Question

Wisconsin Snowmobile Corp. is considering a switch to level production. Cost efficiencies would occur under level production, and aftertax costs would decline by $47,300, but inventory would increase by $430,000. Wisconsin Snowmobile would have to finance the extra inventory at a cost of 12.5 percent.

a-1. Determine the extra cost or savings of switching over to level production.

a-2. Should the company go ahead and switch to level production? Yes No

b. How low would interest rates need to fall before level production would be feasible? (Input your answer as a percent rounded to the nearest whole number.)

Answer 1

a-1) Calculation of extra or saving of switching over to level production:

Increase cost = Inventory increase × interest expense

= $430,000 × 12.5%

= $53,750

Loss = Increase -Savings

= $53,750 - $47,300

= $6,450

Therefore the extra cost is $6,450

a-2) No, don't go ahead to level production,increased ROI is less than the interest cost of more inventories

b) Calculation of interest rate need to follow before level production:

Interest rate = Savings / Increased inventory

= $47,300 / $430,000

= 0.11 or 11%

Therefore the interest rate before level production is 11%