Downhill Boards, a producer of snow boards, is evaluating a new process for appl
ID: 388039 • Letter: D
Question
Downhill Boards, a producer of snow boards, is evaluating a new process for applying the finish to its snow boards. Durable Finish Company has offered to apply the finish for $170,000 in fixed costs and a unit variable cost of $0.65. Downhill Boards currently incurs a fixed annual cost of $125,000 and has a variable cost of $0.90 per unit. Annual demand for the snow boards is 160,000.
1) Calculate the annual cost of the current process used at Downhill Boards.
2) Calculate the annual cost if Durable Finish Company applies the finish.
3) Find the indifference point for these two alternatives.
4. How much of a change in demand is needed to justify outsourcing the process?
Explanation / Answer
Solution:
Durable finish company:
Fixed costs = $170,000
Variable costs = $0.65
Downhill boards:
Fixed costs = $125,000
Variable costs = $0.90
Annual demand = 160,000
(a) Annual cost of the current process is calculated as,
Annual cost = Fixed cost + (Variable cost per unit x Annual demand)
Annual cost = $125,000 + ($0.90 x 160,000)
Annual cost = $269,000
(b) Annual cost if durable finish company applies the finish is calculated as,
Annual cost = Fixed cost + (Variable cost per unit x Annual demand)
Annual cost = $170,000 + ($0.65 x 160,000)
Annual cost = $274,000
(c) Indifference point for the two alternatives is the point where the total costs of both the alternatives will be equal. The indifference point can be calculated using the breakeven analysis. Let the breakeven quantity be represented by Q. Therefore, at the breakeven point,
Total cost of Downhill boards = Total cost of Durable finish company
$125,000 + $0.90 Q = $170,000 + $0.65 Q
0.25 Q = 45,000
Q = 180,000
The indifference point for the two alternatives is 180,000 units.
(d) Current Demand = 160,000 units
Indifference point = 180,000 units
Change in demand = Indifference point - Current demand
Change in demand = 180,000 - 160,000
Change in demand = 20,000 units
In order to justify the outsourcing process, the demand should increase by at least 20,000 units.
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