The management of a firm wants to introduce a new product. The product will sell for $4 a unit and can be produced by either of two scales of operation. In the first, total costs are
TC 5 $3,000 1 $2.8Q.
In the second scale of operation, total costs are
TC 5 $5,000 1 $2.4Q.
a. What is the break-even level of output for each scale of operation?
b. What will be the firm’s profits for each scale of operation if sales reach
5,000 units?
c. One-half of the fixed costs are noncash (depreciation). All other expenses are for cash. If sales are 2,000 units, will cash receipts cover cash expenses for each scale of operation?
d. The anticipated levels of sales are the following:
Year Unit Sales
1.......... 4,000
2.......... 5,000
3.......... 6,000
4.......... 7,000
If management selects the scale of production with higher fixed cost, what can it expect in years 1 and 2? On what grounds can management justify selecting this scale of operation? If sales reach only 5,000 a year, was the correct scale of operation chosen?