Corrigan Enterprises Is Studying The Acquisition Of Two Elec

Corrigan Enterprises Is Studying The Acquisition Of Two Electrical Com

Corrigan Enterprises is considering acquiring two different electrical component insertion systems for the production of its sole product, the universal gismo. The relevant data for these systems are as follows: Model no. 6754 has variable costs of $16.00 per unit and annual fixed costs of $985,600; Model no. 4399 has variable costs of $12.80 per unit and annual fixed costs of $1,113,600. The selling price of the universal gismo is $64 per unit, which is subject to a 5 percent sales commission. For the purposes of this analysis, income taxes are to be ignored. The key questions involve calculating break-even points, assessing profitability under expected sales volumes, and understanding the financial implications of additional equipment purchase and cost differences between the models.

Paper For Above instruction

The decision to acquire new manufacturing equipment is critical for a company's strategic growth and profitability. In the context of Corrigan Enterprises contemplating the purchase of two different electrical component insertion systems, a comprehensive financial analysis is essential. The evaluation hinges on understanding the break-even point, productivity profitability at expected sales levels, investment implications of additional equipment, and the volume at which the two options become financially indistinguishable.

Break-even Analysis for Model no. 6754

The initial step involves calculating the units required to break even if Model no. 6754 is selected. The break-even point occurs when total revenues equal total costs, meaning the company's profit is zero. The selling price per unit, after accounting for a 5 percent sales commission, becomes:

\[ \text{Net price} = \$64 \times (1 - 0.05) = \$60.80 \]

Variable costs per unit for Model 6754 are $16.00, with annual fixed costs of $985,600.

The contribution margin per unit, which is the sales price minus variable costs, is:

\[ \$60.80 - \$16.00 = \$44.80 \]

The break-even number of units (Q) is calculated as:

\[ Q = \frac{\text{Fixed costs}}{\text{Contribution margin per unit}} = \frac{\$985,600}{\$44.80} \approx 22,003 \text{ units} \]

Thus, Corrigan must sell approximately 22,003 units of the universal gismo using Model no. 6754 to break even.

Profitability Comparison at Expected Sales Volume

At an anticipated annual sales volume of 46,000 units, which exceeds the break-even threshold, the net contribution for each model can be evaluated to determine which offers greater profitability.

For Model no. 6754:

- Total revenue: \(46,000 \times \$60.80 = \$2,796,800\)

- Total variable costs: \(46,000 \times \$16.00 = \$736,000\)

- Total contribution margin: \(46,000 \times \$44.80 = \$2,060,800\)

- Total fixed costs: \$985,600

- Net profit: \(\$2,060,800 - \$985,600 = \$1,075,200\)

For Model no. 4399:

- Total revenue: same as above, \( \$2,796,800 \)

- Variable costs: \(46,000 \times \$12.80 = \$588,800\)

- Contribution margin: \(46,000 \times (\$64 \times 0.95 - \$12.80) = 46,000 \times (\$60.80 - \$12.80) = 46,000 \times \$48.00 = \$2,208,000 \)

- Total fixed costs: \$1,113,600

- Net profit: \(\$2,208,000 - \$1,113,600 = \$1,094,400\)

Comparing these figures reveals that Model no. 4399 provides higher net profit at the expected sales volume of 46,000 units (\$1,094,400 vs. \$1,075,200), indicating it is the more profitable choice under these circumstances.

Impact of Additional Equipment and Required Sales for Target Income in Model no. 4399

Purchasing new equipment for Model no. 4399 involves an initial expense of \$450,000, depreciated over five years using the straight-line method, resulting in annual depreciation expense of:

\[ \frac{\$450,000}{5} = \$90,000 \]

Amortization impacts the fixed costs, effectively increasing annual fixed costs to:

\[ \$1,113,600 + \$90,000 = \$1,203,600 \]

The goal is to determine the number of units that must be sold to earn a net income of \$956,400 with Model no. 4399. The total contribution margin per unit remains at \$48.00 as calculated earlier. The net income is computed as follows:

\[ \text{Net income} = \text{Total contribution margin} - \text{Fixed costs} \]

Rearranged to solve for the required contribution margin:

\[ \text{Contribution margin} \times Q - ( \text{Fixed costs} + \text{Depreciation} ) = \$956,400 \]

\[ \$48.00 \times Q - \$1,203,600 = \$956,400 \]

\[ \$48.00 \times Q = \$956,400 + \$1,203,600 = \$2,160,000 \]

\[ Q = \frac{\$2,160,000}{\$48.00} = 45,000 \text{ units} \]

Given the expected sales volume of 46,000 units, this sales target is achievable, and the company can meet its income objective with this model by selling approximately 45,000 units.

Indifference Point Between the Two Models

Calculating the volume where the total costs of both systems are equal involves setting their total costs (fixed + variable) equal, considering the contribution margins.

Mathematically, the total costs are:

\[ \text{Total cost} = \text{Fixed costs} + (\text{Variable cost per unit} \times Q) \]

Since sales commissions are proportional and similar for both, they are encompassed within the net selling price, simplifying comparison.

Letting \(Q\) be the break-even volume:

\[ \text{Fixed costs}_1 + \text{Variable cost}_1 \times Q = \text{Fixed costs}_2 + \text{Variable cost}_2 \times Q \]

\[ 985,600 + 16.00 Q = 1,113,600 + 12.80 Q \]

Rearranged:

\[ 16.00 Q - 12.80 Q = 1,113,600 - 985,600 \]

\[ 3.20 Q = 128,000 \]

\[ Q = \frac{128,000}{3.20} = 40,000 \text{ units} \]

At a sales volume of 40,000 units, the total costs of both systems are identical, making management indifferent between the two options. Above this volume, Model no. 4399 becomes more cost-effective due to lower variable costs and fixed costs, whereas below this level, Model no. 6754 is preferable.

Conclusion

This comprehensive analysis emphasizes the importance of detailed cost and sales data in making capital acquisition decisions. The calculations reveal that for modest sales volumes, Model no. 6754 suffices, but at higher expected sales, Model no. 4399 offers superior profitability, especially when considering the additional equipment investment. The breakeven analysis provides strategic insight into sales targets, while the indifference point guides decisions when sales are uncertain. Such financial analyses are vital tools for optimizing manufacturing investments and enhancing corporate profitability.

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