DIM
Diagnostic Imaging & Medical (DIM) has introduced a revolutionary new magnetic resonance imaging (MRI) device that it sells to hospital radiology departments. Their new device has a much larger chamber that reduces patients’ claustrophobic reactions compared to current machines. The following table displays how total cost per year varies with annual production. In other words, if DIM produces nine machines, the nine machines have a total manufacturing cost of $2.93 million.
Units | Total Manufacturing Cost |
0 | $1,000,000 |
1 | 1,500,000 |
2 | 1,800,000 |
3 | 1,950,000 |
4 | 2,050,000 |
5 | 2,170,000 |
6 | 2,314,000 |
7 | 2,486,000 |
8 | 2,690,000 |
9 | 2,930,000 |
10 | 3,210,000 |
11 | 3,534,000 |
12 | 3,906,000 |
13 | 4,330,000 |
14 | 4,810,000 |
15 | 5,350,000 |
To simplify the analysis, assume DIM has no period costs, only the product costs in the above table. Management receives a bonus based on reported profits, where profits are calculated using absorption costing.
Required:
a. At a selling price of $500,000 per MRI, management expects to sell six units next year and plans to produce a few extra machines. The extra units are for training, marketing, and temporary spare parts in case an installed MRI fails and spare parts are needed.
Management has financing and production capacity to vary production between 6 and 10 units. How many MRIs do you expect management to produce? Show your analysis that leads to this conclusion.
b. Instead of expecting to sell six units at $500,000 each as in part (a), management expects to sell 11 units at $400,000 per unit. With expected sales at 11 units and a price of $400,000, DIM has the resources to produce between 11 and 15 MRIs. How many MRIs do you expect management to produce if expected sales are 11 units? Show your analysis that leads to this conclusion.
c. Describe the differences and similarities in your answers to parts (a) and (b). Pay particular attention to the relation between units sold [6 in part (a) and 11 in part (b)] and expected units produced, and how this relation differs or does not differ between parts (a) and (b). Also, explain what is causing your answers in parts (a) and (b) to differ or not differ.
d. Provide some plausible explanations of why average costs may increase beyond a certain quantity of production.
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