Question

Kelly Kneppy owns a company that manufactures and sells camping equipment and outdoor

gear. Kelly’s latest creation is the Bear-B-Gone, a tent constructed of Kevlar and reinforced steel

mesh that could theoretically protect campers (who hadn’t followed appropriate food storage

guidelines) from bear attacks. Kelly believes the Bear-B-Gone offers many of the same desirable

features as other tents on the market, and that this extreme safety feature will make it one of the

best-selling tents in short order.

Kelly can make the Bear-B-Gone with one of two available technologies. The first is a labor-

intensive process, that if chosen will require $600,000 per year in fixed overhead costs, and the

following in variable costs of production per unit: direct materials of $75, direct labor of $75,

and overhead of $20. The second technology is a more automated (machine-dependent) process,

that if chosen will require $2,000,000 per year in fixed overhead costs, and the following in

variable costs of production: direct materials of $75, direct labor of $5, and overhead of $60.

Kelly believes she can sell the tent for $200.

1. Suppose possible sales are expected to range between 40,000 and 60,000 units as noted

above, and that production will equal sales (no beginning/ending inventory). Which

process has the greater range in profit? Why might this be a factor for Kelly to consider in making her decision?

Assume sales were to fall at the midpoint of the projections above, 50,000 units.

Now, under which process would you say Kelly’s profit

is more sensitive to changes in demand (sales)? Why? Does this make one of the options

strictly “better” than the other? Why or why not?

Answer 1

Profitability analysis under both methods :

Method 1: Labor intensive method:

No. of units	40000	50000	60000
Sales per unit	200	200	200
Variable cost per unit
Direct material	75	75	75
Direct Labor	75	75	75
VOH	20	20	20
Total variable cost per unit	170	170	170
Contribution per unit	30	30	30
Total contribution	1200000	1500000	1800000
Fixed cost	600000	600000	600000
Profit	6,00,000	9,00,000	12,00,000

Method 2: More automated process

No. of units	40000	50000	60000
Sales per unit	200	200	200
Variable cost per unit
Direct material	75	75	75
Direct Labor	5	5	5
VOH	60	60	60
Total variable cost per unit	140	140	140
Contribution per unit	60	60	60
Total contribution	2400000	3000000	3600000
Fixed cost	2000000	2000000	2000000
Profit	4,00,000	10,00,000	16,00,000

Range given 40,000 - 60,000

Therefore with the above working it is clear that as range 40,000 units Method A is preferred due to high profits

and at range 60,000 units Method B is preferred due to high profit.

If the sales are at mid point 50,000 units method 2 is preferred due to high profit.

Bottom line : 0 - 40,000 units = method A is preferred (Fixed cost is low)

> 40,000 units = Method B is preferred (Variable cost is low)

Since 50,000 falls in >40,000 units Method B is preferred.