The Generic Publications Textbook Company sells all of its books for $100 per bo
ID: 2711904 • Letter: T
Question
The Generic Publications Textbook Company sells all of its books for $100 per book, and it currently costs $50 in variable costs to produce each text. The fixed costs, which include depreciation and amortization for the firm, are currently $2 million per year. Management is considering changing the firm’s production technology, which will increase the fixed costs for the firm by 36 percent but decrease the variable costs per unit by 36 percent. If management expects to sell 45,000 books next year, should they switch technologies?
Explanation / Answer
With Existing technology
Expenses; variable cost = 45,000*50=2,250,000
fixed cost =$2,000,000
Sales =$100*45,000=4,500,000
EBIT=4,500,000-$2,000,000-2,250,000=$250,000
By introducing new technoligy the firm would be able to lower its variable cost component but since introducing new technology also means buying new machinery, it would raise the fixed cost component.
Variable costs after introduction of new technology = $50(1-36/100)*45000=$1440000
Fixed costs after introduction of new technology = $2,000,000(1+36/100)=$2,720,000
Total sales after introduction of new technology = $45,000*100=$4,500,000
EBIT includes raw profit without any tax or interest expenses = 4,500,000-2,720,000-$1,440000=$340000
the EBIT increases in the second case hence adopt new technology
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