22 April 2011
Wk 7 Case 2
Case of the Pricing Predicament
Calibrated manufacturing makes an electronic component that is in great demand. The component sells for $20 each. Calibrated’s current capacity is 10,000 units per week. For the last few months, however, the company has been receiving new orders at a rate of 14,000 units per week, and now has a substantial backlog. The company expects this order rate to continue, if it maintains price. Calibrated’s current operating data follows:
Sales Revenue $200,000
Variable Costs $100,000
Fixed Costs $80,000
Pretax Profit $20,000
For each incremental addition of 500 units of output weekly, Calibrated would need to purchase new equipment that would add $1,500 to weekly fixed costs. No other fixed costs would become incremental for this price change. Labor costs currently account for half of all variable costs. Additional hires, however, are expected to be more costly than the average of current employees because of their lower productivity. Although new hires are paid (wages + fringe benefits) only 80% of the current average, they can produce only two-thirds as much output per hour. Consequently, labor costs for additional output with new hires is 20% higher than the current average.
Calibrated is debating whether to keep its current price and expand to meet the demand or to raise its price to reduce demand somewhat before deciding whether or not to expand.
1. How much would Calibrated’s weekly profits increase if it expanded to meet the entire amount of its current excess demand?
New incremental costs:
Fixed Costs = 1500 x 4000/500 = $12,000 (every 500 units cost $1500, so incremental 4000 units would cost 1500 x 4000/500)
Variable cost per unit = $10
Current Labor cost per unit = 1/2 of variable cost = $5
New Labor cost per unit for incremental units = $6 (20% higher than current $5)
New Variable cost per unit =$11