Question

Q2. Because hula hoops have come back in style, Hoops Unlimited wants to enter the market quickly. It has three choices: (a) refurbish the old equipment at a cost of $600, (b) make major modifications at the cost of $1100, or (c) purchase new equipment at a net cost of $1800. If the firm chooses to refurbish the equipment, materials and labour would be $1.10 per hoop. If it chooses to make modifications, materials and labour would be $0.70 per hoop. If it buys new equipment, variable costs are estimated to be $0.40 per hoop.

5) Construct a graph with the total cost functions of those three choices.

6) Which alternative should Hoops Unlimited choose if it thinks it could sell more than 3000 hula hoops? Option #1: Refurbish the old equipment at a cost of $600 Option #2: Make major modifications at the cost of $1100 Option #3: Purchase new equipment at a net cost of $1800 Option #1 or 2. Answer: __________

Answer 1

Summary

Option	Fixed Cost	Variable Cost	Total Cost for 3000 units
a	600	1.1	3900
b	1100	0.7	3200
c	1800	0.4	3000

Explanation:

Total cost = Variable Cost * Units + Fixed Cost

Total cost is calculated for quantities from 0 to 7000 at a 500 units interval and then the graph is plotted taking units on x axis (horizontal) and total cost on y axis (vertical)

Units	Total Cost a	Total Cost b	Total Cost c
0	600	1100	1800
500	1150	1450	2000
1000	1700	1800	2200
1500	2250	2150	2400
2000	2800	2500	2600
2500	3350	2850	2800
3000	3900	3200	3000
3500	4450	3550	3200
4000	5000	3900	3400
4500	5550	4250	3600
5000	6100	4600	3800
5500	6650	4950	4000
6000	7200	5300	4200
6500	7750	5650	4400
7000	8300	6000	4600

5. Graph:

6. Alternative c should be chosen if Hoops Unlimited thinks it can sell more than 3000 hula hoops.

The total cost of hula hoops for 3000 units for each option:

a. 1.1*3000 + 600 = 3900

b. 0.7*3000 + 1100 = 3200

c. 0.4*3000+1800 = 3000

Option 3 has lowest cost, hence it should be chosen

Also from the graph, the total cost for option c is the green line which is the bottom-most line after a unit of approx 2400. This means for a quantity of 2400 or more, option c has the lowest cost. Hence for sale qty of 3000 or more the cost-effective option is Option C.