The management of a firm wants to introduce a new product. The product will sell for $6.50 a unit and can be produced by either of two scales of operation. Following are the total costs:
First scale of operation: TC = $2,500 + $5.00Q
Second scale of operation: TC = $4,000 + $4.30Q
a) What is the break-even level of output for each scale of operation?
b) What will be the firm's profits for each scale of operation if sales reach 5,000 units?
c) One-half of the fixed costs are noncash (depreciation). All other expenses are for cash. If sales are 2,000 units, will cash receipts cover cash expenses for each scale of operation?
d) If management selects the scale of production with higher fixed cost, what can it expect in years 1 and 2? On what grounds can management justify selecting this scale of operation? If sales reach only 4,000 a year, was the correct scale of operation chosen?
Following are the anticipated levels of sales:
|
Year
|
Unit Sales
|
|
1
|
3,000
|
|
2
|
3,500
|
|
3
|
4,000
|
|
4
|
5,000
|