Starfax, Inc., manufactures a small part that is widely used in various electronic products such as home computers. Operating results for the first three years of activity were as follows (absorption costing basis): Year 2 Year 3 Year 1 710,000 240,000 Sales Cost of goods sold $950,000 760,000 $ 950,000 496,000 755,000 Gross margin Selling and administrative expenses 264,000 195,000 180,000 210,000 210,000 Net operating income (loss) $ 30,000 84,000 (15,000) In the latter part of Year 2, a competitor went out of business and in the process dumped a large number of units on the market. As a result, Starfax's sales dropped by 20% during Year 2 even though production increased during the year. Management had expected sales to remain constant at 50,000 units; the increased production was designed to provide the company with a buffer of protection against unexpected spurts in demand. By the start of Year 3, management could see that inventory was excessive and that spurts in demand were unlikely. To reduce the excessive inventories, Starfax cut back production during Year 3, as shown below Year 2 60,000 50,000 40,000 50,000 Year 1 Year 3 40,000 Production in units Sales in units 50,000 Additional information about the company follows