Question

You have been hired as a consultant for Wrigley a well-known and loved worldwide manufacturer of chewing gum. Three of these brands - Juicy Fruit®, Wrigley's Spearmint® and Altoids® - have heritages stretching back more than a century. Wrigley sells its products in more than 180 countries around the world. The CEO of Wrigley, William Perez is in charge of a recent acquisition of a manufacturer of organic chewing gum, Natural Mint, Inc. which is located in Portland, Oregon. The company has one main product which is made in five flavors. He has asked you to prepare a preliminary cost-volume-profit analysis to determine whether changes should be made to the cost structure of selling expenditures.

The following information was presented for use in the analysis:

Fixed costs:	Variable Costs (per unit):
Administrative Costs: $245,000	Direct Materials: $0.075
Selling Costs: $260,000	Direct Labor: $0.055
Fixed Overhead Costs: $230,000	Variable Overhead: $0.035
	Variable Selling: $0.010

Selling price per unit: $2.00

Questions (each question is independent of the others):

1. What is the current break-even point in units and in dollars? Also compute the margin of safety.

2. Assume the company sold 500,000 packs of gum last year. What is Natural Mint's operating leverage? If sales decreased 10%, by what % will Net Income decrease? Create a contribution margin income statement to prove that your calculations are correct.

3. What is the break-even point in units if variable selling costs are increased to 0.05 per unit? Would you recommend this change to the CEO if the expected sales level is 520,000 packages? Explain - consider the breakeven point and profit.

4. Independent of Question 3, what is the break-even point in dollars if the variable selling is eliminated and replaced with an increase to Fixed Selling costs of $200,000? Would you recommend this change to the CEO if the expected sales level is 550,000 units? Explain - consider the breakeven point margin of safety and profit.

Answer 1

Answer 1.
SP Per Unit	2.000
Variable Cost per Unit:
Direct Materials	0.075
Direct Labor	0.055
Variable Overhead	0.035
Variable Selling	0.010
Total Variable Cost per Unit	0.175
Contribution per Unit	1.825
Contribution Margin Ratio	91.25%
Fixed Costs:
Administrative Costs	245,000.000
Selling Costs	260,000.000
Fixed Overhead	230,000.000
Total Fixed Costs	735,000.000
BEP (In Units) = Fixed Costs / Contribution Margin per Unit
BEP (In Units) = $735,000 / $1.825
BEP (In Units) = 402,739.73 or say 402,794 Units
BEP (In $) = Fixed Costs / Contribution Margin Ratio
BEP (In $) = $735,000 / 91.25%
BEP (In $) = $805,479.452 or say $805,480 (Approx.)
Margin of Safety = Sales - BEP (In $)
Margin of Safety = $1,000,000 - $805,480 = $194,520
Assume Company Sold 500,000 Packs of Gums
Answer 2.
Operating Leverage = Contribution / Net Operating Income
Operating Leverage = $912,500 / $177,500
Operating Leverage = 5.14 (Approx.)
Contribution = $1.825 X 500,000 = $912,500
Net Operating Income = $912,500 - $735,000 = $177,500
If sales Decrease by 10%
Net Income decrease by = 10% X 5.14
Net Income decrease by = 51.41%
Income Statement
Contribution - $1.825 X 450,000 Units	821,250.00
Fixed Costs	735,000.00
Net Income	86,250.00
Net Income decrease by = ($177,500 - $86,250) / $177,500
Net Income decrease by = 51.41%
Answer 3.
SP Per Unit	2.000
Variable Cost per Unit:
Direct Materials	0.075
Direct Labor	0.055
Variable Overhead	0.035
Variable Selling	0.050
Total Variable Cost per Unit	0.215
Contribution per Unit	1.785
Contribution Margin Ratio	89.25%
BEP (In Units) = $735,000 / $1.785
BEP (In Units) = 411,764.71 or say 411,765 Units (Approx.)
Income Statement
Contribution Margin - $1.785 X 520,000 Nos	928,200.000
Fixed Costs	735,000.000
Net Operating Income	193,200.000
Yes, the changes should be made as it will increase the Net Operating to $193,200
Answer 4.
SP Per Unit	2.000
Variable Cost per Unit:
Direct Materials	0.075
Direct Labor	0.055
Variable Overhead	0.035
Total Variable Cost per Unit	0.165
Contribution per Unit	1.835
Contribution Margin Ratio	91.75%
Fixed Costs:
Administrative Costs	245,000.000
Selling Costs	460,000.000
Fixed Overhead	230,000.000
Total Fixed Costs	935,000.000
BEP (In Units) = Fixed Costs / Contribution Margin per Unit
BEP (In Units) = $935,000 / $1.835
BEP (In Units) = 509,536.78 or say 509,537 Units
Margin of Safety = Sales - BEP (In $)
Margin of Safety = $1,100,000 - $1,019,074 = $80,926
Income Statement
Contribution Margin - $1.835 X 550,000 Nos	1,009,250.000
Fixed Costs	935,000.000
Net Operating Income	74,250.000
No, the change should not be made,a s it will decrease the net operating income to $74,250