¶ … Fixed Costs are the rent paid for the production facility, the utility bills, some salaries (the doorman, the secretary, the guards or even the manager), and accounting, legal and consultancy bills. On the other hand, Variable Costs are incurred by the acquisition of raw materials (flower, sugar, baking soda etc.), packaging materials, distribution costs, the salaries of the kitchen staff or various taxes.
I have prepared two tables wherein I have calculated the Fixed, Variable and Total Costs for the first and the second alternatives. In the first case, the Total Variable Costs amount to $11,900, while the Total Costs reach $16,900. The Cost for one unit (bar) is 99 cents.
Total
Washington
New York
Los Angeles
Demand
17,000
10,000
5,000
2,000
Production capacity
20,000
Production
17,000
Fixed Costs
5,000
Variable Costs/unit
Variable Costs
11,900
Total Costs
16,900
Costs per unit
0.994117647
Price
Revenue
34,000
Profit
17,100
The second alternative implies total Fixed Costs of $9,000, much more than in the first case, $10,200 worth of Variable Costs, Total Costs of $19,200 and a Cost per unit of $1,13, which is significantly more than the 99 cents of the first alternative.
II
Total
Washington
New York
Los Angeles
Demand
17,000
10,000
5,000
2,000
Production capacity
21,000
12,000
6,000
3,000
Production
17,000
10,000
5,000
2,000
Fixed Costs
9,000
4,000
3,000
2,000
Variable Costs/unit
0.60
0.60
0.60
0.60
Variable Costs
10,200
6,000
3,000
1,200
Total Costs
19,200
10,000
6,000
3,200
Costs per unit
1.129411765
1
1.2
1.6
Price
2
2
2
2
Revenue
34000
20000
10000
Profit
14,800
10,000
4,000
The conclusion is that the first alternative should be chosen, since the Costs per unit are much smaller. This fact is attributable to the lower Fixed Costs ($5,000 compared to $9,000). Although the variable costs are not so high ($10,200 compared to $11,900), the advantage is offset by the difference implied by the Fixed Costs. The 10 cents saved as a result of lower distribution costs do not seem to have any significant impact.
Therefore, in these conditions, the first alternative is preferable.
3. Suppose that the demand increases to the production capacity. The situation would present itself as follows:
I
Total
Washington
New York
Los Angeles
Demand
20,000
(Unknown)
(Unknown)
(Unknown)
Production capacity
20,000
Production
20,000
Fixed Costs
5,000
Variable Costs/unit
0.70
Variable Costs
14,000
Total Costs
19,000
Costs per unit
0.95
Price
2
Revenue
40,000
Profit
21,000
In the first case, the Fixed Costs remain unchanged, the Variable Costs rise to 14,000, the Total Costs reach 19,000, while the Costs per unit drop by 4 cents, indicating $0.95.
II 0,6
Total
Washington
New York
Los Angeles
Demand
21,000
12,000
6,000
3,000
Production capacity
21,000
12,000
6,000
3,000
Production
21,000
12,000
6,000
3,000
Fixed Costs
9,000
4,000
3,000
2,000
Variable Costs/unit
0.60
0.60
0.60
0.60
Variable Costs
12,600
7,200
3,600
1,800
Total Costs
21,600
11,200
6,600
3,800
Costs per unit
1.028571429
0.9
1.1
1.2
Price
2
2
2
2
Revenue
42,000
24000
12000
Profit
20,400
12,800
5,400
2,200
The second case (the production capacity equals demand at a level of 21,000 units) shows that the Variable Costs reach $12,600, while the Total Costs amount to $21,600. The Costs per unit indicate a $1 and 3 cents, which is more than the value obtained by applying the first alternative. The choice is obvious. Dem and Greg should still go with the first option since, lacking other information, the Cost per unit is smaller than the one implied by the second option.
4. If the Variable Costs per Unit are increased by 10 cents, then there is no advantage in picking the second alternative. The Total Variable Costs are equal for both options (for an equal production, obviously), while The Fixed Costs are almost double in the second case, compared to the first ($9,000 compared to $5,000). Therefore, the first alternative is definitely preferable.
II 0,7
Total
Washington
New York
Los Angeles
Demand
21,000
12,000
6,000
3,000
Production capacity
21,000
12,000
6,000
3,000
Production
21,000
12,000
6,000
3,000
Fixed Costs
9,000
4,000
3,000
2,000
Variable Costs/unit
0.70
0.70
0.70
0.70
Variable Costs
14,700
8,400
4,200
2,100
Total Costs
23,700
12,400
7,200
4,100
Costs per unit
1.128571429
1.0
1.2
1.3
Price
2
2
2
2
Revenue
42,000
24000
12000
Profit
18,300
11,600
4,800
1,900
5. I have included in the hereinabove tables the $2 price per unit, the Total Revenue and the Total Profit (the difference between the Revenue and the Total Price). The results indicate that the best results are obtained by applying the first option (a single plant) and utilizing it to its fullest (a 20,000 units production). If the second alternative is applied, the Profit reaches a value of 20,400, which is not too bad but still not perfect.
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