Question

Fat Tire Bicycle Company currently sells 37,000 bicycles per year. The current bike is a standard​ balloon-tire bike selling for $100​, with a production and shipping cost of $25. The company is thinking of introducing an​ off-road bike with a projected selling price of $370 and a production and shipping cost of ​$225. The projected annual sales for the​ off-road bike are 15,000. The company will lose sales in​ fat-tire bikes of 10,000 units per year if it introduces the new​ bike, however.

What is the erosion cost from the new​ bike?

Should Fat Tire start producing the​ off-road bike?

Answer 1

Requirement – (1), Erosion cost from the new​ bike

Erosion cost from the new bike = lose sales in​ fat-tire bikes per year x (Selling price per unit – Shipping cost per unit)

= 10,000 units x ($100 per unit - $25 per unit)

= 10,000 units x $75 per unit

= $750,000

Requirement - (2)

Net Cash flow with standard​ balloon-tire bike

Net Cash flow from standard​ balloon-tire bike = $27,75,000 [37,000 units x ($100 per unit - $25 per unit)]

Net Cash flow with standard​ balloon-tire bike and the off-road bike

Cash flow from standard​ balloon-tire bike = $20,25,000 [(37,000 units – 10,000 units) x ($100 per unit - $25 per unit)]

Cash flow from off-road bike = $21,75,000 [15,000 units x ($370 per unit - $225 per unit)]

Net Annual cash flow = Cash flow from standard balloon-tire bike + Cash flow from off-road bike

= $20,25,000 + $21,75,000

= $42,00,000

Therefore, the Increase in Net Cash flow per year = $42,00,000 - $27,75,000

= $14,25,000

DECISION

“YES”. The Fat Tire Bicycle Company should start producing the​ off-road bike, since would increase the cash flows by $14,25,000 per year.