Northern Woods is considering two methods of production for a new product.The first method will require fixed assets costing $450,000 that will be depreciated straight-line to zero over the product's 3-year life.Annual fixed costs are $316,000 and variable costs per unit are $8.64.The second method will require fixed assets costing $790,000,annual fixed costs of $211,000,and variable costs per unit of $6.57.The firm expects to sell 46,000 units per year at $20 a unit.The discount rate is 16 percent and the tax rate is 21 percent.Should the product be produced and if so,which method of production should be implemented and why?
A)Yes; Method A; because A has the lower initial cost
B)Yes; Method A; because it will break-even on a financial basis with fewer annual sales
C)Yes; Method B; because it has lower annual costs
D)Yes; Method B; because B has a financial break-even quantity that is less than the expected sales units
E)No; Neither method of production will financially break-even within the expected life of the project.

Question

Quizplus · Accepted Answer

To determine which method of production to use we can calculate the financial break-even quantity for each one. Financial break-even is the quantity of sales at which the project will generate just enough income to cover all costs, both fixed and variable, and result in zero profit. 
For Method A, the financial break-even quantity is calculated as follows:

Total Fixed Costs / (Price - Variable Cost per Unit) 
= $316,000 / ($20 - $8.64) 
= 32,621 units

For Method B, the financial break-even quantity is:

Total Fixed Costs / (Price - Variable Cost per Unit) 
= $211,000 / ($20 - $6.57) 
= 22,581 units

Since the expected sales are 46,000 units per year, it is clear that Method B will generate a profit while Method A will result in a loss. Therefore, the best choice is to produce the new product using Method B.

Northern Woods Is Considering Two Methods of Production for a New