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 $13 per unit produced, regardless of the number of units. The second lease option (flat-rate lease) is one where Canton would pay $195,000 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 $130 per unit and unit variable cost (excluding any machine lease costs) are $65. Monthly fixed costs (excluding any machine lease costs) are $403,000.

Required:

a. What is the monthly break-even level assuming:

1. 1. The unit-rate lease?
2. 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 24,500 units. What is the operating leverage assuming:

1. 1. The unit-rate lease?
2. 2. The flat-rate lease?

d. Assume monthly volume of 24,500 units. What is the margin of safety percentage assuming:

1. 1. The unit-rate lease?
2. 2. The flat-rate lease?

Answer 1

Question 1

Particulars	Unit Lease Rate	Flat Lease Rate
Sales Price per Unit	130	130
Less: Variable Lease Cost per Unit	(13)	(0)
Less: Variable Costs excluding Lease Costs	(65)	(65)
Contribution Margin per Unit	52	65

For Unit Lease Rent

Break Even Point in Units = Fixed Costs / Contribution Margin per Unit

Fixed Costs = $ 403,000

Contribution Margin per Unit = $ 52

Break Even Point in Units = 403,000 / 52

Break Even Point in Units = 7,750 Unit's

For Flat Lease Rent

Fixed Costs = $ 598,000

Contribution Margin per Unit = $ 65

Break Even Point in Units = 598,000 / 65

Break Even Point in Units = 9,200 Units

Question 2

Let Number of Units be X

Then Contribution Margin for Flat Lease Rent = $ 65X

Then Contribution Margin for Unit Lease Rent = $ 52X

Fixed Costs under Flat Lease Rent = $ 598,000

Flat Cost under Unit Lease Rent = $ 403,000

Operating Income Under Flat Lease Rent = Operating Income Under Unit Lease Rent

Contribution Margin for Flat Lease Rent - Fixed Costs for Flat Lease Rent = Contribution Margin for Unit Lease Rent - Fixed Costs for Flat Lease Rent

65X - 598,000 = 52X - 403,000

65X - 52X = 598,000 - 403,000

13X = 195,000

X = 195,000 / 13

X = 15000 Units

At the Level of 15,000 Units Operating Income will be Same under Both Lease Options.

Question 3

Particular	Flat Lease Rent	Unit Lease Rent
Contribution Margin	15,92,500	12,74,000
÷ Operating Income	9,94,500	8,71,000
Operating Leverage	1.60 Times	1.46 Times

Particulars	Flat Lease Rent	Unit Lease Rent
Contribution Margin per Unit	65	52
* Number of units	24,500	24,500
Contribution Margin	15,92,500	12,74,000
Less: Fixed Costs	(598,000)	(403,000)
Operating Income	9,94,500	8,71,000

Question 4

For Flat Lease Rent

Margin of Safety Sales = Total Sales - Break Even Sales

Total Sales = $ 31,85,000 (24,500 Units * $ 130 per Unit)

Break Even Sales = Fixed Costs / Contribution Margin Ratio

Contribution Margin Ratio = Contribution Margin per Unit / Sales Price per Unit * 100

= 65 / 130 * 100

= 50%

Break Even Point in Dollars = 598,000 / 50%

Break Even Point in Dollars = $ 11,96,000

Margin of Safety Sales = 31,85,000 - 11,96,000

Margin of Safety Sales in Dollars = $ 19,89,000

Margin of Safety in % = Margin of Safety Sales in Dollars / Total Sales * 100

= 19,89,000 / 31,85,000 * 100

= 62.45%

For Unit Lease Rent

Margin of Safety Sales = Total Sales - Break Even Sales

Total Sales = $ 31,85,000 (24,500 Units * $ 130 per Unit)

Break Even Sales = Fixed Costs / Contribution Margin Ratio

Contribution Margin Ratio = Contribution Margin per Unit / Sales Price per Unit * 100

= 52 / 130 * 100

= 40%

Break Even Point in Dollars = 403,000 / 40%

Break Even Point in Dollars = $ 10,07,500

Margin of Safety Sales = 31,85,000 - 10,07,500

Margin of Safety Sales in Dollars = $ 21,77,500

Margin of Safety in % = Margin of Safety Sales in Dollars / Total Sales * 100

= 21,77,500 / 31,85,000 * 100

= 68.37%