Problem 8-5 A company that produces pleasure boats has decided to expand one of
ID: 355203 • Letter: P
Question
Problem 8-5 A company that produces pleasure boats has decided to expand one of its lines. Current facilities are insufficient to handle the increased workload, so the company is considering three alternatives, A (new location), B (subcontract), and C (expand existing facilities) Alternative A would involve substantial fixed costs but relatively low variable costs: fixed costs would be $320,000 per year, and variable costs would be $800 per boat. Subcontracting would involve a cost per boat of $3,000, and expansion would require an annual fixed cost of $56,000 and a variable cost of $1,200 per boat. Expansion would result in an increase of $71,000 per year in transportation costs, subcontracting would result in an increase of $27000 per year, and adding a new location would result in an increase of $5,100 per year Which alternative would yield the lowest total cost for an expected annual volume of 132 boats? O A O B ??Explanation / Answer
Based on the available information( missing:- cost per boat is not indicated and also the expected profits),I would recommend the Option A as the right choice of Sub-contracting as it involves zero fixed cost/investment outlay and the increase in transportation cost is also lower @$27,000 p.a compared to a new location option in which transportation cost goes very high @$71000 p.a.
Sub-contracting also makes sense if the annual demand in following years fluctuates or comes down wherein the fixed costs for a new location or expansion Option would take much longer to get amortized due to lower volumes.
Sub-contracting also has zero labour related liabilities/challenges which is not the case for a direct manufacturing company.