The company is studying the effect on its financial statements of purchasing som
ID: 2540383 • Letter: T
Question
The company is studying the effect on its financial statements of purchasing some new equipment which would allow it to automate a large portion of its operations. Since direct labor costs will decline, variable costs would decrease by $900.00 per unit. However, total fixed costs would increase by $2,250,000. The volume of sales is expected to increase by 600 units if the new equipment is purchased. If the company operates in an industry that is sensitive to changes in the economy, do you think CedarWorks should purchase the new equipment. Explain.
Explanation / Answer
Saving in cost per unit = 900
However, there is an increase in fixed cost to the extent of 2,250,000. This is with respect to a corresponding increase in sales units.
Assume fixed cost was 2,000,000 before purchase of equipment and number of sales units was 1,000. Per unit fixed cost would be 2,000.
After purchase of equipment, fixed cost is 4,250,000 and number of units sold is 1,600. Per unit fixed cost is now 2,656.25.
Although there is a reduction in Variable cost, the increase in fixed cost results in an increase in the overall product cost per unit.
Therefore, Cedarworks should not purchase this equipment.