Question 4 (Total 16 marks)

Canton Corporation is considering introducing a new product Model X with a recommended unit selling price of $65 with a target profit of $100,000. The product can be manufactured using either Option A or Option B. The manufacturing method will not affect the quality or sales of the product. The estimated manufacturing costs of the two methods are as follows:

Model X	Option A	Option B
Variable manufacturing cost	$11.00 per unit	$24 per unit
Variable selling and administrative expenses	$2.00 per unit	$2.00 per unit
Fixed manufacturing cost	$1,999,200 per year	$1,349,980 per year
Fixed selling and administrative expenses	$1,000,000 per year	$1,000,000 per year

Required:

a. Calculate the target profit in units if Canton Corporation uses the:

(i) (2 marks) Option A method.

(ii) (2 marks) Option B method.

b. (2 marks) Determine the sales volume (in units of product) at which the net income is the same for the two manufacturing methods.

c. Assuming the expected sales of 100,000 units,

(i) (2 marks) What is the degree of operating leverage for the two methods?

(ii) (2 marks) Based on your answers to part c(i), predict the net income under each of the two production methods if sales increase to 120,000 units.

d. Assuming the expected sales are still 100,000 units,

(i) (2 marks) What is the margin of safety in dollars for the two methods?

(ii) (2 marks) What is the purpose of calculating the margin of safety?

e. (2 marks) What is your recommendation to the management concerning which manufacturing method should be used? Explain.