A manufacturer is evaluating options regarding his productio

A manufacturer is evaluating options regarding his production equipment. He is trying to decide whether he should refurbish his old equipment for $70,000, make major modifications to the production line for $135,000, or purchase new equipment for $230,000. The product sells for $10, but the variable costs to make the product are expected to vary widely, depending on the decision that is to be made regarding the equipment. If the manufacturer refurbishes, the variable costs will be $7.20 per unit. If he modifies or purchases new equipment, the variable costs are expected to be $5.25 and $4.75, respectively.

(a) Which alternative should the manufacturer choose if it the demand is expected to be between 30,000 and 40,000 units?
(b) What will be the manufacturer’s profit if the demand is 38,000 units?

Solution

Working Notes -1 REFURBISH MODIFY PURCHASE (A) $70,000 $135,000 $230,000 Sale price $10 $10 $10 Variable Cost $7.20 $5.25 $4.75 (B) Contribution $2.80 $4.75 $5.25 If Demand Is in (Units)= ( C) 30000 $84,000.00 $142,500.00 $157,500.00 (D) Net Gain (C-A) $14,000.00 $7,500.00 ($72,500.00) Notes: Here refurbish will be more beneficial If Demand Is in(Units)= ( E) 40000 $112,000.00 $190,000.00 $210,000.00 (F ) Net Gain $42,000 $55,000 ($20,000) Notes: Here modification will be more beneficial ANSWER: (i) As per the above calculation it seems that we if go for modification then in the long term consideration it will give more constant profitabilty. IN comparision with the refurbishment the contribution per unit is also more than it. Answer (ii): If demand is (units ).= 38000 Contribution per unit $4.75 Total contibution= $180,500.00 Expenses= $135,000 Net Profit= $45,500