's is making a small profit, but they would prefer to increase their Operating Income.

Data for all Questions:

   per unit

variable material $0.30

variable labor $0,35

variable overhead $0.10

variable marketing $0.05

fixed overhead $0.25

fixed marketing    $0.20

Answer 1

Ans:

A.) Contribution margin statement:

	Raw Material 1	Amount ($)	Raw material 2	Amount ($)
Sales	20,000,000*1.50	30,000,000	20,000,000*1.50	30,000,000
Variable cost	20,000,000*.80	16,000,000	20,000,000*.65	13,000,000
Contribution Margin		14,000,000		17,000,000
Fixed cost		9,000,000		10,000,000
Net Income		5,000,000		7,000,000

Working:

Cost for Existing material:

Variable cost per unit:

Material: $0.30

Labor: $0.35

Overhead: $0.10

Marketing: $0.05

Total : $0.80 per unit.

Fixed cost:

Overhead: 20,000,000*$0.25 = $5,000,000

Marketing : 20,000,000*$0.20= $4,000,000

Total : $9,000,000

Cost Under new Material:

Variable cost per unit:

Material: $0.15

Labor: $0.35

Overhead: $0.10

Marketing: $0.05

Total : $0.65 per unit.

Fixed cost:

Overhead: 20,000,000*$0.25 = $5,000,000

Marketing : 20,000,000*$0.20= $4,000,000

Scrap cost: $1,000,000.

B.)

Break even in units:

Raw Material 1: Fixed cost/contribution margin per unit = 9,000,000/$0.70= 12,857,143

Raw Material 2: Fixed cost/contribution margin per unit = 10,000,000/$0.85= 11,764,706

C.)

Break Even in sales:

Raw Material 1: Break even units* Selling price per unit: 12,857,143*1.50 = $19,285,714.5

Raw Material 2: Break even units* Selling price per unit: 11,764,706*1.50 = $17,647,059

D.)

If sales decline stuckies can handle a reduce in sale upto:

Excess profit at normal level/contribution margin per unit: ($7,000,000-$5,000,000)/$0.85 = 2,352,941 Units.

= 2,352,941*1.50 = $3,529,411.5

A decline in sale upto $3,529,411.5 is bearable.

Contribution margin statement:

	Raw material 2	Amount ($)
Sales	17,647,059*1.50	26,470,588
Variable cost	17,647,059*.65	11,470,588
Contribution Margin		15,000,000
Fixed cost		10,000,000
Net Income		5,000,000

E.)

If there is a change in material doesn't affect the quality of output and also the quantity for sale is not reduced as a result in lower quality of output. I would definately like to switch to new material because it gives company an additional profit of $2M. However if quality of output degrades it may affect the sale in long run, in such a case a decision would vary depend upon expected sale projections of future.