Question

You have been working for home-building companies for a number of years. You enjoy construction work, and now you want to start your own home-building company that you will run yourself. You quit your previous job that had been paying $40,000 per year. You have $40,000 in your savings account that you withdraw to start this company. The savings account had been paying you 5% interest. Because the $40,000 from your savings is not enough to start the company, you also borrow $2,300,000 from the bank. (The bank manager is willing to loan you such a large amount because he knows of your reputation and experience in the home-building industry.) You use the money to hire workers and buy the tools, machinery, and raw materials with which you will build houses. The cost per worker is $20,000 per year. In your first year, you plan to hire 48 workers to do the construction work, which means that the annual labor cost of your company will be $960,000 (48 x $20,000). With 48 workers, your company can build seven houses. You must also buy raw materials--land, wood, nails, plasterboard, and so forth. Each house requires $20,000 worth of raw materials. The cost of raw materials for seven houses is $140,000 (7 x $20,000). Finally, the bank charges 6% interest on your loan. The interest cost is $138,000 (6% of $2,300,000). What are the total fixed costs for your construction company?

Answer 1

Fixed cost is the expense which does not change with the increase or decrease in the number of goods required for the firm to function. These are expenses which the company has to pay when there is no business activity being conducted. Thus the fixed cost is the labor cost which will not vary throughout the year. The raw material cost will vary depending on the number of houses the company constructs. Interest cost is also a fixed component but it will come under finance cost and not operating cost. Thus the total fixed cost will be $960,000 which is the labor cost plus $20,000 as they will have to keep one house worth of inventory if they were to start work, total will be $980,000, but if they don't keep inventory than fixed cost will be just $960,000. Raw material cost will be variable cost depending on the number of houses it constructs, however it will have to maintain some form of raw material, we have assumed it will keep one house worth of inventory. Finance cost will be $138,000 plus $2,300,000 which will be paid.