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What is the annual operating income from Deluxe at the current price of $5,000?

Finance Basics

A Steven’s Medical Equipment Company manufactures hospital beds. Its most popular model, Deluxe, sells for $5,000. It has variable costs totaling $2,800 and fixed costs of $1,000 per unit, based on an average production run of 5,000 units. It normally has four production runs a year, with $600,000 in setup costs each time. Plant capacity can handle up to six runs a year for a total of 30,000 beds.

A competitor is introducing a new hospital bed similar to Deluxe that will sell for $4,000. Management believes it must lower the price to compete. Marketing believes that the new price will increase sales by 25% a year. The plant manager thinks that production can increase by 25% with the same level of fixed costs. The company currently sells all the Deluxe beds it can produce.

Question 1: What is the annual operating income from Deluxe at the current price of $5,000?

Question 2: What is the annual operating income from Deluxe if the price is reduced to $4,000 and sales in units increase by 25%?

B Mercy Greeting Cards Incorporated is starting a new business venture and are in the process of evaluating its product lines. Information for one new product, traditional parchment grade cards, is as follows:

Sixteen times each year, a new card design will be put into production. Each new design will require $100 in setup costs.

The parchment grade card product line incurred $75,000 in development costs and is expected to be produced over the next four years.

Direct costs of producing the designs average $0.50 each.

Indirect manufacturing costs are estimated at $50,000 per year.

Customer service expenses average $0.10 per card.

Current sales are expected to be 2,500 units of each card design. Each card sells for $3.50.

Sales units equal production units each year.

What is the total estimated life-cycle operating income?

C Novacar Company manufactures automobiles. The Red Car Division sells its red cars for $25,000 each to the general public. The red cars have manufacturing costs of $12,500 each for variable and $5,000 each for fixed costs. The division’s total fixed manufacturing costs are $25,000,000 at the normal volume of 5,000 units.

The Blue Car Division has been unable to meet the demand for its cars this year. It has offered to buy 1,000 cars from the Red Car Division at the full cost of $13,000. The Red Car Division has excess capacity and the 1,000 units can be produced without interfering with the current outside sales of 5,000. The 6,000 volume is within the division’s relevant operating range.

Explain whether the Red Car Division should accept the offer. Support your decision showing all calculations


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