Tom Johnson Manufacturing intends to increase the capacity through the addition

Question

Tom Johnson Manufacturing intends to increase the capacity through the addition of new equipment. Two vendors have presented proposals. The fixed cost for proposal A is $50,000 and for proposal B is $70,000. The variable cost for A is $12 and for B, $11. The selling price of a product produced from proposal A is $20 and from proposal B is $22. a. What is the breakeven point in units and in dollars for proposal A? b. What is the breakeven point in units and in dollars for proposal B? c. If the expected volume is 8500 units, which proposal should be chosen? d. At what level of production, A and B becomes indifferent?

Explanation / Answer

Break even point is the point when the Total sales = Total Costs (FC+VC)

Let number of units produced = x

For A : 20x = 50,000 + 12x

For B : 22x = 70,000 + 11x

(a) Breakeven Point for A::: 20x - 12x = 50,000. Therefore 8x = 50,000, x = 6250

Therefore Breakeven Point in Units = 6250 and Dollars = 20x = 20*6250 = $ 1,25,000

(b) Breakeven Point for B::: 22x - 11x = 70,000. Therefore 11x = 70,000, x = 6363.64

Therefore Breakeven Point in Units = 6363.64 and Dollars = 22x = 22*6363.64 = $ 1,40,000.08

(c) We need to see which Equipment will Maximise profit

For A: The profit is 8x - 50,000 = 8*8500 - 50,000 = 68,000-50,000 = $18,000

For B: The profit is 11x - 70,000 = 11*8500 - 70,000 = 93,500-70,000 = $ 23,500

Therefore for producing 8,500 units, equipment B should be chosen.

(d) For this, we need to equate the profit equations for both.

8x - 50,000 = 11x - 70,000

Therefore, 3x = 20,000

x = 6666.67

When x = 6666.67, A and B become indifferent, i.e it does not matter which Equipment is used.

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