Question

Edit:

Leeraner Golf Specialties (LGS), a German company, manufactures a variety of golf paraphernalia, such as head covers for woods, embroidered golf towels, and umbrellas. LGS sells all its products exclusively in Europe through independent distributors. Given the popularity of Tiger Woods, one of LGS’s more popular items is a head cover in the shape of a tiger.

LGS is currently making 500 tiger head covers a week at a per unit cost of 4,30 €, which includes both variable costs and allocated fixed costs. LGS sells the tiger head covers to distributors for 5,05 €. A distributor in Japan, Tamagotchi Imports, wants to purchase 100 tiger head covers per week from LGS and sell them in Japan. Tamagotchi offers to pay LGS 2,80 € per head cover. LGS has enough capacity to produce the additional 100 tiger head covers and estimates that if it accepts Tamagotchi’s offer, the per unit cost of all 600 tiger head covers will be 3,90 €. Assume the cost data provided (4,30 € and 3,90 €) are accurate estimates of LGS’s costs of producing the tiger head covers. Further assume that LGS’s variable cost per head cover does not vary with the number of head covers manufactured.

Required:

To maximize firm value, should LGS accept Tamagotchi’s offer? Explain why or why not.

Given the data in the problem, what is LGS’s weekly fixed cost of producing the tiger head covers?

Besides the data provided above, what other factors should LGS consider before making a

decision to accept Tamagotchi’s offer?

Answer 1

There is no capacity constraint for making additional 100 covers

Cost for manufacturing 500 covers=500*4.30= € 2,150

Cost of manufacturing 600 covers=600*3.90= €   2,340

Additional costs for additional 100 covers=(2340-2150)= € 190

Per unit cost of additional 100 units=190/100=€ 1.90

Amount offered ==€ 2.8 per cover

Per unit contribution, if the offer is accepted=(2.8-1.9)=€ 0.9

Increase in profit , if the offer is accepted=100*0.9=)=€ 90

To maximize firm value, LGS SHOULD accept Tamagotchi’s offer, since this offer increases profit of LGS by € 90

CALCULATION OF WEEKLY FIXED COST:

Total cost=F+Q*V

F=Fixed Cost

Q=Quantity of production

V=Variable cost per unit

Cost of manufacturing 500 covers= € 2,150

2150=F+500*V……Equation (1)

Cost of manufacturing 600 covers= € 2,340

2340=F+600*V……Equation (2)

Subtracting Equation (1) from Equation (2):

(2340-2150)=100*V

V=190/100= € 1.9

Variable cost per unit=€ 1.9

2340=F+600*1.9

F=2340-(600*1.9)=2340-1140=€ 1,200

FIXED COST PER WEEK=€ 1,200

Other factors to be offered:

Whether it will have impact on current customer demand

Market competition

Whether it is one time offer or regular sell.

Whether LGS has plans to export to Japan