Plastic Glow Company makes glow sticks. It uses a process costing system and has had a just-in-time inventory policy. The plant has a capacity to produce 500,000 units a year but currently operates at 300,000 units per year. Direct material and direct labor costs are variable and manufacturing overhead is primarily fixed. Production costs for 2011 are as follows:
Number of units produced and sold.........$300,000
Direct materials..................$ 15,000
Direct labor..................$30,000
Manufacturing overhead.............$105,000
Total costs....................$150,000
Equivalent cost per unit..............$0.50
Glow sticks are a novelty item with high competition, and the market is very price sensitive. Jim
Taylor, the production manager, receives a bonus each year based on the gross margin (sales price per unit less cost per unit) on glow sticks. Jim is worried about a potential sales price reduction in 2012 and, as a result, feels a need to reduce costs. He decides to take advantage of the excess plant capacity and increase production to 350,000.
Required:
a. If Jim increases production to 350,000 units per year, what will be the new equivalent cost per unit?
b. Would increasing the production level be a good idea? Why or why not?