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138.

P. Harrison Limited manufactures and sells highly faddish products directed toward the preteen

market. A new product has come onto the market that the company is anxious to manufacture

and sell. Enough capacity exists in the company's plant to manufacture a maximum of 35,000

units of the new product each month. Total fixed costs (both manufacturing and non-

manufacturing) will amount to $60,000 per month. The company's controller projects an operating

loss of $15,000 if the company manufactures and sells 30,000 units of the new product per

month.

The marketing department predicts that demand for the new product will exceed the maximum

35,000 units that the company is able to manufacture in its own plant. Additional manufacturing

capacity can be rented from another company at a fixed cost of $20,000 per month to

manufacture 50,000 units of the new product monthly. The variable costs to manufacture and sell

units of the new product made in the rented facility will be higher at $3.75, due to somewhat less

efficient operations than in the company's own plant. The new product, however, will sell for

$4.50 per unit, regardless of where it is manufactured.

Required:

a) Calculate the monthly break-even sales for the new product in units if the company operates

only in its own plant, that is, it manufactures a maximum of 35,000 units. (NOTE: If there is no

break-even sales level, state so together with the supporting calculations and reasoning.)

b) Calculate the monthly break-even sales for the new product in units if the company rents the

additional manufacturing capacity, that is, it manufactures more than 35,000 units. NOTE: Again,

if there is no break-even sales level, state so together with the supporting calculations and

reasoning.)

c) Suppose there are NO manufacturing capacity constraints for the manufacture of the new

product at either the company's own plant or the rented facility.

(i) At what level of non-zero production and sales (in units) would you expect the company to be

indifferent between the two manufacturing facilities?

(ii) Calculate the degree of operating leverage at a monthly sales level of 50,000 units at EACH

manufacturing facility.

(iii) Which one of the two manufacturing facilities will be MORE advantageous for the

manufacture of the new product, assuming the marketing department predicts very strong and

increasing demand for the new product? Explain, strictly on the basis of the degree of operating

leverage calculations in Part c (ii) above.

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