Question

BREAK EVEN ANALYSIS

Southern Environmental Consulting​ (SEC), Inc. designs plans and specifications for asbestos abatement​ (removal) projects in​ public, private, and government buildings.​ Currently, SEC must conduct an air test before allowing the occupancy of a building after the asbestos has been removed. SEC subcontracts​ air-test samples to a laboratory for analysis by transmission electron microscopy​ (TEM). To offset the cost of TEM​ analysis, SEC charges its clients $100 more than the​ subcontractor's fee. The only expenses in this system are the costs of shipping the​ air-test samples to the subcontractor and the labor involved in shipping the samples. With the growth of the​ business, SEC must consider either continuing to subcontract the TEM analysis to outside companies or developing its own TEM laboratory. Because of the passage of the Asbestos Hazard Emergency Response Act​ (AHERA) by the U.S.​ Congress, SEC expects about​ 1,000 air-sample tests per year over eight years. The​ firm's MARR is known to be 15​%.

​(a) Determine the cost of an​ air-sample test by the TEM laboratory​ (in-house).

The unit cost is ____.

(b) Determine the break even cost.

Additional information.

Description of alternatives are as below:

Subcontract option: The client is charged $400 per​ sample, which is $100 above the subcontracting fee of $300. Labor expenses are $1,500 per​ year, and shipping expenses are estimated to be $0.50 per sample.

TEM purchase option: The purchase and installation cost for the TEM is $415,000.The equipment would last for eight​ years, at which time it would have no salvage value. The design and renovation cost is estimated to be $9,500 and it is paid only once along with the installation cost. The client is charged $300 per sample based on the current market price. One​ full-time manager and two​ part-time technicians are needed to operate the laboratory. Their combined annual salaries will be $50,000. Material required to operate the lab includes carbon​ rods, copper​ grids, filter​ equipment, and acetone. The costs of these materials are estimated at ​$6,000 per year. Utility​ costs, operating and maintenance​ costs, and the indirect labor needed to maintain the lab are estimated at $18,000 per year. The extra​ income-tax expenses would be $20,000.

Answer 1

The following data are given to us:

Equipment cost	$415,000.00
Life	8 years
Design & Renovation	$9,500.00
Samples per year	1,000
Selling Price p.u	$300.00
Annual salary	$50,000.00
RM cost	$6,000.00
Miscellaneous expense	$18,000.00
Tax expense	$20,000.00

Total capital outlay here is the equipment cost plus the design & renovation cost = $424,500. This cost is to amortized over the life of the equipment. So the amortization per year would be $53,062.50.

a. The cost of air sample test done in-house would include the following:

Cost	Amount
Raw Material cost	$6,000.00
Salary	$50,000.00
Miscellaneous expense	$18,000.00
Depreciation & Amortization	$53,062.50
Tax expense	$20,000.00
Total cost	$147,062.50

Hence, the total annual cost would be $147,062.50. Since, the company expects 1,000 samples per year, the cost per unit would be $147,062.50 / 1000 = $147.06. This is also the break even price, i.e., the price at which the sample test must be charged for the operations to break even.

Now, to calculate the breakeven sales, we can use the below formula:

Breakeven sales = Fixed cost / contribution margin

Contribution margin = Contribution / Sales %; and

Contribution = Sales - Variable costs

Among the expenses captured in the above table, raw material cost is a variable cost, the per unit raw material cost is $6,000/1000 = $ 6 p.u.. All other costs are fixed. So fixed cost per year is $141,062.50. So

Contribution p.u.= $300- $6 = $294

Therefore, Contribution margin = $294 / $300= 98%

Hence, breakeven sales = $141,062.50 / 0.98 = $143,941.33.

At this breakeven sales, with a selling price of $300 per sample, the company will have to sell ~480 samples to achieve breakeven.