Preston Company Is Analyzing Two Alternative Methods of Producing Its

Essay

Preston Company is analyzing two alternative methods of producing its product. The production manager indicates that variable costs can be reduced 40% by installing a machine that automates production, but fixed costs would increase. Alternative 1 shows costs before installing the machine; Alternative 2 shows costs after the machine is installed. (a) Compute the break-even point in units and dollars for both alternatives. (b) Prepare a forecasted income statement for both alternatives assuming that 30,000 units will be sold. The statements should report sales, total variable costs, contribution margin, fixed costs, income before taxes, income taxes, and net income. Below the income statement, compute the degree of operating leverage. Which alternative would you recommend and why?
$$\begin{array} { l | l | l } & \text { Alternative } \quad 1 & \text { Alternative 2 } \\\hline \text { Variable costs per unit } & \$ 20 & ? \\\hline \text { Fired costs } & \$ 200,000 & \$ 274,400 \\\hline \text { Selling price per unit } & \$ 40 & \$ 40 \\\hline \text { Income tax rate } & 25 \% & 25 \%\end{array}$$