Question

The Oriole Publications Textbook Company sells all of its books for $100 per book, and it currently costs $50 in variable costs to produce each text. The fixed costs, which include depreciation and amortization for the firm, are currently $2 million per year. Management is considering changing the firm’s production technology, which will increase the fixed costs for the firm by 46 percent but decrease the variable costs per unit by 46 percent. If management expects to sell 45,000 books next year, should they switch technologies? (Round answers to nearest whole dollar,e.g. 5,275.)

The current EBIT for the firm is $ .

If the firm changes technology, the firm’s new EBIT will be $ .

The firm should rejectadopt the new technologies.

Answer 1

Answer

Current EBIT = $250,000

EBIT with new technology = $365,000

Therefore, the firm should accept the new technologies as it would increase the firm's EBIT by $115,000

Explanation

Calculation of firm's EBIT with the existing technology :

Sales = 45000 * $100 = $4,500,000

Variable cost = 45000 * $50 = $2,250,000

Fixed cost = $2,000,000

EBIT = Sales - variable cost - fixed cost

EBIT = $4,500,000 - $2,250,000 - $2,000,000

EBIT = $250,000

Calculation of firm's EBIT with the new technology

Sales = 45000 * $100 = $4,500,000

Variable cost = 45000 * $50 (1 - 0.46) = $1,215,000

Fixed cost = $2,000,000 * (1 + 0.46) = $2,920,000

EBIT = Sales - variable cost - fixed cost

EBIT = $4,500,000 - $1,215,000 - $2,920,000

EBIT = $365,000

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