Reference no: EM132510200
Alpha Inc. operates in a highly competitive environment where new product launches are vital to ensure the sustainability of its business. The company is in the midst of deciding whether to adopt a labour-intensive or a more capital-intensive manufacturing system for its latest new product. There will be no discernible difference in quality between the two manufacturing methods. The management accountant has extracted the following estimates relating to the two methods:
Labour-intensive Capital-intensive
Direct material per unit $16.80 $15.00
Direct labour per unit 0.8 DLH+ @ $27.00 0.5 DLH @ $36.00
Variable overhead per unit 0.8 DLH @ $18.00 0.5 DLH @ $18.00
Fixed overhead $3,960,000 $7,320,000
DLH refers to Direct Labour Hours
- These costs are directly attributable to the new product line. They are avoidable if production does not commence.
- Based on a marketing research conducted by the company, consumers are likely to be acceptable to a unit price of $90. Selling expenses are estimated to be $1,500,000 annually for the fixed component and $6 for each unit for the variable component.
Required:
Question (a) Calculate the break-even points in annual unit sales of the new product to be launched by Alpha Inc.
Question (b) Besides the break-even point analysis, management must also consider the operating leverage for each manufacturing method. Explain the concept of operating leverage. How is this concept applicable to Alpha Inc.'s decision?
Question (c) Draft a report to the CEO. You may include in your report the following:
(i) Recommendation on which method is better for the company. You may consider the point at which the company is indifferent between the two (2) methods. Justify your recommendation.
(ii) Sketching graphs (without detailed plotting) to help to explain the cost behaviours of the two (2) methods.
(iii) Any other business factors that management should consider before selecting the manufacturing method.