Selftest Problems And Solutions

ST8.1 Learning Curves. Modern Merchandise, Inc., makes and markets do-it-yourself hardware, housewares, and industrial products. The company's new Aperture Miniblind is winning customers by virtue of its high quality and quick order turnaround time. The product also benefits because its price point bridges the gap between ready-made vinyl blinds and their high-priced custom counterpart. In addition, the company's expanding product line is sure to benefit from cross-selling across different lines. Given the success of the Aperture Miniblind product, Modern Merchandise plans to open a new production facility near Beaufort, South Carolina. Based on information provided by its chief financial officer, the company estimates fixed costs for this product of $50,000 per year and average variable costs of

AVC = $0.5 + $0.0025Q where AVC is average variable cost (in dollars) and Q is output.

A. Estimate total cost and average total cost for the projected first-year volume of 20,000 units.

B. An increase in worker productivity because of greater experience or learning during the course of the year resulted in a substantial cost saving for the company. Estimate the effect of learning on average total cost if actual second-year total cost was $848,000 at an actual volume of 20,000 units.

ST8.1 Solution

A. The total variable cost function for the first year is

At a volume of 20,000 units, estimated total cost is

Estimated average cost is

B. If actual total costs were $848,000 at a volume of 20,000 units, actual average total costs were

Therefore, greater experience or learning has resulted in an average cost saving of $10.60 per case because

ST8.2 Minimum Efficient Scale Estimation. Kanata Corporation is a leading manufacturer of telecommunications equipment based in Ontario, Canada. Its main product is microprocessor-controlled telephone switching equipment, called automatic private branch exchanges (PABXs), capable of handling 8 to 3,000 telephone extensions. Severe price cutting throughout the PABX industry continues to put pressure on sales and margins. To better compete against increasingly aggressive rivals, the company is contemplating the construction of a new production facility capable of producing 1.5 million units per year. Kanata's in-house engineering estimate of the total cost function for the new facility is where TC = total costs in thousands of dollars, Q = output in thousands of units, and MC = marginal costs in thousands of dollars.

A. Estimate minimum efficient scale in this industry.

B. In light of current PABX demand of 30 million units per year, how would you evaluate the future potential for competition in the industry?

Learning Effect = Actual AC — Estimated AC = $42.40 - $53 = -$10.60 per case

Alternatively,

TC = $3,000 + $1,000Q + $0.003Q2 MC = $1,000 + $0.006Q

ST8.2 Solution

A. Minimum efficient scale is reached when average costs are first minimized. This occurs at the point where MC = AC.

Therefore,

(Note: AC is rising for Q > 1,000(000).) Alternatively, MES can be calculated using the point cost elasticity formula, because MES is reached when eC = 1.

B. With a minimum efficient scale of 1 million units and total industry sales of 30 million units, up to 30 efficiently sized competitors are possible in Kanata's market.

Potential Number of Efficient Competitors = Market Size

MES Size

Thus, there is the potential for n = 30 efficiently sized competitors and, therefore, vigorous competition in Kanata's industry.

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