1. Tex-House builds and sells houses for $200,000 each. The firms fixed costs ar

Question

1. Tex-House builds and sells houses for $200,000 each. The firms fixed costs are $3,000,000. 50 houses are built and sold each year. Profits total about $2,000,000. The firm estimates that it can change its production process by adding 4,000,000 to investment and $1,000,000 to fixed costs. This would reduce variable costs by $30,000 and increase output by 30 units. To permit sales of the new output, prices would have to be lowered by $20,000 per unit.
• Should the firm make the change
• At the new production level, what price would make profits equal zero?
• Will the new production situation expose the firm to more or less risk?

Explanation / Answer

currently: profit = revenue - variable costs - fixed costs 2,000,000 = 50*200,000 - 3,000,000 - 50*X X = 100,000 After investment New profit = (50+30)*(200,000-20,000) - 4,000,000 - (50+30)*(100,000-20,000) new profit = 4,000,000 By making this investment the firm would double its profit, so in 2 years they would be able to recoup their investment. So yes they should make the investment. Break even price: = 80*p - 4,000,000 - 80*80,000 p = (4,000,000 + 80*80,000)/80 = 130,000 The new production level with expose the company to more risk since they now sell more houses to break even. But the break-even price per house has also fallen from 160,000 to the current 130,000. So in some ways this project does not add an excessive amount of risk.

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