Break-even point in annual unit sale
The break-even analysis gives the number of units of output that must be produced and sold that will ensure that the total cost incurred equals the total revenue earned. Therefore, it will give the minimum number of units of goods that need to be produced and sold to enable the business to pay the total cost of production (DuBrin, 2008). Thus, at break-even point;
Total revenue (P * Q) = total cost [Variable (VC * Q) + fixed cost]
Capital-intensive manufacturing method
Substitute the values in the equation above
$30 * Q = $14 * Q + $2,508,000 + $502,000 + $2Q
30Q = 14Q + $3,010,000 + 2Q
30Q – 16Q = 3,010,000
14Q = 3,010,000
Q = 215,000
The break-even number of units under the capital-intensive method is 215,000 units.
Labor-intensive manufacturing method
Substitute the values in the equation above
$30 * Q = $18 * Q + $1,538,000 + $502,000 + $2Q
30Q = 18Q + $2,040,000 + 2Q
30Q – 10Q = 2,040,000
10Q = 2,040,000
Q = 204,000
The break-even number of units under the labor-intensive method is 204,000 units.
The unit of sales volume at which the company will be indifferent
The management of Martinez will be indifferent between the two production techniques at the point where they generate the same amount of profit. This will be the sales volume at which the profit is zero (DuBrin, 2008).
Capital-intensive manufacturing method
Break-even sales = Break-even unit * price
= 215,000 * 30
= $6,450,000
Labor-intensive manufacturing method
Break-even sales = Break-even unit * price
= 204,000 * 30
= $6,120,000
Thus, based on the calculations, the management of Martinez will be indifferent between the two methods when the annual unit sales volume is $6,450,000 for the capital-intensive method and $6,120,000 for the labor-intensive method. Further, it can be observed that the labor-intensive method requires lower units of annual sales and lower sales volume to break-even. Therefore, it may be preferred to the capital-intensive method (DuBrin, 2008).
Circumstances under which the company should employ each of the two methods
The capital-intensive manufacturing method entails the use of machinery and equipment in the production process. Therefore, this manufacturing method requires a hefty investment in capital items and not the labor force. Under the capital-intensive method, the production process is likely to be automated with a systematic flow of the manufacturing process. Also, under this manufacturing method, the overhead of the company is made up of the cost of maintaining the equipment and machinery. The cost used in the acquisition of capital items is recovered by maximizing efficiency. Therefore, it can be noted that a capital-intensive manufacturing process can be difficult to expand the scale of operation.
Despite the cost involved in setting up a capital-intensive process, there are several circumstances under which the capital-intensive process can be used (Shapiro, 2005). First, a firm operating in an industry in which technology changes quickly may need to use a capital-intensive manufacturing process because the entire system can be adjusted to suit the changes in technology. Thus, they are relatively flexible as compared to labor-intensive processes. Secondly, firms that are in the early stages of operation may need to use a capital-intensive approach to enable them to increase output and grow faster than when the labor-intensive method is used. Thus, a company can use capital-intensive methods to enable it to speed up the process of growth (Shapiro, 2005).
On the other hand, the labor-intensive manufacturing process requires the use of more labor than capital items in the production process. The process is suitable for small scale production. Besides, the method results in the production of personalized products (Shapiro, 2005). The use of the labor-intensive process results in increased labor-related costs such as wages and other costs that relate to labor such as staff training and incentives. A company can be flexible when it uses labor because it can employ additional temporary employees or it can negotiate with current employees to work overtime. Several circumstances necessitate companies to use a labor-intensive method in the manufacturing process.
First, a company may want to use the method to lower production costs. This can be attributed to the fact that labor is readily available in most economies and it is cheap (Shapiro, 2005). Thus, it can be argued that the use of labor results in lower production costs and overheads. Secondly, firms may be advised to use a labor-intensive method to reduce the levels of unemployment. This in turn leads to efficient use of human capital in a country (Shapiro, 2005). An increase in employment rate results in an increase in disposable income in a country and consumption expenditure. These changes result in economic growth. Further, companies may use labor-intensive methods to reduce rural-urban migration. It can be argued that companies will set up production plants in rural areas that have cheap labor (Shapiro, 2005). This reduces migration to urban centers. Thus, the labor-intensive manufacturing process contributes to regional economic growth in a country.
References
DuBrin, A. (2008). Essentials of management. Alabama, USA: Cengage Learning.
Shapiro, A. (2005). Capital budgeting and investment analysis. India: Pearson Education India.