Xanadu, Corporation manufactures and sells one product, Alph, for $47 per unit. Xanadu is the only manufacturer that produces Alph because it is a patent protected product. Although Xanadu, Corp. only sells one product they have loyal customers all over the world and the company has remained profitable for many years. Annual unit sales are consistently

The company maintains no beginning or ending inventories and its relevant range of production is 25,000 units to 65,000 units annually. Shipping costs are 20% of variable selling expense. Annually, Xanadu typically produces and sells 40,000 units of its product. Unit costs and fixed costs are as follows:

	Amount Per Unit Total
Direct materials	$	8.00
Direct labor	$	10.00
Variable manufacturing overhead	$	2.50
Fixed manufacturing overhead	$	7.00 280,000
Fixed selling expense	$	2.50 100,000
Variable selling expense	$	3.50
Fixed administrative expense	$	2.00 80,000
Sales commissions	$	1.00
Variable administrative expense	$	2.00

Required:

Round answers to two decimal places except operating leverage, which is rounded to one decimal place. Do not round intermediate answers.

Two executives at Xanadu, Neil and Geddy, have different opinions about improving profitability.

1. Neil believes that the quality of the product could be improved by spending $1.25 more per unit on better raw materials. The higher quality raw material will require improvements on the current manufacturing machinery, increasing fixed manufacturing overhead $75,000 per year. Neil also believes that increasing fixed selling expense by adding an advertising campaign at a cost of $25,000 per year will increase sales. The selling price per unit of Alph will remain at $47.00 per unit. Neil estimates that sales volume would increase 21.5%. Shipping costs will remain 20% of variable selling expense. Discuss the effect Neils plan will have on net operating income, the breakeven point, and the degree of operating leverage of Xanadu Corp.

2. Geddy believes that sales volume can be increased by reducing some expenses and increasing advertising and promotional campaigns. Geddy proposed the following as an alternative to Neils plan: (1) Reduce variable selling expenses by 20%, (2) increase sales commissions by $1.50 per unit, (3) increase fixed selling expenses by $60,000 and (4) to get products to customers faster, shipping costs will increase to 30% of variable selling expense. The selling price will remain $47 per unit. Geddy is confident that these changes will increase sales by 21.5%. Discuss the effect Geddys plan would have on the net operating income, the breakeven point and the degree of operating leverage of Xanadu Corporation.

3. Under each scenario, what impact would a 30% decline in sales have on operating income?

4. Which option, if either, would you recommend to Xanadu Corporation? Provide a well thought out explanation for your selection.

Amount Per Unit Total Direct materials $ 8.00 Direct labor $10.00 Variable manufacturing overhead $ 2.50 Fixed manufacturing overhead $ 7.00 280,000 Fixed selling expense $ 2.50 100,000 Variable selling expense $ 3.50 Fixed administrative expense $ 2.00 80,000 Sales commissions $ 1.00 Variable administrative expense $ 2.00