Breakeven Analysis Question: A firm has decided to manufacture widgets. There ar

Question

Breakeven Analysis Question:

A firm has decided to manufacture widgets. There are two production processes available for consideration. Process A involves the purchase of a $132,000 machine that will last for 10 years and have a $10,000 salvage value at that time. Annual operating and maintenance costs amount to $10,000 for the machine. In addition, using process A requires additional costs amounting to $0.90 per widget produced. The second process, Process B, requires an investment of $72,000 in a machine that at the end of 10 years has a salvaged value of $10,000. Annual operating and maintenance costs amount to $4,000 for this machine. There are additional costa of $1.20 per widget produced when Process B is used. Ignoring the time value of money (discounted cash flow), for what annual production volume(s) is Process A preferred? Clearly show the method you have used, and state and justify any assumptions that you have made. Discuss any significant risks that are associated with your conclusion.

Explanation / Answer

At 40,000 units level the company would be at breakeven. Process A would be preferred at volume of more than 40,000 units

Process A Process B Purchase                    132,000                     72,000 Salvage value                       10,000                     10,000 operating cost                       10,000                       4,000 Additional cost                           0.90                         1.20 Annual depreciation                       12,200                       6,200 operating cost                       10,000                       4,000 Total cost                       22,200                     10,200 Additional cost                           0.90                         1.20 Selling price                                 5 Sales unit                       40,000 Sales revenue                    200,000                  200,000 Total cost                       58,200                     58,200 Profit                    141,800                  141,800

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