Question

The Metal Shop produces 1.7 million metal fasteners a year for industrial use. At this level of production, its total fixed costs are $486,000 and its total costs are $791,000. The firm can increase its production by 5 percent, without increasing either its total fixed costs or its variable costs per unit. A customer has made a one-time offer for an additional 50,000 units at a price per unit of $.165. Should the firm sell the additional units at the offered price? Why or why not?

Answer 1

Answer: The offer should be rejected.

Explanation:

Given the following :

Total units produced = 1,700,000 units

Total cost = $791,000

Total fixed cost = $486,000

5% increase in production = (0.05 × 1,700,000) = 85,000

Units required by customer = 50,000 ( it is still within range without incurring additional fixed and variable cost).

Hence, total variable cost :

Total cost - total fixed cost

$(791,000 - 486,000) = $305,000

Variable cost per unit :

Total variable cost / total units produced

$305,000 / 1,700,000

= $0.179

Variable cost = marginal cost (Since variable cost per unit will be unchanged).

Offered price = $0.165

$0.165 < $0.179

Since offered price < marginal cost ; The offer should be rejected.