Question

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.

Answer 1

Average variable cost= 5 + 0.0001Q(given in question)

Output(Q) = 50,000 (given in question)

AVC - 5 =0.0001 x Q

AVC - 5 = 0.0001 X 50000                                  => q= 50000

AVC - 5 = 5

AVC= 10

AVC= Variable Cost(VC) / output(Q)

10= VC/ 50000

VC= 500000

Total cost= VC + Fixed costs(FC)

Total cost = 500000 + 500000= $1000000

Average total cost = Total Cost / Output(Q)

Average total cost = 1000000 / 50000

Average total cost= $20

Question (B).

Actual total cost= 1,080,000

Actual Quantity= 65,000

Actual Average Variable Cost= Actual total cost / Actual quantity

Actual average variable cost = 1080000 / 65000= 16.61

Current average variable cost = 10              (Calculated in Part A)

Effect of learning on actual average total cost = {(Actual average total cost - current average total cost) / Actual average total cost} x 100

Effect of learning on actual average total cost = {(16.61 - 10) / 16.61 } x 100

Effect of learning on actual average total cost (in percentage) = (6.61/16.61) x 100= 0.39 x 100 = 39.79 %

Therefore, the effect of learning on actual average total cost is a decrease in average total cost by 39%