Northern Woods Is Considering Two Methods of Production for a New

question 30

Multiple Choice

Northern Woods is considering two methods of production for a new product.The first method will require fixed assets costing $450,000 that will be depreciated straight-line to zero over the product's 3-year life.Annual fixed costs are $316,000 and variable costs per unit are $8.64.The second method will require fixed assets costing $790,000,annual fixed costs of $211,000,and variable costs per unit of $6.57.The firm expects to sell 46,000 units per year at $20 a unit.The discount rate is 16 percent and the tax rate is 21 percent.Should the product be produced and if so,which method of production should be implemented and why?

• A)Yes; Method A; because A has the lower initial cost
• B)Yes; Method A; because it will break-even on a financial basis with fewer annual sales
• C)Yes; Method B; because it has lower annual costs
• D)Yes; Method B; because B has a financial break-even quantity that is less than the expected sales units
• E)No; Neither method of production will financially break-even within the expected life of the project.

---

Definitions:

Forever

A term indicating an infinite or unspecified period of time, often used in the context of time without end.

Average Total Cost

The cost per unit of output, calculated by dividing the total cost by the quantity of output produced.

Natural Monopoly

A market condition where a single firm can supply a good or service to an entire market at a lower cost than could two or more firms.

Natural Monopoly

A market structure where a single supplier is most efficient in providing goods or services due to high fixed or startup costs.