Question

CBA’s production line of the Widget gadget has a fixed cost of $200,000 and the variable cost is $5 per unit.

a) If the company sells the first 10,000 units at a price of $20 and then sells all additional units at $15 per unit, what is the break-even point?

b) Suppose that the company is considering outsourcing this to FED company. If so, it will save the fixed and variable costs per unit. If the cost of outsourcing is $13 per unit, over what range would each of the production options (in-house and outsourcing) be preferred? Assume that the price per unit will remain the same whether it produces the product internally or outsources it.

c) Johndoe Company is interested in buying the Widget gadget from CBA. Johndoe Company is open to letting CBA manufacture them in-house or outsource them under certain conditions. Johndoe will only buy the outsourced if CBA reduces the selling price to $18 per unit. Also, if CBA does outsource this, Johndoe will only buy 8,000 units. On the other hand, if CBA produces the product internally, Johndoe will be willing to pay $20 per unit for all the products and Johndoe will buy 12,000 widgits. Economically, which option (produce internally or outsource) is better for CBA?   

Answer 1

Solution a:

Variable cost per unit = $5

Contribution margin per unit for first 10000 units = $20 - $5 = $15 per unit

Total contribution margin on 10000 units = 10000 * $15 = $150,000

Fixed costs = $200,000

At breakeven contribution is equal to fixed costs.

Remaining contribution margin to earn in order to breakeven = $200,000 - $150,000 = $50,000

Contribution margin per unit on additonal units = $15 - $5 = $10 per unit

Nos of units to be sold to earn $50,000 contribution margin = $50,000 / 10 = 5000 units

Breakeven point in units = 10000 + 5000 = 15000 units

Solution b:

Cost of outsourcing = $13 per unit

Cost of production = $5 per unit + $200,000

Let range over which production option will be preferred is x units, therefore at x units cost under both option will remain the same.

$13X = 5X + $200,000

X = 25000 units

Therefore over 25000 units production option will be preferred

Solution c:

Produce internally:

Cost of production = 12000*$5 + $200,000 = $260,000

Revenue = 12000 * $20 = $240,000

Profit (Loss) = $240,000 - $260,000 = ($20,000)

Outsourcing option:

Cost of outsourcing = 8000*$13 = $104,000

Revenue = 8000 * $18 = $144,000

Profit (Loss) = $144,000 - $104,000 = $40,000

The better option is CBA should outsource the widget gadget.