Question

The Infusion Pump Roll-Out
Jim Altschuler and Mary James were sitting in their conference room on a late Friday in January.
They had just received the latest cost projections from the project manager on the new infusion
pump system that had been in development for two years. Based on the latest design changes the
results were going to result in a major revision to the initial pricing forecasts. While early tests
with potential buyers showed great receptivity at an initial price of $5.00, the project manager
said the latest cost projects suggested that this retail process was no longer feasible, but needed
an initial price of at least $8.00. In fact, the design changes that had been required because of
recent regulatory changes had resulted in a new variable cost of closer to a $4.94 unit cost.

In order to produce this new pump, the project manager said that the company would have to buy
a mold that could stamp out a key component. The mold could produce 500,000 units. Jim and
Mary were a little taken aback at these new cost estimates and were concerned about whether
this jeopardized this roll-out. Several years ago, the company introduced a new device that
failed. The distributors who carried the item were not pleased and it took almost eighteen months
to restore their confidence in the company and get them to accept another new introduction.

“I'm not sure we should move forward with this roll-out,” Jim said hesitantly. “The whole design
is too novel. It requires clinicians to use it in a way that it totally different from the way they are
used to, we’ve talked about bundling the purchase in unit quantities of twenty-five, and now we
are talking about having to raise the price to $8.00.”

“Sorry, Jim,” said Mary, “We’ve worked together a long time, so you know I respect your
judgment, but not on this one. We have a good product here. I know the price has to rise, but I
almost wonder whether with our brand name we couldn’t even get customers to pay a premium
for this pump?” In fact, I think we should be buying two molds and ramp production to a million
units and spend at least $20,000 or $30,000 to advertise this pump alone. We know the market
for this is huge based on the research data we bought from that research firm. Let’s go for it.

“I don’t know Mary,” Jim responded, “It seems like in the past year the market has been flooded
with more and more low priced $3 and $4 pumps from Asia. How can you talk price premium?”
“There’s bottom feeders in every market Jim, we have to make a decision here.”

Molds = $120,000    $120,000    $240,000
Advert. = $20,000 $30,000 $20,000
Total = ? ? ?
Variable costs = ??????
Price = ??????
Breakeven = ?????????????????????

Answer 1

Molds and Advert. expense both are Fixed cost as they are not going to change with number of products being produced.
Total Fixed Cost= Molds + Advertisement budget Chosen

Option 1.Mold of $120,000 and Advert. of $20000 Total Fixed Cost=$140000
Option 2.Mold of $120,000 and Advert. of $30000 Total Fixed Cost=$150000
Option 3.Mold of $240,000 and Advert. of $20000 Total Fixed Cost=$260000
Variable Cost=$4.94
Price=$8
Margin=Price-Variable Cost= $8-$4.94= $3.06
Break Even: Total Fixed Cost/Per unit margin
Option 1:45752 Unit
Option 2:49020 Unit
Option 3:84967 Unit