Seven Seas Company manufactures 100 luxury yachts per month. Included in each yacht is a compact media center. Seven Seas manufactures media center in-house, but is considering the possibility of outsourcing that function. At present, the variable cost per unit is $275, and the fixed costs are $39,000 per month. The CEO wishes to boost operational income by $5,000. He has an offer from a foreign producer to provide the media centers at a contract rate of $300 per unit. The required saving in fixed cost in order to achieve his objective would be:

Question

Quizplus · Accepted Answer

First, we need to find the current contribution margin per unit:
Contribution margin = Selling price - Variable cost
Contribution margin = $0 (since we are only considering the cost of the media center)
Contribution margin per unit = $0 - $275 = -$275 (negative because it is a cost)

Next, we need to determine how much fixed cost savings are needed to increase operational income by $5,000:
Contribution margin ratio = Contribution margin per unit ÷ Selling price per unit
Contribution margin ratio = (-$275) ÷ $0 = undefined (cannot be determined since selling price is zero)

However, we can still use the equation: CM = (P × Q) - (V × Q) - FC
where CM is the contribution margin, P is the selling price per unit, Q is the quantity sold, V is the variable cost per unit, and FC is the fixed cost.

We know that Seven Seas currently manufactures 100 yachts per month with a media center in each yacht, so they are producing 100 media centers per month.

Current CM = (0 × 100) - (275 × 100) - 39,000 = -$66,500
New CM = (300 × 100) - (275 × 100) - FC

We want the new CM to be $5,000 higher than the current CM, so we can set up the following equation:

New CM - Current CM = $5,000
(300 × 100) - (275 × 100) - FC - (-$66,500) = $5,000
FC = $60,000 - $5,000
FC = $55,000

Therefore, the required saving in fixed cost in order to achieve the CEO's objective would be $55,000 - $39,000 = $16,000, or approximately $7,500 more than the fixed costs Seven Seas is currently incurring for media center production. The correct answer is C.

Seven Seas Company Manufactures 100 Luxury Yachts Per Month