Question

The cost structure of two firms competing in the same industry is represented by the following cost formulas: Company X = $1,816,000 + $42/ unit; Company Z = $956,000 + $82/unit. The selling price is $133 per unit for both companies. Required: Calculate the indifference point between the two cost structures, that is, the amount of unit sales that produce the same operating income for Company X and Company Z. If sales volume were expected to increase by 25% over the next two years, which cost structure would you prefer?

Answer 1

Ans:

a)Indifference point Means the amount of unit sales that produce the same operating income for Two companies/Alternatives

Indifference point = Difference in fixed cost/Difference in variable cost per unit

= $1,816,000 - $956,000/$82-$42

=21,500 units

Indifference point Amount = 21,500 units*$133=$2,859,500

b)If sales volume were expected to increase by 25% over the next two years, The cost structure which gives more profit should prefer

Sales units= 21,500 units*125%=26,875 units

Profit = sales – Total cost

Company x =26,875 units*$133 - ($1,816,000 + $42*26,875 units)

         Profit=$629,625

Company Z =26,875 units*$133 - ($956,000 + $82*26,875 units)

         Profit=$414,625

So Company X cost Structure should Prefer