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?
$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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