Christian Company manufactures and sells one of its products at a price of $120.00 per unit. The costs of manufacturing and marketing the product at the company’s normal volume of 10,000 units per year follow:
Cost per unit
Manufacturing costs:
Direct Materials $32.00
Direct Labor 21.00
Variable overhead 7.50
Fixed manufacturing overhead ($255,000 total) 25.50
Total manufacturing costs per unit $86.00
Nonmanufacturing costs:
Variable marketing, distribution & administrative $15.30
Fixed marketing & administrative ($32,000 total) 3.20
Total nonmanufacturing costs per unit 18.50
Total cost per unit $104.50
Christian Company is considering investing in a new, more automated, production process. The new equipment would increase Christian Co.’s fixed manufacturing overhead costs by $20,000 per year. However, this new investment is expected to reduce Christian’s direct labor costs by 10% and their variable manufacturing overhead costs by 20%. The expected sales volume, selling price, and other costs are expected to remain the same.
(1) What is the breakeven point if Christian invests in the new equipment?
(2) At what volume level would Christian have the same pretax operating income under either cost structure? In other words, what is the point of indifference for sales volume?
(3) How would this change in cost structure affect Christian’s operating leverage? Discuss how operating leverage could impact this decision?
(4) What is your recommendation – should Christian invest in the new equipment? Explain your recommendation (why or why not?).