Senate Inc.is considering two alternative methods for producing playing cards.Method 1 involves using a machine with a fixed cost (mainly depreciation)of $12,500 and variable costs of $1.00 per deck of cards.Method 2 would use a less expensive machine with a fixed cost of only $5,000,but it would require a variable cost of $1.50 per deck.The sales price per deck would be the same under each method.At what unit output level would the two methods provide the same operating income (EBIT)?
A) 17,100
B) 15,300
C) 15,000
D) 12,750
E) 13,500

Question

Quizplus · Accepted Answer

To find the unit output level where the two methods provide the same operating income, we need to set up an equation where the operating incomes of the two methods are equal.

Let x be the number of decks produced. Then the operating income (EBIT) for Method 1 would be:

EBIT1 = Sales Price - Variable Costs - Fixed Costs
EBIT1 = x(P) - x($1.00) - $12,500

And the operating income (EBIT) for Method 2 would be:

EBIT2 = Sales Price - Variable Costs - Fixed Costs
EBIT2 = x(P) - x($1.50) - $5,000

Where P is the sales price per deck.

We want to find the level of x where EBIT1 = EBIT2. So we set up the equation:

x(P) - x($1.00) - $12,500 = x(P) - x($1.50) - $5,000

Simplifying and solving for x, we get:

x = ($7,500) / ($0.50)
x = 15,000

Therefore, at a unit output level of 15,000 decks, the two methods would provide the same operating income.

The best choice(s) would be to choose Method 2 only if the company expects to produce less than 15,000 decks. If the company expects to produce more than 15,000 decks, then Method 1 would be the better choice as it has lower variable costs per deck.