A soft drink company has three bottling plants throughout the country. Bottling
ID: 2386246 • Letter: A
Question
A soft drink company has three bottling plants throughout the country. Bottling occurs at the regional level because of the high cost of transporting bottled soft drinks. The parent company supplies each plant with the syrup. The bottling plants combine the syrup with carbonated soda to make and bottle the soft drinks. The bottled soft drinks are then sent to regional grocery stores.The bottling plants are treated as costs centers. The managers of the bottling plants are evaluated based on minimizing the cost per soft drink bottled and delivered. Each bottling plant uses the same equipment, but some produce more bottles of soft drinks because of different demand. The costs and output for each bottling plant are: A B CUnits Produced 10,000,000 20,000,000 30,000,000Variable Costs $ 200,000 $ 450,000 $ 650,000Fixed Costs $1,000,000 $1,000,000 $1,000,000a. Estimate the average cost per unit for each plant.b. Why would the manager of plant A be unhappy with using the average cost as the performance measure?c. What is an alternative performance measure that would make the manager of plant A happier?d. Under what circumstances might the average cost be a better performance measure?Explanation / Answer
a) To compute the average cost, the total cost should be calculated.
Total cost for plant-A = Variable costs + Fixed costs
= $200,000 + $1,000,000
= $1,200,000
Average cost = $1,200,000 / 10,000,000 = $0.12
Total cost for plant-B = $450,000 + $1,000,000
= $1,450,000
Average cost = $1,450,000/20,000,000
= $0.0725
Total cost for plant-C = $650,000 + $1,000,000
= $1,650,000
Average cost = $1,650,000 / 30,000,000
= $0.055
b) The average cost for plabnt-A is more when compared with other two plants. The average cost is irrelevant when producing the extra units. As we know fixed cost does not change with the number of units produced. Since average cost is a function of fixed cost, so this is also an irrelevant cost.
c) The alternative measure for the average cost if the marginal cost which is defined as change in costs that occurs when there is a change in output. This can make the manager happy.
d) The advantage to average cost is that your reported income may fluctuate less year over year. Using average cost is advantageous to tax purposes which therefore decreases the income tax burden for the current year.
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