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Fixed and Variable Costs

In connection with surfacing a new highway, a contractor


has a choice of two sites on which to set up the asphaltmixing plant equipment. The contractor estimates that it will
cost $1.15 per cubic yard mile (yd 3-mile) to haul the asphaltpaving material from the mixing plant to the job location.
Factors relating to the two mixing sites are as follows
(Production costs at each sites are the same):
Cost factor
Site A
Site B
Average hauling
6 miles
4.3 miles
distance
Monthly rental of site
$1,000
$5,000
Cot set up and
$15,000
$25,000
remove equipment
Hauling expense
$1.15/yd3-mile $1.15/yd3-mile
Flagperson
Not required
$96/day
The job requires 50,000 cubic yards of mixedasphalt-paving material. It is estimated that four months (17
weeks of five working days per week) will be required for
the job. Compare the two sites in terms of their fixed,
variable and total costs. Assume that the cost of the return
trip is negotiable. Which is the better site? For the selected
site, how many cubic yards of paving material does the
contractor have to deliver before starting to make a profit if
paid $8.05 per cubic yard delivered to the job location?
Optimal Demand When Demand Is a Function of Price
A company produces an electronic timing switch that is used
in consumer and commercial products. The fixed cost (CF) is
$73,000 per month, and the variable cost (cv) is $83 per unit.
The selling price per unit is p = $180 0.02(D), based on
equation. For this situation, (a) determine the optimal
volume for this product and confirm that a profit occurs
(instead of a loss) at this demand; (b) find the volumes at
which breakeven occurs; that is, what is the range of
profitable demand?
Breakeven Point When Price Is Independent of Demand
An engineering consulting firm measures its output in a
standard service hour unit, which is a function of the
personnel grades levels in the professional staff. The
variable cost (cv) is $62 per standard service hour. The
charge-out rate [i.e., selling price (p)] is $85.56 per hour.
The maximum output of the firm is 160,000 per year, and its
fixed cost (CF) is $2,024,000 per year. For this firm, (a) what
is the breakeven point in standard service hours and in
percentage of total capacity? (b) What is the percentage
reduction in the breakeven point (sensitivity) if fixed costs
are reduced 10%; if variable cost per hour is reduced 10%;
and if the selling price per unit is increased by 10%?
How Fast Should the Airplane Fly?
The cost of operating a jet-powered commercial (passengercarrying) airplane varies as the three-halves power of its
velocity; specifically, CO = knv3/2, when n is the trip length in
miles, k is a constant of proportionality, and v is velocity in
miles per hour. It is known that at 400 miles per hour, the
average cost of operation is $300 per mile. The company
that owns the aircraft wants to minimize the cost of
operation, but that cost must be balanced against that cost of
passengers time (CC), which has been set at $300,000 per
hour. (a) At what velocity should the trip be planned to
minimize the total cost, which is the sum of the cost of
operating the airplane and the cost of passengers time? (b)
How do you know that your answer for the problem in Part
A minimizes the total cost?

Energy Savings through Increased Insulation


This example deals with a discrete optimization problem of
determining the most economical amount of attic insulation
for a large single-story home in Virginia. In general, the heat
lost through the roof of a single-story home is

In southwest Virginia, the number of heating days


per year is approximately 230, and the annual heating
degree-days equals 230 (65F-46F) = 4370 degree-days per
year. Here, 65F is assumed to be the average inside
temperature and 46F is the average outside temperature
each day.
Consider a 2,400-ft2 single-story house in
Blacksburg. They typical annual space-heating load for this
size of a house is 100 x 106 BTU. That is, with no insulation
in the attic, we lose about 100 x 106 BTE per year.*
Common sense dictates that the no insulation alternative is
not attractive and is to be avoided.
With insulation in the attic, the amount of heat lost
each year will be reduced. The value of energy savings that
results from adding insulation and reducing heat loss is
dependent on what type of residential heating furnace is
installed. For this example, we assume that an electrical
resistance furnace is installed by the builder, and its
efficiency is near 100%.
Now were in a position to answer the following
question: What amount of insulation is most economical?
An additional piece of data we need to involves the cost of
electricity, which is $0.0074 per kWh. This can be converted
to dollars per 10^6 BTU as follows (1kWh = 3,413 Btu):

The cost of several insulation alternatives and


associated space-heating loads for this house are given in the
following table
Amount of Insulation
R11
R19
R30
R38
Investmen
600
900
1300
1600
t cost ($)
Annual
heating
74x106 69.8x106 67.2x106 66.2x106
load
(Btu/year)
In view of these data, which amount of attic
insulation is most economical? The life of the insulation is
estimated to be 25 years.
To Produce or Not to Produce?
A manufacturing plant consists of three departments: A, B,
and C. Department A occupies 100 square meters in one
corner of the plant. Product X is one of the several products
being produced in Department A. The daily production of
Product X is 576 pieces. The cost accounting records show
the following average daily production costs for Product X:

The department foreman has recently learned about an


outside company sells X at $0.35 per piece. Accordingly, the
foreman figured a cost per day of $0.35(576) = $201.60,
resulting in a daily savings of $288.40-$201.60=$86.80.
Therefore, a proposal was submitted to the plant manager
for shutting down the production line of Product X and
buying it from the outside company.
However, after examining each component
separately, the plant manager decided not to accept the
foremans proposal based on the unit cost of product X:
1. Direct labor: because the foreman was supervising
the manufacture of the other products in
Department A in addition to Product X, the only
possible savings in labor wound occur if the
operator working 4 hours per days on Product X
were not reassigned after this line is shut down.
That is, a maximum savings of $90.00 per day
would result.
2. Materials: The maximum savings on direct material
will be $86.40. However, this figure could be lower
if some of the material for Product X is obtained
from scrap of another product.
3. Overhead: Because other products are made in
Department A, no reduction in total floor space
requirements will probably occur. Therefore, no
reduction in overhead costs will result from
discontinuing Product X. It has been estimated that
there will be daily savings in the variable overhead
costs traceable to Product X of about $3.00 due to a
reduction in power costs and in insurance
premiums.
PROBLEMS