Question 1 32 Marks (60 mins) The Antigen Corporation is a manufacturer of the Axon, which it sells in the intermediate market. The following information is available about the Axon (revenue and costs are provided on a per unit basis): Revenue $130.00 Manufacturing costs: Material $37.50 Labour 4.00 Manufacturing overhead 30.00 Total Manufacturing costs $71.50 Annual volume, in units 22,000 Machine hours available (M1) (annual) 5,000 hours Axon is produced using production equipment referred to as M1. The $4.00 per unit labour cost represents the cost of the employee to run the machine (M1). Manufacturing overhead costs are approximately 30% fixed, based on current volume of 22,000 units. Each Axon requires 0.1 hours of machine time on M1. Antigen is considering the purchase of new equipment, M2, that has a cost of $2,000,000. This machine would produce a second product, Dendrite. Dendrite will require 0.2 hours of time on M1 and 0.25 hours on M2. The demand for Dendrite is increasing and Antigen would be the dominant producer in the field. Although both products require the use of M1, they are distinct from each other, and sales of Dendrite would not affect the demand for Axon. Company management estimates that revenue for Dendrite will be $350.00 per unit. Variable overhead costs on M2 are expected be the same per machine hour as on M1. The direct material cost for Dendrite is $65.00 per unit. The hourly labour rate for the machine operator will be the same as the hourly labour rate for the operator of M1. Sales commissions equal 5% of sales on the Axon and it is anticipated that this commission rate would apply to Dendrite as well. The maximum machine hours available on M2 is 6,000 hours per year. Aside from the cost of purchasing M2, there will be no other increase in fixed costs if Dendrite is produced. All administrative costs are considered fixed. M2 should be depreciated for tax purposes at a CCA rate of 20% Management is uncertain as to the demand for the Dendrite. Conservatively, they have estimated that demand in the first two years will be 16,000 units. They expect demand to increase to 25,000 units for years 3 to 5.Question 1 (continued) It is anticipated that M2 will have a useful life of 5 years. For purposes of a conservative evaluation, the company has assumed the residual value will be $200,000. The CCA class will remain open. The company's combined corporate tax rate is 40% and Antigen requires a 15% return, after tax, on projects with the level of risk associated with Dendrite. The company intends to make full use of the Accelerated Investment Incentive for CCA purposes. The vice president of marketing has indicated that unless M2 is purchased, the company's ability to compete in the target market segment will be impeded. She feels the company has an opportunity to become a market leader in the field. The president is concerned that if the equipment is purchased, it will take the company into new markets where it has not competed before. He is also worried that if the company is not able to fill all of the orders for the Axon, the customers may look elsewhere for this product. Required: Prepare a report to the president. The report should include a supported recommendation for the proposed acquisition of M2, as well as any relevant qualitative issues. You can assume that the company will prioritize production of Dendrite over Axon if faced with capacity issues. To help you with your analysis, answer the questions below: 1. Assume M2 has not yet been purchased. a. calculate the unit pre-tax contribution margin for Axon (4 marks) b. calculate the total pre-tax contribution for Antigen (1 marks) 2. Assuming M2 is purchased: a. what is the unit pre-tax contribution for Dendrite? (6 marks) b. how many units of Dendrite can be produced on M2 (ignore market demand constraints)? (2 marks) C. how many units of Dendrite can be produced in year 1? (1 mark) d. how many units of Dendrite can be produced in year 3? (2 marks) e. assuming Antigen maximizes production of Dendrite in year 3, how many units of Axon could they produce in year 3 with the remaining capacity? (2 marks) f. ignoring the time value of money, what is the TOTAL contribution for Dendrite for each of years 1-5? (4 marks) 3. Management has requested your analysis as to whether or not they should purchase M2. Provide a quantitative analysis showing incremental cash flows, and capital budgeting analysis as to whether the equipment should be purchased. Please note, there are a lot of part marks here, so even if you're stuck, it's worth it to write something down! (8 marks) 4. What are some qualitative factors that Antigen should consider? (2 marks)