4. Total fixed costs are $25,000 per year. The variable cost per unit is $10.00

Question

4. Total fixed costs are $25,000 per year. The variable cost per unit is $10.00 per unit up to 5,000 units per year and $7.50 per unit thereafter.

a. Develop a cost function for this cost.

b. What could cause the change in variable costs shown above? Explain

c. List three assumptions that are made when developing these types of cost functions and give one reason that each assumption might not hold

Explanation / Answer

a Lt us assume that prodcution vol is x and x > 50000 Total cost is C   So Total Cost Function : C=25,000+10*5,000+7.5*(x-5,000) b Variable cost may increase whenthe normal production volume is excceded and we need to produce extra volume utilizing same Labor and infrastructure. The Labor overtime is often more than the normal overtime rate. Variable Manufacturing overheads like electricity, utility costs and other directly variable part of factroy overhead may also increase after a threshhold limit based   on normal production capacity. Like electricity charge per unit goes up after a certain slab of consumption. c Three assumptions made during the cost function developmenet are ;             1 Varable cost linear realtionship with volume will be same as assumed. It may not be true if the product mix is changed or cost of componenets change in different proportion.             2 Fixed cost assumed same over the total volume. It may not always be true and sudden cjange in any of fixed cost componenet may change the equation.             3 The segergation between fixed and variable cost components are fixed. The segregation may change and some variable cost may become semi variable or fixed over changed   volume giving a different effect to the cost function.

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