Lakin Corporation is considering a switch to level production. Cost efficiencies
ID: 2782942 • Letter: L
Question
Lakin Corporation is considering a switch to level production. Cost efficiencies would occur under level production, and aftertax costs would decline by $36,000, but inventory would increase by $300,000. Lakin Corporation has to finance the extra inventory at a cost of 13.5%. Determine the extra cost or savings of switching over to level production. Should the company go ahead and switch to level production?
Select one:
a. The company should not switch to level production since the benefits outweigh the costs.
b. The company should switch to level production since the benefits outweigh the costs.
c. The company should switch to level production since the costs outweigh the benefits.
d. The company should not switch to level production since the costs outweigh the benefits.
Explanation / Answer
Benefits if there is a switch in level of production
After tax cost would decline by $36000. thus the benefit is $36000
Incremental cost due to a switch in level of production
Increase in inventory * cost of finance for extra inventory
$300.000 * 13.5%
$ 40,500
Assumption - In absence of any information relating to the tax rate it has been assumed that the finance cost of 13.5% is after tax.
thus as in this case the incremental cost of $40,500 is more than the benefit of $30,000 company should not switch to new level of production.
answer is D. the company should not switch to level production since the costs outweigh the benefits.
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