A company produces two main products: electronic control devices and specialty m

Question

A company produces two main products: electronic control devices and specialty microchips. The average total cost of producing a microchip is $300; the firm then sells the chips to other high-tech manufacturers for $550. Currently, there are enough orders for microchips to keep its factory capacity fully utilized. The company also uses its own chips in the production of control devices. The average total cost (AC) of producing such a device is $500 plus the cost of two microchips. (Assume all of the $500 cost is variable and AC is constant at different output volumes.) Each control device sells for an average price of $1,500.

a) Should the company produce control devices? Is this product profitable? Briefly explain your answer
b) Answer part (a) assuming outside orders for microchips are insufficient to keep the firm

Explanation / Answer

a. From the given data, we infer that the rough cost incurred to produce one control device is approximately $1100 (i.e $500 + cost fo two microchips, where in cost of each micro chip is $300)

When the cost of the microchip is taken as such that is when the production cost is considered then the total production cost of each control device is $1100, but when the selling price of the microchip is considered then the production cost of each control device will be $500 +$500 +$500 = $1500. This is as same as that of the selling price of each control device.

Hence when the microchip is used in its production rate then the sale of control devices are profitable but when the microchips are used in their selling rate then the production of control devices are not profitable. Instead the company can concentrate in manufacturing control chips.

b. When the outside orders for microchips are insufficient to keep the production unit of the firm fully utilized then the production of control devices can be used as an option. But only on a temporary basis since costing plays a major role in deciding which product should be produced and in what quantity.

c. Yes, the company can produce control devices in the short run when $200 of the average cost of control devices is fixed. Further based on the assumption that microchip
capacity is fully utilized, the company can definitley give a thought on producing control devices. Since the average cost of control devices are reduced the total cost of producing the control device will also get reduced. Hence when a product is profitable it is absolutely viable for the company to take a decision to produce a product on a short run and see how costing is working with the strategy.

This is purely strategic and depends on forecasting and costing analysis done by financial advisors and consultants.

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