Assignment

1. Opportunity Costs. Two graduate business students are considering opening a full-service car wash in Greenville, North Carolina, after graduation. This is an alternative to employment with a local manufacturing firm where they would each earn $72,000 per year. A fully equipped facility can be leased at a cost of $32,000 for the year. Additional projected costs are $15,000 for overhead, and $5 per automobile for materials and supplies. Full detail automobile cleaning would be priced at $25.

A. What is the accounting cost function for this business?
B. What is the economic cost function for this business?
C. What is the economic breakeven number of units for this operation? (Assume a $25 price and ignore interest costs associated with the timing of the lease payments.)

2. Degree of Operating Leverage. Heat Tamers, Inc., of Bend, Oregon produces special heat-resistant boots used primarily by firefighters, smoke-jumpers and steelworkers. It is contemplating an expansion into the heat resistant leather market charging a price of $150 per pair of boots. The production of each pair of boots would require $60 in materials, and 1.5 hours of labor at the rate of $20 per hour. Energy, supervisory and other variable overhead costs would amount to $25 per unit. The accounting department has derived an allocated fixed overhead charge of $30 per pair of boots (at a projected volume of 280,000 pairs) to account for the expected increase in fixed costs.

A. What is Heat Tamers' breakeven sales volume (in pairs) for heat-resistant boots?
B. Calculate the degree of operating leverage at a projected volume of 280,000 units and explain what the DOL means.

3. Multiplant Operation. Nature's Green, Inc., a manufacturer of alfalfa tablets sold in health-food stores, currently operates just outside of Meno, California. Nature's Green is considering two alternative proposals for expansion, because it has run out of acreage to grow its organically-farmed alfalfa. It has found the following sites where farmers are willing to supply organic alfalfa: Alternative 1: Construct a single plant in Big Cabin, Oklahoma with a monthly production capacity of 50,000 cases, a monthly fixed cost of $275,000, and a variable cost of $100 per case. Alternative 2: Construct three plants, one each in Eudora, Kansas, Springfield, Missouri, and Tonkawa, Oklahoma, with capacities of 25,000, 20,000 and 15,000, respectively, and monthly fixed costs of $200,000, $175,000, and $160,000 each. Variable costs would be only $95 per case because of lower distribution costs. To achieve these cost savings, sales from each smaller plant would be limited to demand within its home state. The total estimated monthly sales volume of 49,000 cases in these three southeastern states is distributed as follows: 20,000 cases in Kansas, 15,000 cases in Missouri, and 14,000 cases in Oklahoma.

A. Assuming a wholesale price of $120 per case, calculate the breakeven output quantities for each alternative.
B. Assuming sales at the projected levels, which alternative expansion scheme provides Nature's Green with the highest profit per month?
C. If sales increase to production capacities, which alternative would prove to be more profitable?

4. Learning Curve. Teddy Bear, Inc., a rapidly growing manufacturer of high fashion children's shoes, plans to open a new production facility in Bethesda, Maryland. Based on information provided by the accounting department, the company estimates fixed costs of $500,000 per year and average variable costs at:

AVC = $5 + $0.0001Q

where AVC is average variable cost (in dollars) and Q is output measured in cases of output per year.

A. Calculate total cost and average total cost for the coming year at a projected volume of 50,000 pairs of shoes.

B. An increase in worker productivity due to greater experience or learning during the course of the year resulted in a substantial cost saving for the company. Calculate the effect of learning on average total cost if actual total cost was $1,080,000 at an actual volume of 65,000 pairs of shoes.

5. Optimal Price. Last month, Rick's Bike Shop, Inc. increased the price on the 24 ounce can of bearing grease by 1%. In response, sales dropped by 4%.

A. Calculate the point price elasticity of demand for bearing grease.

B. Calculate the optimal price for bearing grease if marginal cost is $4.60 per unit.