Martinez Company has decided to introduce a new product.

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 Intensive            Labor Intensive

Direct Material                                    $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

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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.

Instructions

With the class divided into groups, answer the following.

(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.

(a)

(1)                    Capital-Intensive		(2)                        Labor-Intensive
Fixed manufacturing costs            $2,508,000 Incremental selling expenses             502,000 Total fixed costs                               $3,010,000		Fixed manufacturing costs             $1,538,000 Incremental selling expenses             502,000 Total fixed costs                                $2,040,000
Selling price                                             $30.00 Variable costs         Direct materials              $5.00                            Direct labor                       6.00                            Variable overhead          3.00                            Selling expenses            2.00         16.00 Contribution margin                                $14.00		Selling price                                              $30.00 Variable costs         Direct materials              $5.50         Direct labor                       8.00         Variable overhead          4.50         Selling expenses            2.00         20.00 Contribution margin                                $10.00
Total fixed costs (1)                          $3,010,000		Total fixed costs (1)                          $2,040,000
Contribution margin per unit (2)           $14.00		Contribution margin per unit (2)            $10.00
Break-even in units (1) ÷ (2)                215,000		Break-even in units (1) ÷ (2)                204,000

(b)     Martinez Company would be indifferent between the two manufac­turing methods at the volume (X) where total costs are equal.

                                                     $16X + $3,010,000 = $20X + $2,040,000

                                                                            $4X    = $970,000

                                                                                   X  = 242,500 units

(c)      Martinez should employ the capital-intensive manufacturing method if annual sales are expected to exceed 242,500 units and the labor-intensive manufacturing method if annual sales are not expected to exceed 242,500 units. The labor-intensive method is more profitable for sales up to 242,500 units because the fixed costs are lower. The capital-intensive method is more profitable for sales above 242,500 units because its contribution margin is higher.