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Estimated manufacturing costs:
Computer‐Assisted Labor‐Intensive
Direct material $5.00 $5.60
Direct labor .5DLH@$12 $6.00 .8DLH@$9 $7.20
Variable overhead .5DLH@$ 6 $3.00 .8DLH@$6 $4.80
Fixed overhead $2,440,000 $1,320,000
p $
Unit sales price = $30
Selling expenses = $500,000 annually, plus $2/unit sold
©Dr. Chula King
All Rights Reserved
Problem 7‐44 (continued)
Part 1: Calculate the estimated break‐even point for the two methods
Computer‐Assisted
Contribution margin/unit = 30 – (5 + 6 + 3 + 2) = 30 – 16 = $14/unit
Break‐even point in units = ($2,440,000 + $500,000) ÷ $14 = $2,940,000 ÷
$14 = 210,000 units
Labor‐Intensive
Contribution margin/unit = 30 – (5.60 + 7.20 + 4.80 + 2.00) = 30 – 19.60 =
$10.40/unit
Break‐even point in units = ($1,320,000 + $500,000) ÷ $11.40 =
$1,820,000 ÷ $10.40 = 175,000 units
©Dr. Chula King
All Rights Reserved
Problem 7‐44 (continued)
Part 2: At what annual unit sales volume will the firm be indifferent
between the two manufacturing methods?
Let X = unit sales volume at which the firm will be indifferent
Computer‐Assisted Total Cost = $16X + $2,940,000
Labor‐Intensive Total Cost = $19.60X + $1,820,000
$16X + $2,940,000 = $19.60X + $1,820,000
$3.6X = $1,120,000
X = $1,120,000 ÷ $3.6 = 311,111 units
©Dr. Chula King
All Rights Reserved
Problem 7‐44 (continued)
Part 3: Explain the concept of operating leverage. How is this concept
related to Celestial Products’ decision?
Operating leverage refers to the use of fixed costs in an organization’s
overall cost structure. It is a measure at a given level of sales, of how
a percent change in sales volume will affect profits. An organization
with a relatively high proportion of fixed costs and a low proportion
of variable costs would have a higher degree of operating leverage
than an organization with a relatively low proportion of fixed costs
g y p p
and a high proportion of variable costs. The operating leverage factor
is computed by dividing the contribution margin by net income. The
Computer‐Assisted manufacturing method has the greater amount of
fixed cost ($2,949,000 versus $1,820,000) and thus utilizes a greater
degree of operating leverage.
©Dr. Chula King
All Rights Reserved
Problem 7‐44 (continued)
Part 4: Describe the circumstances under which the firm should
employ each of the two manufacturing methods.
The point of indifference between the two methods is 311,111 units.
If sales are expected to exceed that level, the computer‐assisted
method would be preferable. On the other hand, if sales are
expected to be below that level, the labor‐intensive method would be
preferable.
Part 5: Identify some business factors other than operating leverage
Part 5: Identify some business factors other than operating leverage
that management should consider before selecting the
manufacturing method.
• Variability or uncertainty with respect to demand and selling price
• Ability to produce and market the new product quickly
• Ability to discontinue production and marketing of the new product
while incurring the least amount of loss.
©Dr. Chula King
All Rights Reserved