Question

An electronics firm is currently manufacturing an item that has a variable cost of $0.50 per unit and a selling price of $1.00 per unit. Fixed costs are$14,000 per month. Current volume is 30,000 units per month. The firm wants to improve the product quality by adding a new piece of equipment at an additional fixed cost of $6,000 a month. Variable cost would increase to $0.60 a unit but volume should jump to 50,000 units a month due to improved productivity. Although the new product is of a higher quality, the firm intends to stay with the selling price of $1.00 per unit (for competitive purposes). (a) Should the firm buy the new equipment?(b) The firm is now considering stepping the new volume to 45,000 units a month to produce even better quality products and increase the selling price to $1.10 a unit. Under these circumstances, should the company buy the new equipment and increase the selling price?

Answer 1

Answer:

Part (a) Should the firm buy the new equipment

The Firm Should not Buy the New Equipment since there is  No Profit ( instead $1000 Profit lost) from this decision and is in a worse off position than before.

Part (b) should the company buy the new equipment and increase the selling price?

The Firm Should Buy the New Equipment since an incremental Profit of $ 1500 is expected from this decision.

Explanation:

Part (a) Should the firm buy the new equipment

                                                 Do Not Buy      Buy New Equipment

                                                        $                                $

Sales                                             30,000                     50,000

Less Variable Cost                       15,000                      30,000

Contribution                                  15,000                      20,000

Less Fixed Costs                          14,000                      20,000

Net Income                                     1,000                           0

The Firm Should not Buy the New Equipment since there is  No Profit ( instead $1000 Profit lost) from this decision and is in a worse off position than before.

Part (b) should the company buy the new equipment and increase the selling price?

                                                 Do Not Buy      Buy New Equipment

                                                        $                                $

Sales                                             30,000                     49,500

Less Variable Cost                       15,000                      27,000

Contribution                                  15,000                     22,500

Less Fixed Costs                          14,000                      20,000

Net Income                                     1,000                        2,500

The Firm Should Buy the New Equipment since an incremental Profit of $ 1500 is expected from this decision.