Question

Wisconsin Snowmobile Corp. is considering a switch to level production. Cost efficiencies would occur under level production, and aftertax costs would decline by $36,900, but inventory costs would increase by $410,000. Wisconsin Snowmobile would have to finance the extra inventory at a cost of 10.5 percent.

(a-1) Determine the extra cost or savings of switch over to level production. (Input the amount as positive value. Omit the "$" sign in your response.) $
(a-2) Should the company go ahead and switch to level production?
(b) How low would interest rates need to fall before level production would be feasible?

Answer 1

Answer and Explanation:

a-1 The extra cost or saving is as follows

Cost-saving $36,900

Less: Increased cost ($410,000 × 10.5%) $43,050

Loss -$6,150

a-2 Since the company has suffered the loss of $6,150 so the company should not go to switch to level production

b. Now the interest rate is

= Saving cost ÷ Inventory cost increased × 100

= $36,900 ÷ $410,000 × 100

= 9%

This interest rate is decreased by 9% or the switch is less for the feasible

In the case when the inventory has to be considered permanent current assets and the locking long term interest rate is 10.5% so the switching option could be chosen but if it is volatile in short term interest rate, so it would become dip for short term interest rate i.e below 9%