Question - Panda Flowers

Panda Flowers is developing 50 Hectares of Green Houses for Roses using Spanish Technology. 40 Hectares are already producing Roses which are exported to USA.

Panda Flowers is situated in the Flower Business about 100 Km from Nairobi, the capital of Kenya.

-From Panda Flowers' website (http://pandaflowers.net/aboutus.html)

For the current year, Panda Flowers plans to plant one hectare of newly developed land with carnations.Like the roses being currently produced, the carnations will be exported to the USA.

The one-hectare plot is expected to be able to produce up to 50,000 stems per year, and Panda expects to be able to charge $1.00 per stem.However, their customers will only pay for stems received in good condition, and based on past experience, Panda will sell (and thus be paid for) only 8 stems out of every 10 which are produced and shipped.

Under their current growing practices, Panda expects to have a variable cost (mostly labor and shipping, but also materials such as bulbs, pots, fertilizer, etc) of $0.60 per stem produced.

Fixed costs will be approximately $12,000 per year, and is mostly the cost of the land and equipment.

Required:

1.What is Panda's breakeven point for carnations under current growing practices (in number of stems produced per year)?Hint: it is more than their current production capacity.

One reason the initial plan (in part 1) is not feasible is that production is highly labor-intensive.Panda Flowers is considering an increase in automation to lower their variable labor costs, although this will also increase fixed costs (for example, by increasing rent and/or depreciation).

Specifically, assume that for any reduction in variable cost per stem, there will be a 10,000 times greater increase in fixed costs per year.In addition, the reduction of variable cost is limited to a maximum of $0.10 per stem - i.e., from $0.60 per stem down to $0.50 per stem.Further reduction below that is not possible regardless of the increase in fixed costs.

For example, to decrease variable costs by $0.10, the largest possible reduction, fixed costs will increase by $1,000 (10,000x$0.10).To decrease variable costs by a tenth of a cent ($0.001), fixed costs will increase by $10 (10,000x$0.001).

2.Assuming full production (50,000 stems) how much profit will Panda Flowers earn if it adopts the maximum amount of automation - this is, if it reduces variable costs by the full $0.10 per stem?

3.What is the minimum amount of automation (expressed in the reduction of variable cost per stem) that Panda Flowers must adopt in order to break even? Assume full production of 50,000 stems.

4.A large uncertainty about Panda Flowers' plan is the future demand for carnations.Assume that they cannot grow other flowers on the same plot of land, at least in the short term.Do you think that the automation plan makes the risk of future demand fluctuations more or less of a concern?Explain briefly, using the concept of operating leverage.No numbers are necessary!