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 Labor-Intensive
Direct materials $6 per unit $6.50 per unit
Direct labor $7 per unit $9.00 per unit
Variable overhead $3 per unit $5.00 per unit
Fixed manufacturing costs $2,877,000 $1,767,000

Creative Ideas’ market research department has recommended an introductory unit sales price of $36. The incremental selling expenses are estimated to be $572,000 annually plus $2 for each unit sold, regardless of manufacturing method.

With the class divided into groups, answer the following.

(a)

Calculate the estimated break-even point in annual unit sales of the new product if Creative Ideas Company uses the: (Round answers to 0 decimal places, e.g. 5,275.)

(1) Capital-intensive manufacturing method.
(2) Labor-intensive manufacturing method.

Capital-Intensive Labor-Intensive
Break-even point in units

(b)

Determine the annual unit sales volume at which Creative Ideas Company would be indifferent between the two manufacturing methods. (Round answer to 0 decimal places, e.g. 5,275.)

Annual unit sales volume ____________ units

Answer 1

A. Calculation of Break even point in annual unit sales

Break even point = Total fixed cost/contribution margin

1.Capital intensive manufacturing method

Fixed manufacturing cost = $2,877,000

Fixed selling expenses = $572,000

Total fixed cost = $3,449,000

Contribution margin = selling price - variable cost per unit

Variable cost per unit = Direct material + Direct Labour + variable overhead + selling overhead = $6+$7+$3+$2 = $18

Sales price = $36

Contribution margin = $36 - $18

= $18

Break even point = $3,449,000/$18

= 191,611units

2. Labour intensive manufacturing method

Fixed manufacturing cost = $1,767,000

Fixed selling expenses = $572,000

Total fixed cost = $2,339,000

Contribution margin = $36-($6.5+$9-$5+$2)

= $13.5

Break even point = $2,339,000/$13.5

= 173,259 units

B. Creative ideas company would be in different between the two manufacturing methods where total cost of both methods are equal

$18x + $3,449,000 = $22.5x + $2,339,000

4.5x = 1,110,000

x = 246,667 units