A company is debating whether to change its cost structure so that fixed costs increase from $300,000 to $400,000,but variable costs decrease from $5 per unit to $4 per unit.If it were to implement the change at its current production level of 100,000,profit would not change.What would happen to the company's profit if the change were implemented and production increased to 125,000?

Question

Quizplus · Accepted Answer

At the current production level of 100,000, profit will not change. This implies that the current profit is equal to the total revenue minus the current total cost:

Profit(100,000) = Total Revenue(100,000) - Total Cost(100,000)

Now, if production increases to 125,000, the new profit will be:

Profit(125,000) = Total Revenue(125,000) - Total Cost(125,000)

The new total revenue will be:

Total Revenue(125,000) = 125,000 x Price = 125,000 x $10 = $1,250,000

The new total cost will be:

Total Cost(125,000) = Fixed Cost + Variable Cost(125,000)
= $400,000 + 125,000 x $4 = $900,000

Therefore,

Profit(125,000) = $1,250,000 - $900,000 = $350,000

This is greater than the current profit of $300,000. Hence, if the change were implemented and production increased to 125,000, the company's profit would increase.

A Company Is Debating Whether to Change Its Cost Structure