(12 points) Fashions, Inc. is a retail store that sells sweaters and jackets. In

Question

(12 points) Fashions, Inc. is a retail store that sells sweaters and jackets. In the past, it has bought all its sweaters from a supplier. However, Fashions has the opportunity to acquire a small manufacturing facility where it could produce its own sweaters. The projected data for each of the two options are as follows: Continue Buying $30.00 $20.00 Selling price per unit Variable cost per unit Total fixed costs (per Produce Themselves $30.00 $15.00 $150,000 $0 month) a. To earn an operating profit of $125,000 per month, how many sweaters would Fashions have to sell if it buys the sweaters from the supplier? b. To earn an operating profit of $125,000 per month, how many sweaters would Fashions have to sell if it produces its own sweaters? c. At what sales volume is Fashions, Inc. indifferent regarding which option they choose? d. Beyond the simple fact that they expect to make more money, describe why Fashions Inc. prefers to continue buying sweaters from a supplier (produce the sweaters themselves) at expected volumes lower (higher) than the one calculated in c.

Explanation / Answer

Solution:

Part a –

Number of Sweaters would need to be sell to make profit $125,000, if buys from the supplier = (Total Fixed Cost + Desired Profit) / Contribution Margin per unit

= (0 + 125,000) / 10

= 12500 Sweaters

Part b –

Number of Sweaters would need to be sell to make profit $125,000, if produces its own = (Total Fixed Cost + Desired Profit) / Contribution Margin per unit

= (150,000 + 125,000) / 15

= 18,333 Sweaters

Part c –

Indifferent sales volume means the volume under which both the options can be worked out. In other words, the volume sales at which between two alternatives there will be no profit no gain in selection of any one from them.

Let Indifferent Volume Sales = X

Total Cost under option Continue buying = Total Cost under option Produce own

Total Cost = Variable Cost + Fixed Cost

Total Cost Under Continue buying (X*20 Variable Cost per unit + Fixed Cost 0) = Total Cost under own production (Variable Cost 15*X + 150,000)

20X = 15X + 150,000

5X = 150,000

X = 150,000 / 5

X = 30,000 Sweaters

Indifferent Volume Sales under is 30,000 Sweaters

Part d –

In buying sweaters the company does not have any fixed cost which under produce own option have and it needs to recover the fixed cost first by the company to make any profit.

The first priority of the company in a production of product is to recover the fixed cost.

SO under buying option, there will be no fixed cost.

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