Last year, a toy manufacturer introduced a new toy truck that was a huge success
ID: 1092483 • Letter: L
Question
Last year, a toy manufacturer introduced a new toy truck that was a huge success. The company invested $2.5 million for a plastic injection molding machine (which can be sold for $2.0 million) and $100,000 in plastic injection molds specifically for the toy (not valuable to anyone else). Labor and the cost of materials necessary to make each truck is about $3. This year, a competitor has developed a similar toy that has significantly reduced demand for the toy truck. Now, the original manufacturer is deciding whether they should continue production of the toy truck. a. If the estimated demand is 100,000 trucks, what is the break-even price for the toy truck? b. What is the specific rule (involves price) as to whether this manufacturer should shut down?
Explanation / Answer
The relevant costs are the 2,000,000 the equipment can be sold for (the rest are sunk costs that should not be considered). So to recover the 2,000,000 the company would have to make a margin of 2,000,000/100,000= 20, so they would have to sell the trucks for 20+3 (variable costs) = 23. So if they can get that price or better they should continue, if not they should shut down.
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