Martinez Company has decided to introduce a new product. The new product can be manufactured by either a capital-intensive method or a labor-intensive method. The manufacturing method will not affect the quality of the product. The estimated manufacturing costs by the two methods are as follows: Capital Labor Intensive Intensive Direct materials $5 per unit $5.50 per unit Direct labor $6 per unit $8.00 per unit Variable overhead $ 3 per unit $ 4.50 per unit Fixed manufacturing costs $ 2,508,000 $ 1,538,000 Martinez’s market research department has recommended an introductory unit sales price of $ 30. The incremental selling expenses are estimated to be $502,000 annually plus $2 for each unit sold regardless of manufacturing method.
a. Calculate the estimated break-even point in annual unit sales of the new product if Martinez company uses the:
1. Capital – intensive manufacturing method
2. Labor – intensive manufacturing method
b. Determine the annual unit sales volume at which Martinez Company would be indifferent between the two manufacturing methods. c. Explain the circumstance under which Martinez should employ each of the two manufacturing methods.
Decision Making Across the Organization
Managers that work for a company that sells goods and services to customers must have a good understanding of budgets planning to account for both fixed cost and variable costs. Making a decision within leadership of a company requires the management to know cost effectiveness, what price to sell the items, and the actual cost effectiveness of their product or service to ensure they are competitive within the market. There are many different decisions that are made within a company and there are many different viewpoints from managers to make these decisions in order to be successful. The cost behavior analysis is the study of how specific costs of an item that is used within a company changes the levels of business activity. An example we can use is the American automotive maker General Motors. Looking at today’s vehicles and the items such as Bluetooth functions, DVD players, satellite radio and other amenities, prices have increased. About 6-7 years ago you could purchase the same vehicle you are purchasing to day for about 10-20% less. Due to inflation, bank interest loans decreases and the amount of new technology that is added to a new vehicle prices have gone significantly higher. This could also be due to a rising economy and rising job market and bank loans being allowed to go from 60 months previously all the way to 82 months. In today’s market because of interest rates being lower customers are able to buy more expensive cars that are in their monthly price range of a loan versus the concern of the full price of the vehicle. In our exercise the Martinez Company had decided to introduce a new product. However, the new product can be manufactured by of two methods; either capital intensive method or the labor intensive method. Below are the solutions for the problems that were issued:
A-1 Capital – intensive manufacturing method
Selling price per unit = $30
Total variable cost per unit = $5 + $6 + $3 + $2 = $16
Total fixed cost = $2,508,000 + $502,000 = $3,010,000
Contribution margin per unit = $30 – $16 = $14
Break-even point (units) = $3,010,000 ÷ $14
= 215,000 units per year.
A-2 Labor – intensive manufacturing method
Selling price per unit = $30
Total variable cost per unit = $5.50 + $8 + $4.5 + $2 = $20
Total fixed cost = $1,538,000 + $502,000 = $2,040,000
Contribution margin per unit = $30 – $20 = $10
Break-even point (units) = $2,040,000 ÷ $10
= 204,000 units per year.
= ($3,010,000 – $2,040,000) / ($14 – $10)
= 242,500 units per year.
Capital Intensive methodLabor Intensive method
Direct materials 1,212,500 1,333,750
Direct labor 1,455,000 1,940,000
Variable overhead 727,500 1,091,250
Variable selling expenses 485,000 485,000
Fixed manufacturing costs 2,508,000 1,538,000
Fixed selling expenses 502,000 502,000
The net income under both the manufacturing method is $385,000 when 242,500 units were sold that year. Therefore the Martinez Company would be indifferent or neutral between the two manufacturing methods at this level of annual sales. C.
The Martinez Company should be employ the capital intensive manufacturing method if the units produced are identical in nature capital. They can also use the capital intensive manufacturing method if they want to be more accurate of production and a reduction in errors. This method can also reduce the average cost per unit by increasing the level of output or products sold. If the Marinez Company wanted to employ the labor intensive manufacturing method it should be employed when flexibility is key. If the products are meeting a different level of customer or consumer demands this would be the best method to use. This is also used when actual labors are involved with the production like a service versus a product and the employee can physically check the demand of the consumer and change the level of need as necessary. For products versus services the products can be customized from what a customer prefers or demands as well as feedback on production can occur.
Kimmel, P.D. Weydandt, J.J., and Kieso, D.E. (2011) accounting; Tools
for business decision making (4th ed.). Hoboken NJ: John Wiley and Sons.