Question

ABC Firm produces one product: a high-quality motorized unicycle. Sales have been steadily rising. In the most recent month, 10,000 units were produced and 9,500 were sold. The income statement follows:

                                    Sales                $2,327,500

                                    VC                     1,558,000

                                    CM                      $769,500

                                    FC                         566,000

                                    NI                        $203,500

The product has been much less profitable than predicted one year ago when the firm was established.  Management would like to reduce costs to the minimum to increase net income. It is considering replacing much of the direct labour force with machines. The machines produce a highly standardized product and can operate 23 hours per day. Thus more units can be produced. The machine would decrease variable manufacturing costs by 25%, but depreciation on the machines would amount to $250,000 per month. Selling and Administrative costs have been carefully examined and controlled.

The amount to $45 per unit plus $256,000 per month. Management does not believe that any further reductions can be made.

Sales for next month are predicted to be 11,500 units. The firm has the capacity under either production model to meet that demand.

1. Which way will the firm be more profitable, under the current production model or with the proposed machines?
2. Which way will the firm be more risky, under the current production model or with the proposed machines? Note: there are many measures of risk. There is no need to go beyond the material for this module.

Answer 1