Question

Creative Ideas Company has decided to introduce a new product. The new product can be manufactured by either a capital-intensive method or a labor-intensive method. The manufacturing method will not affect the quality of the product. The estimated manufacturing costs by the two methods are as follows.

Capital- Intensive:

Direct materials $5 per unit

Direct labor $6 per unit

Variable overhead $3 per unit

Fixed manufacturing costs $2,524,000

Labor- Intensive:

Direct materials $5.50 per unit

Direct labor $8.00 per unit

Variable overhead $4.50 per unit

Fixed manufacturing costs $1,550,000.

Creative Ideas’ market research department has recommended an introductory unit sales price of $32. The incremental selling expenses are estimated to be $502,000 annually plus $2 for each unit sold, regardless of manufacturing method. Assume that the annual unit sales volume at which Creative Ideas would be indifferent between the two manufacturing models is 243,500 units. Explain the circumstance under which Creative Ideas should employ each of the two manufacturing methods.

Answer 1

Answer)

Contribution margin per unit under:

Labor intensive method:$5.50+$8+$4.5=$18

Capital intensive method:$5+$6+$3=$14

Contribution margin Difference:

$18-$14=$4 more in labour intensive method

Breakeven point:fixed costs/Contribution margin

Labor intensive method(including incremental selling expenses):

=($1550000+$502000)/($32-$5.5-$8-$4.5-$2)

=171000 units

Capital intensive menthod including incremental selling expenses):

($2524000+$502000)/($32-$5-$6-$3-$2)

=189125 units.

Profits are current level:

Labor intensive method:

(($32-$5.5-$8-$4.5-$2)×243500 units)-$1550000-$502000

=$870000

Capital intensive method:

(($32-$5-$6-$3-$2)×243500 units)-$2524000-$502000

=$870000

Here, if creative ideas want to move to breakeven quickly or think thinks it seems lead than 243500 units then it should choose labour intensive methods.

If creative ideas thinks it sales can be more than 243500 units than it should choose capital intensive method as it have $4 more Contribution margin and at 243500 unit both methods have same profits where after such raised in unit sale, creative ideas can get more $4 per unit after 243500 units.