An electronics firm is currently manufacturing an item that has a variable cost of $0.50 per unit and a selling price of $1.00 per unit. Fixed costs are$14,000 per month. Current volume is 30,000 units per month. The firm wants to improve the product quality by adding a new piece of equipment at an additional fixed cost of $6,000 a month. Variable cost would increase to $0.60 a unit but volume should jump to 50,000 units a month due to improved productivity. Although the new product is of a higher quality, the firm intends to stay with the selling price of $1.00 per unit (for competitive purposes). (a) Should the firm buy the new equipment?(b) The firm is now considering stepping the new volume to 45,000 units a month to produce even better quality products and increase the selling price to $1.10 a unit. Under these circumstances, should the company buy the new equipment and increase the selling price?

The Firm Should not Buy the New Equipment since there is No Profit ( instead $1000 Profit lost) from this decision and is in a worse off position than before.

Part (b) should the company buy the new equipment and increase the selling price?

The Firm Should Buy the New Equipment since an incremental Profit of $ 1500 is expected from this decision.

Explanation:

Part (a) Should the firm buy the new equipment

Do Not Buy Buy New Equipment

$ $

Sales 30,000 50,000

Less Variable Cost 15,000 30,000

Contribution 15,000 20,000

Less Fixed Costs 14,000 20,000

Net Income 1,000 0

The Firm Should not Buy the New Equipment since there is No Profit ( instead $1000 Profit lost) from this decision and is in a worse off position than before.

Part (b) should the company buy the new equipment and increase the selling price?

Do Not Buy Buy New Equipment

$ $

Sales 30,000 49,500

Less Variable Cost 15,000 27,000

Contribution 15,000 22,500

Less Fixed Costs 14,000 20,000

Net Income 1,000 2,500

The Firm Should Buy the New Equipment since an incremental Profit of $ 1500 is expected from this decision.

anthougo anthougo · Answer 2 · 2022-01-27T15:30:07+01:00

a) Based on 50,000 units, the firm will be making a profit of $0 ($50,000 - $30,000 - $20,000) instead of $1,000 with the previous arrangement, and should not buy the new equipment.

b) Based on 45,000 units and a selling price of $1.10, the firm will be making a profit of $2,500 ($49,500 - $27,000 - $20,000) instead of $1,000 with the previous arrangement, and should buy the new equipment.

Data and Calculations:

Variable cost = $0.50

Selling price per unit = $1.00

Contribution margin per unit = $0.50 ($1.00 - $0.50)

Fixed costs per month = $14,000

Current volume per month = 30,000 units

Sales revenue = $30,000 ($1.00 x 30,000)

Total variable cost = $15,000 ($0.50 x 30,000)

Net income = $1,000 ($30,000 - $15,000 - $14,000)

Buying Equipment with Increased Volume of 50,000 units:

Additional fixed cost per month = $6,000

Total fixed cost per month based on improvement = $20,000 ($6,000 + $14,000)

New variable cost = $0.60

New volume per month = 50,000 units

Selling price = $1.00

New Contribution margin per unit =$0.40 ($1.00 - $0.60)

Sales revenue = $50,000 ($1.00 x 50,000)

Total variable cost = $30,000 ($0.60 x 50,000)

Net income = $0 ($50,000 - $30,000 - $20,000)

Buying Equipment with Increased Volume of 45,000 units:

Additional fixed cost per month = $6,000

Total fixed cost per month based on improvement = $20,000 ($6,000 + $14,000)

New variable cost = $0.60

New volume per month = 45,000 units

Selling price = $1.10

New Contribution margin per unit =$0.50 ($1.10 - $0.60)

Sales revenue = $49,500 ($1.10 x 45,000)

Total variable cost = $27,000 ($0.60 x 45,000)

Net income = $2,500 ($49,500 - $27,000 - $20,000)

Thus, under these circumstances, the company should only buy the new equipment if it will increase the selling price.

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