Question

You are the general manager of a firm that manufactures personal computers. Due to a soft economy, demand for PCs has dropped 50 percent from the previous year. The sales manager of your company has identified only one potential client, who has received several quotes for 10,000 new PCs. According to the sales manager, the client is willing to pay \(800 each for 10,000 new PCs. Your production line is currently idle, so you can easily produce the 10,000 units. The accounting department has provided you with the following information about the unit (or average) cost of producing three potential quantities of PCs:

Based on this information, should you accept the offer to produce 10,000 PCs at \)800 each? Explain.

Short answer

The offer should be accepted.

Step-by-step solution

Decision

It is important to bear in mind that this decision to produce computers for a potential client will occur in the short term, so we must consider that the fixed costs are already paid regardless of whether the company produces 10,000 units or 0 units.

Therefore, the decision to produce these units will be based on whether the sales prices of each computer, or the income that the company will obtain, will be equal to the average variable costs. Therefore, we can reorder the financial information table by highlighting the average variable cost (AVC):

Profit

As can be seen in the three levels of production, the cost of producing each unit in the short-term will be $750, which is less than the $800. It has been estimated that the potential customer will pay for each computer. However, the customer is only interested in 10,000 units and given the market circumstances, only the quantities demanded will be produced.

Thus, the profit of the company will be the following:

$\begin{array}{c}\text{Benefit}=\left(\$800\times 10,000\right)-\left(\$750\times 10,000\right)\\ =\$500000\end{array}$

Since the deal is accruing $50000 profit to the firm, the manager should go for it.