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A firm plans to begin production of a new small appliance. The manager must decide whether to purchase the motors for the appliance from a vendor at $8 each or to produce them in-house. Either of two processes could be used for in-house production; Process A would have an annual fixed cost of $160,000 and a variable cost of $6 per unit, and Process B would have an annual fixed cost of $195,000 and a variable cost of $5 per unit. Determine the range of annual volume for which each of the alternatives would be best. (Round your first answer to the nearest whole number. Include the indifference value itself in this answer.) For annual volumes of or less, is best. For annual volumes above that amount, is best.

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Answer:

Process A: Annual fixed cost of $160,000 and a variable cost of $6 per unit  

Process B: Annual fixed cost of $195,000 and a variable cost of $5 per unit  

Let annual production be x

Process A: Total Cost = $160,000 + $6x

Process B: Total Cost = $195,000 + $5x

Motors from a vendor for $8 so total cost: 8x

For break-even Process A:  

$160,000+ $6x = 8x

x = $80,000.

If annual production x is more than 80,000 it is better to apt for Process A.  

For break-even Process B:  

$195,000+ 5x = 8x

x = $65,000

If annual production x is more than $65,000 it is better to apt for Process B.

Determine the range of annual volume for which each of the alternatives would be best :

Given data :

Process A:

Annual fixed cost of $160,000 and a variable cost of $6 per unit  

Process B:

Annual fixed cost of $195,000 and a variable cost of $5 per unit  

  • Let annual production be A.

Process A:

Total Cost = Fixed Cost +Variable Cost

Total Cost = $160,000 + $6A

Process B:

Total Cost = Fixed Cost +Variable Cost

Total Cost = $195,000 + $5A

The motors for the appliance from a vendor at $8 therefore the the Total cost will be  $ 8A.

For break-even Process A:  

  • $160,000+ $6x = 8A
  • A = $80,000.

 

For break-even Process B:  

  • $195,000+ 5x = 8A
  • A = $65,000

It is better to choose process A.

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