Calculation of Average Costs with Economies of Scope Dee's Dry Cleaning is considering a merger with Larry's Laundry Supply Stores. Dee's total operating costs of producing services are $600,000 for sales volume of $4 million. Larry's total operating costs of producing services are $200,000 for a sales volume (J_P) of $1 million. For a sales volume of $5 million, calculate the reduction in production costs the merged firms need to experience such that the total average cost (TAC) for the merged firms is equal to 10%.

Question

Quizplus · Accepted Answer

First, we need to calculate the combined total operating costs and sales volume for the merged firms:

Total operating costs = Dee's costs + Larry's costs = $600,000 + $200,000 = $800,000
Sales volume = Dee's sales + Larry's sales = $4 million + $1 million = $5 million

Next, we can use the formula for total average cost (TAC):

TAC = Total costs / Sales volume

We want TAC to be equal to 10%, or 0.1. Using algebra, we can rearrange the formula to solve for the reduction in production costs needed:

Reduction in production costs = (TAC * Sales volume) - Total costs 
Reduction in production costs = (0.1 * $5 million) - $800,000 = $200,000

Therefore, the merged firms need to experience a reduction in production costs of $200,000 in order to have a TAC of 10%. The correct choice is B, decrease of $300,000.