Question

All Things Tennis (ATT), a French company, manufactures a variety of tennis gear, such as racket covers, tennis bags, and embroidered towels. ATT sells all its products exclusively in Europe through independent distributors. ATT’s most popular line is a series of racket covers with various animal pictures on the cover.

ATT is currently making 500 animal racket covers a week at an average per unit cost of 3.50 €, which includes both variable costs and allocated fixed costs. The variable cost of each racket cover is 1.10 €. ATT sells the racket covers to distributors for 4.25 €. A distributor in Canada Toronto Sports, wants to purchase 100 racket covers per week from ATT and sell them in Canada. Toronto offers to pay ATT 2 € per racket cover. ATT has enough capacity to produce the additional 100 racket covers and estimates that if it accepts Toronto’s offer, the per unit cost of all 600 racket covers will be 3.10 €. Assume the cost data provided (3.50 € and 3.10 €) are accurate estimates of ATT’s costs of producing the racket covers. Further assume that ATT’s variable cost per racket cover does not vary with the number of racket covers manufactured.

Required:

a. Given the data in the problem, what is ATT’s weekly fixed cost of producing the animal racket covers?
b. To maximize firm value should ATT accept Toronto’s offer? Explain why or why not.
c. Besides the data provided in the problem, what other factors should ATT consider before making a decision to accept Toronto’s offer?

Answer 1

(a) ATT's weekly fixed cost of producing the animal racket covers
If 500 animal racket covers are made
Average Cost Per Unit	€        3.50
Variable Cost Per Unit	€        1.10
Fixed Cost Per Unit	€        2.40
Weekly Fixed Cost = 2.4 € x 500 = 1200 €
If 600 animal racket covers are made
Avergae Cost Per Unit	€        3.10
Variable Cost Per Unit	€        1.10
Fixed Cost Per Unit	€        2.00
Weekly Fixed Cost = 2 € x 600 = 1200 €
Thus, there is no increase in fixed cost due to additional units.
The Weekly Fixed Cost of ATT's for producing the animal racket covers is 1200 €
(b) Should ATT accept Toronto's Offer
Since, as we have seen above there is no additional fixed cost for producing 100 units and there is enough capacity to produce the additional units, ATT should accept the Toronto's offer. Sales price is more than the Variable cost.
Sales price per unit	€        2.00
Variable Cost Per Unit	€        1.10
Contribution per unit	€        0.90
Additional Net Income = 0.9 € x 100 = 90 €