Question

Candice Corporation has decided to introduce a new product. The market research department has recommended a selling price of $30 per unit. The product can be manufactured using either a capital-intensive or labor-intensive method. The manufacturing method will not affect the quality or sales of the product. The estimated costs of the two methods are as follows:

	Capital intensive	Labor intensive
Variable costs per unit	$16.00	$19.60
Fixed manufacturing costs per year	$2,440,000	$1,320,000
Fixed SG&A costs per year	$500,000	$500,000

1. Calculate the break-even point in units for each method.

2. Determine the sales volume Q at which the net operating profit is the same for the two manufacturing methods. (Hint: Write the equation “Unit CM * Q - Total fixed costs” for each method; Set the two equations equal to each other and then solve for Q.)

3. What is your recommendation to management concerning which manufacturing method should be used?

4. Assume that management has decided to use the capital intensive method and is currently selling 400,000 units per year. Management is contemplating using plastic rather than metal gearing in the product. This change would reduce variable costs by $2 per unit (so VC/unit = $14). Selling price would not change. The company's sales manager predicts that this would reduce the overall quality of the product and thus would result in a decline in sales to a level of 360,000 units per year. Should this change be made?

Answer 1