Question

Howell Industrics specializes in precision plastics. Their latest invention promises to revolutionize the electronics industry, and they have already made and sold 75 of the miracle devices. They have cstimated average costs as given in the following table: $$\begin{array}{cl} \text { Unit } & A T C \\ \hline 74 & \$ 10,000 \\ 75 & \$ 12,000 \\ 76 & \$ 14,000 \end{array}$$ Backus Electronics has just offered Howell \(\$ 150,000\) if it will produce the 76 th unit. Should Howell accept the offer and manufacture the additional device?

Short answer

Yes, Howell should accept the offer because the amount offered ($150,000) is greater than the cost of producing the unit ($14,000). As a result, they would make a profit of $136,000 from this transaction.

Step-by-step solution

Identify the Offer and the Cost

From the provided data, we know that Backus Electronics has offered $150,000 for the 76th unit. The ATC for the 76th unit is $14,000. These values help us understand the relationship between the cost to produce and the offer being made.

Determine the Profit or Loss

To determine if Howell Industrics will make a profit or loss, we subtract the ATC from the offer to see if what's left (if anything) is a positive or negative amount. In other words, profitability would imply that the offer exceeds the ATC.

Evaluate the Economic Decision

After calculating the difference, observe the output and make the final decision. If the output is positive, Howell should accept the offer as it leads to profit. Otherwise, if the output is negative, it is a loss – Howell should reject the offer.

Key concepts

Average Total Cost in Decision Making

The concept of Average Total Cost (ATC) is vital in making smart production decisions. ATC represents the total cost of producing all units divided by the number of units produced. This gives companies an insight into the cost efficiency of producing additional units.

For Howell Industrics, calculating the ATC for each unit tells them how much, on average, they've spent to produce each unit up to that point. In our example, calculating the ATC for the 76th unit involves dividing the total cost of producing all 76 units by 76. Knowing the ATC helps Howell decide if accepting new offers, like the one from Backus Electronics, will be profitable.

Understanding ATC enables businesses to assess their production policies and make better financial decisions, particularly when scaling up production or accepting offers for additional production.

Understanding Profit Maximization

Profit maximization occurs when companies make decisions that result in the largest possible financial return. In terms of Howell Industrics, this means producing and selling units where the revenue exceeds the costs substantially.

To determine if accepting Backus Electronics' offer aligns with profit maximization, Howell needs to ensure the price per unit they're receiving ($150,000 for the 76th unit) exceeds the ATC ($14,000 for the 76th unit). Profit would be the difference, in this case, $150,000 - $14,000 = $136,000.

• If this difference is positive, Howell is maximizing profit by accepting the offer.
• If it's negative, Howell should consider not proceeding, as it would not contribute to profit maximization.

Profit maximization involves making strategic decisions to increase financial gains while minimizing costs, helping businesses grow sustainably.

Strategic Production Decision Making

Production decisions are crucial in determining whether to increase, decrease, or maintain current production levels. These decisions should consider costs, demand, and potential financial benefits.

For Howell, deciding to produce the 76th unit involves weighing the cost of this production against the revenue gained. Since Backus Electronics offers $150,000, and the cost (ATC) is $14,000, Howell stands to gain a significant profit from this transaction.

When making a production decision, companies consider factors such as:

• Market demand and offer terms
• Capacity and resources available
• Impact on existing production and potential constraints

Howell's decision to accept the offer should stem from a careful consideration of these elements, ensuring it aligns with their strategic goals.