Question

A manufacturing company produces expensive toys. Each toy sells for $250 and costs $90. The company incurs a fixed cost of $7500 per day to lease their machines to manufacture the toys. Depending on the volume of production the company must also hire and schedule enough number of employees to carry out the production. The additional labor costs are $550, $1200 and $2650 per day, when the production volume is 0 to 35 units, 0 to 70 units, and 0 to 100 units per day, respectively. The company forecasts the daily expected demand for its toys to be 90 units.

a) (3 points) Compute the break-even point for each range of production volume separately.

b) (5 points) Which production volume range is the best for the company? Explain clearly why.

c) Suppose the company has a production capacity of 100 units per day. (Use this information independent of the production volumes mentioned above). What is the capacity cushion (in terms of no. of units) if the company produces only as much as the forecasted demand? What is the capacity cushion in terms of percentage unutilized production capacity if the company produces only as much as the forecasted demand? What is the resulting production capacity utilization?

Answer 1

a)

	Particulars	Amount
A	Sales (90 units)	22500
B	Cost	8100
C	Labour cost	2650
D	Total contribution	11750
E = (D/90)	Contribution per unit	130.6
F	Fixed Costs	7500
G (F/E)	Break even point	57

b)

	Particulars	35 units	70 units	100 units
A	Sales (90 units)	8750	17500	25000
B	Cost	3150	6300	9000
C	Labour cost	550	1200	2650
D	Total contribution	5050	10000	13350
F	Fixed Costs	7500	7500	7500
G (F/E)	Profit	-2450	2500	5850

As shown in the calculation, the profits would be highest in the product range o upto 100 units. Therefore the range of 70-100 units shall be chosen for production.

3. The capacity cushion is the spare capacity a business has out of its total capacity.

Therefore, capacity cushion = 100 units - 90 units = 10 units i.e 10%.

The production capacity utilisation is 90/100 = 90%.