A company that produces pleasure boats has decided to expand one of its lines. C

Question

A company that produces pleasure boats has decided to expand one of its lines. Current facilities are insufficient to handle the increased workload, so the company is considering three alternatives, A (new location), B (subcontract), and C (expand existing facilities). Alternative A would involve substantial fixed costs but relatively low variable costs: fixed costs would be $290,000 per year, and variable costs would be $900 per boat. Subcontracting would involve a cost per boat of $2,400, and expansion would require an annual fixed cost of $66,000 and a variable cost of $1,700 per boat. Expansion would result in an increase of $86,000 per year in transportation costs, subcontracting would result in an increase of $28,000 per year, and adding a new location would result in an increase of $4,800 per year. Which alternative would yield the lowest total cost for an expected annual volume of 149 boats?

Explanation / Answer

For an expected annual volume of 149 boats,

Total cost of alternative A (new location) = Fixed cost + Increase in transportation cost + Annual volume * Variable cost per boat = 290000 + 4800 + 149*900 = $ 428,900

Total cost of alternative B (subcontract) = Fixed cost + Increase in transportation cost + Annual volume * Variable cost per boat = 0 + 28000 + 149*2400 = $ 385,600

Total cost of alternative C (expand) = Fixed cost + Increase in transportation cost + Annual volume * Variable cost per boat = 66000 + 86000 + 149*1700 = $ 405,300

Alternative B (subcontract) yields the lowest total cost for an expected annual volume of 149 boats. The total cost is $ 385,600

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