a) The computation of the total annual costs of manufacturing shoes for both businesses is as follows:
Company A Company B
Annual fixed costs $120,000 $2.1 million
Total variable costs $80,000 $1,750,000
Total costs $200,000 $3,850,000
b) The computation of the average cost per unit (pair of shoes) for Company A is $10 ($200,000/20,000).
c) The computation of the average cost per unit (pair of shoes) for Company B is $5.50 ($3,850,000/700,000).
d) The two benefits gained by Company B as a result of lower average cost (cost per unit) are:
The cost of production is made up of two elements: variable and fixed costs.
The variable element depends on the units of production. The fixed element of the production cost is a period cost that does not vary within a relevant range.
Company A Company B
Annual output 20,000 700,000
Variable cost per pair $4.00 $2.50
Annual fixed costs $120,000 $2.1 million
Total variable costs $80,000 $1,750,000
Total costs $200,000 $3,850,000
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