Evaluate the Machine Investment: Manual or Automated?

Cost Accounting

Skill: Evaluate

Stimulus

Question

(a) Calculate the break-even point (in units) for Option A and Option B.

(b) Based on the estimated sales of 3,500 units, evaluate which option Puan Halimah should choose. Support your decision with calculations of profit, margin of safety and the indifference point between the two options.

Thinking steps

1. Find the contribution margin per unit for each option: selling price minus variable cost per unit.
2. Compute each option's break-even point: fixed cost divided by contribution margin per unit.
3. Compute expected profit at 3,500 units: (contribution margin x 3,500) minus fixed cost.
4. Compute the margin of safety for each option: expected sales minus break-even point.
5. Find the indifference point by equating the total costs of both options to see at which sales level the better choice switches.
6. Weigh the higher profit against the risk (high fixed cost, low margin of safety), make a decision and justify it.

Model answer

(a) Contribution margin per unit: Option A = RM50 - RM30 = RM20; Option B = RM50 - RM18 = RM32.

BEP Option A = RM24,000 / RM20 = 1,200 units.

BEP Option B = RM60,000 / RM32 = 1,875 units.

(b) Profit at 3,500 units: Option A = (RM20 x 3,500) - RM24,000 = RM46,000; Option B = (RM32 x 3,500) - RM60,000 = RM52,000.

Margin of safety: Option A = 3,500 - 1,200 = 2,300 units (65.7%); Option B = 3,500 - 1,875 = 1,625 units (46.4%).

Indifference point: RM24,000 + RM30q = RM60,000 + RM18q, so RM12q = RM36,000, q = 3,000 units. At this level, both options give the same profit (RM36,000).

Decision: Because the estimated sales of 3,500 units exceed the indifference point of 3,000 units, Option B (machine) should be chosen as it gives RM6,000 more profit (RM52,000 versus RM46,000). However, Option B has a higher fixed cost and a lower margin of safety (46.4% versus 65.7%), so it is riskier if actual sales fall below 3,000 units. Justification: choose Option B if Puan Halimah is confident sales will stay above 3,000 units; but if demand is unstable, Option A is safer because its larger margin of safety means smaller losses when sales decline.