Widget Manufacturing Company must replace a widget machine and is evaluating the

Question

Widget Manufacturing Company must replace a widget machine and is evaluating the capabilities of two systems. A requirement of management is that the machine chosen must be paid for during the first year of operation. The first machine under consideration, machine A, would cost $65,000, and has the capacity to make up to 10,000 widgets per year at a variable cost of $22 per widget. The second machine, machine B, can produce twice as many widgets as machine B, can produce twice as many widgets as machine A and would cost $72,000, but the variable cost is only $17 per widget. Widgets sell for $32 each. Find the BEP in terms of widgets tor each machine. Find the BEP in terms of dollars for each machine. If Widget Manufacturing Company is anticipating a demand of 5,500 units in the next year, which machine should it choose? If the demand is anticipated at 7,500 units, should the company choose a different system? At What volume would Widget Manufacturing Company be indifferent to a choice between the two machine?

Explanation / Answer

a. BEP (breakeven point) = (fixed cost/unit price-variable cost per unit)

For machine 1 = (65,000/32-22) = 65,000/10 = 6,500 widgets

For machine 2 = (72,000/32-17) = 72,000/15 = 4,800 widgets

b. BEP in dollar terms = total fixed costs/contribution margin ratio. contribution margin ratio = (sales-variable costs)/sales

machine 1: contribution margin ratio = (32-22)/32 = 10/32 = 31.25%. BEP = 65,000/31.25% = $208,000

machine 2: contribution margin ratio = (32-17)/32 = 15/32 = 46.875%. BEP = 72,000/46.875% = $153,600

c. if demand = 5,500 units then revenue = 5,500*32 = $176,000. costs for machine 1 = fixed+variable = 65,000+(5500*22) = 186,000. profit = 176,000-186,000 = -10,000 (loss) for machine 1.

cost for machine 2 = fixed+variable = 72,000+(5500*17) = 230,500. profit = 176,000-165,500 = $10,500. Machine 2 is giving a profit while machine 1 is giving loss. hence machine 2 should be selected.

d. demand = 7,500 units then revenue = 7500*32 = $240,000. costs for machine 1 = 65,000+(7500*22) = 230,000. profit = 240,000-230,000 = 10,000

costs for machine 2 = 72,000+(7500*17) = 199,500. profit = 240,000-199,500 = 40,500. as profits are higher for machine 2, it should be selected again.

e. let the volume be x.

costs for machine 1 = 65,000+22x. costs for machine 2 = 72,000+17x

at point of indifference: 65,000+22x = 72,000+17x

5x = 7,000 or x = 1400 widgets

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