Question

An electronics manufacturing firm is currently manufacturing resistors that have a variable cost of $0.50 per unit and a selling price of $1.00 per unit. Fixed costs are $100,000. Current volume is 300,000 units. The firm can substantially improve the product quality by adding a new piece of equipment at an additional fixed cost of $60,000. Variable cost would increase to $0.60, but volume should jump to 500,000 units due to the higher-quality product.

1. Should the firm buy the new equipment?
2. What is the minimum price the company would have to charge in order for the new equipment to be worth purchasing (assuming the higher or lower price doesn’t affect the 500,000 unit volume)?

Answer 1

Part 1

Profit With Old Machinery: Sales = 300000 units, Selling prie=1, VC=0.50, FC= 100000

Profit = Sales - Variable cost - Fixed cost

Profit= (300000 x 1) - (300000 x 0.50) - 100000

Profit = 50000

Profit With Old Machinery: Sales = 300000 units, Selling prie=1, VC=0.60, FC= 160000

Profit = (500000 x 1) - ( 500000 x 0.60) - 160000

Profit = 40000

Decision: Don't buy the machine as your profit reduced by 10000.

Part 2

Minimum Price Company Should Charge =

=

= 0.42 +0.60 = 1.02

= 1.02 per selling price should be charged.