Question

Wisconsin Snowmobile Corp. is considering a switch to level production. Cost efficiencies would occur under level production, and after-tax costs would decline by \(36,000, but inventory would increase by \)300,000. Wisconsin Snowmobile would have to finance the extra inventory at a cost of 13.5 percent.

a. Determine the extra cost or savings of switching over to level production. Should the company go ahead and switch to level production?

Short answer

The company would suffer a loss of $4,500 so they should not switch over to level production.

Step-by-step solution

Calculation of switching over to level of production

The switch over to level production will result in a loss of $4,500.

$\begin{array}{rcl}\mathrm{Switching}\mathrm{over}\mathrm{cost}& =& \mathrm{Increased}\mathrm{inventory}\times \mathrm{Interest}\mathrm{expense}-\mathrm{Savings}\\ & =& \$300,000\times 13.5\%-\$36,000\\ & =& \$40,500-\$36,000\\ & =& \$4,500\left(\mathrm{loss}\right)\end{array}$

Company’s decision for switch-over

The company should not switch over to level production as the ROI is less than the cost of production under level production. The company will suffer a loss of $4,500 under level production.