Problem 1: Your company is building a new facility to produce ibuprofen, a popul
ID: 1885224 • Letter: P
Question
Problem 1: Your company is building a new facility to produce ibuprofen, a popular pain reliever. $40 million has been allocated as the total budget of the plant, including construction. You have $8 million of that budget to spend on tflowing itemss Depreciation Supplies Raw Materials Utilities Payroll Taxes Direct Labor Insurance (building and Clerical salaries Sales commissions Rent Classify each of the items above as either fixed costs or variable costs. Explain the classification for each item. a. b. Classify each of the items above as either one-time costs (you only have to pay it once) or as continuous costs. Rank both the one-time cost items and the continuous cost items from least expensive (Rank 1) to most expensive. c.Explanation / Answer
a. When you start a company, it is well known that one has to incur different typs of expenditure to run it. These different types of expenditure are listed in the table given in the question
Now, these expenditures can be classified as fixed and variable costs
Fixed costs mean that the cost is invariable of output or sales. This means that,it does not change even if you produce more or less. Examples-
Rent,Insurance(building and equipment),Depreciation,Interest on borrowed money,Property taxes,Administrative expenses, clerical salaries
Notice rent, insurance,interest,taxes are paid at a contsant amount each month.Hence they are classified as fixed
Variable costs, on the other hand, are dependent on output or sales.Examples;
Raw materials,Utilities,direct labor,Supplies,payroll tax,sales commissions
Notice these costs to company will increase as output increases i.e. if we produce more, more raw materials are required, more labor is required and hence more salaries and taxes to be paid.
Note- sometimes there is no definitive classification. For example, administrative expenses in case of management are more or less fixed.But, some administrative expenses may even depend on output.For example, more production would require more administrative coordination and hence more cost.
b. Continuous costs are the costs incurred on a regular basis.All the items listed in the table are continuous costs.
One time costs may include cost to buy new machinery or major facility upgrade, costs incurred to repair due to some accident or natural calamity.
c. It is very difficult to come to a ranking of these expenses. But, neverthless I shall try to come at a ranking for this pharmaceutical company
1.Rent, taxes,insurance, depreciation, interest
2.Salaries, commissions,direct labour
3.Raw material, Supplies,Utilities
4. Administrative expenses(R&D)
5. Machinery or facility upgrade
It may be noted that the rankings can vary with the financial condition of a company. A company under debt may have to incur huge costs on interest rates. Hence it varies from comapany to company.
A pharmaceutical company has to incur substantial cost on Research and Development for trials of medicine and be up to date with upcoming new challenges which would otherwise reduce their sales.