BEC MCQ – Capital Investments and Variable Cost Savings
In order to increase the profit margin for a certain product, a company is planning to purchase a custom made machine for $5,000,000. It is anticipated that the introduction of the new machine will reduce the product’s variable costs of labor and maintenance by $5.50 per unit and $.95 per unit, respectively. The product manager estimates that 500,000 units of the product will be manufactured and sold each year with a product life cycle of two years, at which time the machine will be discarded with no salvage value. What is the company’s total cost savings over the product’s life cycle?
A) $725,000
B) $1,450,000
C) $3,225,000
D) $6,450,000
$1,450,000 is correct. We need to recognize that the company will have a reduction in variable costs from purchasing the equipment, but we should also factor in the initial cost to purchase the equipment. There are 3 simple steps to perform to arrive at the correct answer.
Step 1) We’ll start by calculating the total variable cost savings per unit, which is $5.50 for labor and $0.95 for maintenance. Add them together and you get $6.45.
Step 2) Now we need to calculate the total variable cost savings, so multiply the $6.45 by the total number of units produced over the 2 year life cycle. So $6.45 x 1,000,000 units (500,000 per year), and you get total variable cost savings of $6,450,000.
Step 3) Now we just need to take total variable cost savings of $6,450,000 and subtract out $5,000,000 for the initial cost to purchase the equipment. That is how you arrive at total cost savings of $1,450,000.
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