Question

The simple circuit board can be produced either mechanical or by hand. The hand method required $12 of material and takes 2.8 hours/unit with a labor cost of $9/hour. The equipment has a fixed cost rate of $120,000/year and variable costs of $24.50/unit. The customer requires 12,000 units.  

1. If the equipment can be used for other products when not producing these units, which process is the least costly?

2. What if the equipment could only be used for production of this unit?

Answer 1

1. If the equipment can be used fro other products also. then,

Conversion cost per unit (By hand production) = $9*2.8 = $25.20

Conversion cost per unit (by mechanical production) = $24.50

Since the conversion cost by producing from equuipment is less than manual production. In absense of conversion cost of other products which can be manufactured using the equipment it is advisable to manufacture the circuit board by using equioment as it is less costly than manufacturing it by hand.

Savings if we produce circuit board by using equipment:

($25.20 -$24.50)*12000 = $8400

Also fixed cost remains same in both alternatives, so not considered for decision making purpose.

2. If the equipment could only be used for the production of this unit. then, the saving in conversion cost $8400 is less than the total fixed cost of $120000. So, to avoid the heavy fixed it is advisable to manufacture the component by hand.