1. Sam Lucarelli, owner of Lucarelli Products, is evaluating whether to produce a new product line. After thinking through the production process and the costs of raw materials and new equipment, Williams estimates the variable costs of each unit produced and sold at $6 and fixed costs per year at $60,000.
a) If the selling price is set at $18 each, how many units must be produced and sold for Lucarelli to break even? Use both the graphical and algebraic approaches to get your answer.
b) Lucarelli forecasts sales of 10,000 units for the first year if the selling price is set at $14 each. What would be the total contribution to profits from this new product during the first year?
c) If the selling price is set at $12.50, Lucarelli forecasts the first-year sales would increase to 15,000 units. Which price strategy ($14.00 or $12.50) would result in the greater total contribution to profits?
d) What other considerations would be crucial to the final decision about making and marketing the new product?
2. A restaurant is considering adding fresh brook trout to its menu. Customers would have the choice of catching their own trout from a simulated mountain stream or simply asking the waiter to net the trout for them. Operating the stream would require $10,600 in fixed costs per year. Variable costs are estimated to be $6.70 per trout. The firm wants to break even if 800 trout dinners are sold per year. What should be the price of the new item?
3. Charlotte Manufacturing purchases a key component of one of its products from a local supplier. The current purchase price is $1,500 per unit. Efforts to standardize parts succeeded to the point that this same component can now be used in five different products. Annual component usage should increase from 150 to 750 units. Management wonders whether it is time to make this component in-house, rather than to continue buying it form the supplier. Fixed costs would increase by about $40,000 per year for new equipment and tooling needed. The cost of raw materials and variable overhead would be about $1,100 per unit, and labor costs would be $300 per unit produced.
a) Should Charlotte make rather than buy?
b) What is the break-even quantity?
c) What other considerations might be important?
4. G-Force Express, Inc. collected the following information on where to locate a warehouse (1 = poor, 10 = excellent):
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Location Score
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Location Factor
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Factor Weight
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A
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B
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Construction costs
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10
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8
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5
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Utilities available
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10
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7
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7
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Business services
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10
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4
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7
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Real estate cost
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20
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7
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4
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Quality of life
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20
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4
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8
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ATransportation
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30
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7
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6
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a) Which location, A or B, should be chosen on the basis of the total weighted score?
b) If the factors were equally weighted, would the choice change?
5. A manager is trying to decide whether to build a small, medium or large facility. Demand can be low, average or high, with the estimated probabilities being 0.25, 0.40 and 0.35, respectively.
A small facility is expected to earn an after-tax net present value of just $18,000 if demand is low. If demand is average, the small facility is expected to earn $75,000; it can be increased to medium size to earn a net present value of $60,000. If demand is high, the small facility is expected to earn $75,000 and can be expanded to medium $60,000 or large to earn $125,000.
A medium-sized facility is expected to lose an estimated $25,000 if demand is low and earn $140,000 if demand is average. If demand is high, the medium-sized facility is expected to earn a net present value of $150,000; it can be expanded to a large size for a net payoff of $145,000.
If a large facility is build and demand is high, earnings are expected to be $220,000. If demand is average for the large facility, the present value is expected to be $125,000; if demand is low, the facility is expected to lose $60,000.
a) Draw a decision tree for this problem.
b) What should management do to achieve the highest expected payoff?