Question

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 $175,000 and a variable cost of $7 per unit, and Process B would have an annual fixed cost of $195,000 and a variable cost of $6 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. Enter your last answer as a whole number).

     

For annual volumes of   or less, (Click to select)production in house at $4 per unitpurchase from the vendorproduction in house at $5 per unit  is best. For annual volumes at or above that amount, it is best to produce in house at a cost of $  per unit.

Answer 1

we are given the following information Process A ProcessB FC 175000 195000 VC per unit Total cost( TC) equation can be written in the following form: Here FC is total fixed cost, VC is variable cost per unit and Q is annual volume otal cost function for proces TC(A-175000+ 7Q otal cost function for proces TC(B) = 195000 + 6 Q We need to equate the two equations to get the annual volume where both the process will result in same total cost: 175000 + 7Q=195000 + 6 Q 7Q-6Q = 195000-175000 Q= 20,000 20,000 units is the indifference level of production. As process A has lower fixed cost, it is better process if the production volume is lower than 20,000 units. For more than 20,000 units process B is better Purchase from vendor option is better if the production volume is less than 195000/8-6) 97500 units.