Question

Erosion costs. Fat Tire Bicycle Company currently sells 40 comma 000 bicycles per year. The current bike is a standard​ balloon-tire bike selling for ​$100 ​, with a production and shipping cost of ​$25 . The company is thinking of introducing an​ off-road bike with a projected selling price of ​$375 and a production and shipping cost of ​$275 . The projected annual sales for the​ off-road bike are 16 comma 000 . The company will lose sales in​ fat-tire bikes of 8 comma 500 units per year if it introduces the new​ bike, however. What is the erosion cost from the new​ bike? Should Fat Tire start producing the​ off-road bike?

Answer 1

Step-by-step explanation:

1. What is the erosion cost from the new​ bike?

= ($100 - $25) × 8500

= $75 × 8500

= $637500

2. Should Fat Tire start producing the​ off-road bike?

Net annual cash flow with the standard bike = ($100 - $25) × 40000 = $75 × 40000 = $3000000

Net annual cash flow with standard and off road bikes will be:

= [($100 - $25) × (40000 - 8500)] + [($375 - $275) × 16000]

= ($75 × 31500) + ($100 × 16000)

= $2362500 + $1600000

= $3962500

Increase in cash flow will now be:

= $3962500 - $3000000

= $962500

Therefore, Fat Tire Bicycle Company should not stop producing off road bike.