Question

Wisconsin Snowmobile Corp. is considering a switch to level production. Cost efficiencies would occur under level production, and aftertax costs would decline by $27,300, but inventory would increase by $390,000. Wisconsin Snowmobile would have to finance the extra inventory at a cost of 8.5 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

Part a-1:
Assuming that the financing cost is an amount after tax calculations, the expense of the company=Increase in inventory*Cost of extra inventory
=$390,000*8.5%
=$33150
Extra cost or savings=Decline in after tax cost-Financing cost for the extra inventory that we calculated above
Given that, the decline in after tax cost is $27,300.
Extra cost or savings=$27,300-$33150=-$5850

Part a-2:
No, because the cost is greater than saving (and that is why extra cost or savings is showing as negative).

Part b:
Interest rate should fall to a level at which:
Increase in inventory*Interest rate=Decline in after tax cost
$390,000*Interest rate=$27,300
=>Interest rate=$27,300/$390,000=0.07 or 7%
Interest rate needs to be less than or equal to 7% for the level of production to be feasible.