The Velasquez Company, a maker of a variety of metal and plastic products, is in the midst of a business downturn and is saddled with many idle facilities. Columbia Health Care has approached Velasquez to produce 300,000 nonslide serving trays. Columbia will pay $1.50 each. Velasquez predicts that its variable costs will be $1.60 each. Its fixed costs, which had been averaging $1 per unit on a variety of other products, will now be spread over twice as much volume. The president commented, “Sure we’ll lose $.10 each on the variable costs, but we’ll gain $.50 per unit by spreading our fixed costs. Therefore, we should take the offer because it represents an advantage of $.40 per unit.”
Suppose the regular business had a current volume of 300,000 units, sales of $600,000, variable costs of $480,000, and fixed costs of $300,000. Do you agree with the president? Why?