Directions: There are many ways that mushroom/bell anchors maybe manufactured. A

Question

Directions:

There are many ways that mushroom/bell anchors maybe manufactured. Albatross Anchor is considering two new manufacturing processes ( Process A & B ) to reduce costs. From the available information below determine which process has the lowest break even point (this validates the process is more cost effective) and report your analysis and supporting conclusion.

For each process the following fixed costs and variable costs are identified below:

Anchor & Process                                            Process A                     Process B
Sale Price per anchor                                           $45                             $45
Total Fixed costs                                                  $650,000                    $950,000
Variable cost per anchor                                        $36                            $29.99

Based on the above info identify:
a- the total fixed costs per anchor for process A & B
b- the total number of anchors needed to break even for Process A & B
c- from your calculations identify whether you would recommend process A & B for adoption (select only one). please make sure to explain how you arrived at your conclusion

Explanation / Answer

Ans. (a) At Break Even Point:

Total revenue generated = Total cost incurred

i.e. p*x = v*x + F

where, p = Sales Price per Anchor

v = Variable Cost per Anchor

F = Total fixed Cost

x = Total Anchors to be manufactured for Break Even.

Since, p*x = v*x + F

=> (p-v)*x = F

=> (p-v) = F/x

i.e.(p-v) = Total fixed cost per Anchor

Now Total fixed cost per anchor for Process A = (pA -vA) = (45-36) = $9 per Anchor

Total fixed cost per anchor for Process B = (pB -vB) = (45-29.99) = $15.01 per Anchor

Ans. (b) (p-v)*x = F

=> x = F/(p-v) Number of units to be manufactured at break even

For Process A:

xA = FA/(pA-vA) = 650,000/ (45-36) = 72,222.22 72,222 units to be manufactured at break even.

For Process B:

xB = FB/(pB-vB) = 950,000/ (45-29.99) = 63,291.14 63,291 units to be manufactured at break even.

Ans. (c) Process B should be adopted for two reasons:

(1) Since at Break Even point, the units to be manufactured in process B (63291) is less than that of process A (72222), so process B is more cost effective.

(2) Process B is better than Process A in terms of Operating leverage which is defined as the change in net income per unit increase in sales volume. Mathematically, operating leverage can be written as follows:

Operating Leverage = F/(vx*) where x* is units to be manufactured at Break Even point.

Operating leverage for process A = 650,000/(36*72222) = 0.25

Operating leverage for process B = 950,000/(29.99*63291) = 0.5

So process B is also better in terms of operating leverage than process A.

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