Question

You are comparing replacing the current lab, which has a cost function of 400,000 + 15*Volume, with an automated lab that has a cost function of 500,000 + 10*Volume. Doing so would reduce the error rate from 1.5 percent to 1 percent. Your volume is expected to be 45,000 tests per year.

a. You should keep the current lab because its fixed costs are smaller.
b. You should adopt the automated lab because its total costs and error rate are smaller.
c. You should keep the current lab because its total costs and error rate are about the same.
d. None of the above

Answer 1

Answer: b. You should adopt the automated lab because its total costs and error rate are smaller.

Step-by-step explanation:

You should adopt the lab that gives the lowest cost and this is the automated lab because it will have a lower cost due to its lower error rate.

Cost with Automated lab = 500,000 + 10 * 45,000

= $950,000

Cost with current lab = 400,000 + 15 * 45,000

= $1,075,000

Automated lab has a lower cost for the expected volume so should be adopted.