Management believes it can sell a new product for $250. The fixed costs of production are estimated to be $50,000 and the variable costs are $215 a unit for the first scale of operations. The fixed costs of production are estimated to be at $150,000 and variable costs are $170 a unit for the second scale of operations.
a. Prepare a table similar to the one below and complete with the given levels of output and the relationships between quantity and fixed cost, quantity and variable costs, and quantity and total costs.
First Scale of operations
|
Quantity |
Total Revenue |
Variable Costs |
Fixed Costs |
Total Costs |
Profits |
|
0 |
|||||
|
500 |
|||||
|
1,000 |
|||||
|
1,500 |
|||||
|
2,000 |
|||||
|
2,500 |
|||||
|
3,000 |
Second scale of operations
|
Quantity |
Total Revenue |
Variable Costs |
Fixed Costs |
Total Costs |
Profits |
|
0 |
|||||
|
500 |
|||||
|
1,000 |
|||||
|
1,500 |
|||||
|
2,000 |
|||||
|
2,500 |
|||||
|
3,000 |
b. What is the exact break-even number of units sold for each scale of operations?
c. Assume that ½ of the fixed costs in each scale of operations is non-cash depreciation. What is the cash flow generated by each scale of operations if 1,000 of units are sold?
d. You have been asked to advise the management of this company on which scale of production to use. Let us assume that the management is uncertain on how many units they can sell, but estimate it will be between 500 and 3,000 units during the first year and progressively more after that. Please advise management what you learned from the breakeven analysis and the tables that you devised that should help them make up their minds. Give them pros and cons for both alternatives.
First scale of operation
TC = $20,000 + $10.00Q
Second scale of operation
TC = $40,000 + $5.00Q
Following are the anticipated levels of sales:
|
Year |
Unit Sales |
|
1 |
3,000 |
|
2 |
3,500 |
|
3 |
4,000 |
|
4 |
5,000 |
What can management expect for profits or losses in years 1 and 2 if it selects the scale of operations with lower fixed costs? On what grounds can management justify selecting this scale of operation? If sales reach 5,000 a year, which is the correct scale of operation?
|
Year |
A |
B |
C |
|
1 |
$10,000 |
$25,000 |
$12,500 |
|
2 |
$10,000 |
$10,000 |
$8,500 |
|
3 |
$10,000 |
$4,000 |
$6,000 |
|
4 |
$10,000 |
$500 |
$8,000 |
|
5 |
$10,000 |
0 |
$5,000 |
Rank the investments based on payback period. Would you rank them as investments in that order? Why or why not? See the table above for the cash flows of each.
TR = $3Q
TC = $1,500 + $2Q
a. What is the break even level of output?
b. If the firm sells 1,300 units, what are the firm’s earnings or losses?
c. If sales rise to 2,000 units, what are the firms earnings or losses?
d. What happens to the breakeven level of output units if the total cost equation were: TC = $2,000 + $1.80Q
This is not an Excel homework assignment. This is to be saved as a Microsoft Word document.
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