Question

Canton Corp. produces a part using an expensive proprietary machine that can only be leased. The leasing company offers two contracts. The first (unit-rate lease) is one where Canton would pay $10 per unit produced, regardless of the number of units. The second lease option (flat-rate lease) is one where Canton would pay $150,000 per month, regardless of the number produced. The lease will run one year and the lease option chosen cannot be changed during the lease. All other lease terms are the same The part sells for $100 per unit and unit variable cost (excluding any machine lease costs) are $50. Monthly fixed costs (excluding any machine lease costs) are $326.000. Required: a. What is the monthly break-even level assuming 1. The unit-rate lease? 2. The flat-rate lease? b. At what volume would the operating profit be the same regardless of the lease option chosen? C. Assume monthly volume of 23,000 units. What is the operating leverage assuming 1. The unit-rate lease? 2. The flat-rate lease? d. Assume monthly volume of 23,000 units. What is the margin of safety percentage assuming: 1. The unit-rate lease? 2. The flat-rate lease?

Answer 1

1. First(Unit-rate lease) Second(Flat-rate lease)

Selling Price Per Unit $100 $100

(-) Variable Cost Per Unit $50 $50

(-) Machine Lease Cost Per Unit $10 -

Contribution per Unit $40 $50

Break Even Level 8150 units 9520 Units

(Fixed Cost/Contribution P.U.) [$326000/$40] [($326000+$150000)/$50)

2. Indifference Point= Change in Fixed Cost under two alternative/ Change in Variable cost under two alternative

= 15000 units [($476000-$$326000)/($50-$40)]

3. Operating Leverage = Contribution/ EBIT(Profit)

Total Contrion $920000($40*23000) $1150000($50*23000)

Profit $594000($920000-$326000) $674000($1150000-$326000-$150000)

Operating Leverage 1.55 times 1.71 times

4. Margin of Safety = Total Sales units -BEP Sales units

14850 uints (23000-8150) 13480 units (23000-9520)

MOS Percentage= MOS Sales/ Total Sales*100

64.56% [(14850/23000)*100] 58.61% [(13480/23000)*100]