A firm plans to begin production of a new small appliance. The manager must deci

Question

A firm plans to begin production of a new small appliance. The manager must decide whether to purchase the motors for the appliance from a vendor at $9 each or to produce them in-house. Either of two processes could be used for in-house production; Process A would have an annual fixed cost of $170,000 and a variable cost of $5 per unit, and Process B would have an annual fixed cost of $190,000 and a variable cost of $4 per unit. Determine the range of annual volume for which each of the alternatives would be best.

Explanation / Answer

Let annual volume=x

Process A

Total Cost=Fixed +variable=170000+5*x

Cost per unit=Total cost/x=170000/x+5

For in-house production to be cost effective than purchasing

Cost per unit<9

170000/x+5<9

170000/x<4

x>170000/4

x>42500 unit

Thus the range of annual volume for Process A to be best is more than 42500 unit

Process B

Total Cost=Fixed +variable=190000+4*x

Cost per unit=Total cost/x=190000/x+4

For in-house production to be cost effective than purchasing

Cost per unit<9

190000/x+4<9

190000/x<5

x>190000/5

x>38000 unit

Thus the range of annual volume for Process B to be best is more than 38000 unit

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