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Cambridge IGCSE0450

Costs, scale of production and break-even analysis

Business Studies 0450 Chapter Notes

What this chapter covers

Costs, scale of production and break-even analysis - Identify and classify costsCosts, scale of production and break-even analysis - Economies and diseconomies of scaleCosts, scale of production and break-even analysis - Break-even analysis
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In this chapter

  1. 1Fixed and variable costs
  2. 2Total cost
  3. 3Average cost
  4. 4Using cost data to compare options
  5. 5Stop or continue production
  6. 6What economies of scale are
  7. 7Purchasing economies of scale
  8. 8Technical and financial economies of scale
  9. 9Managerial and marketing economies of scale
  10. 10Diseconomies of scale
  11. 11Weighing economies against diseconomies
  12. 12What break-even means
  13. 13Calculating break-even output
  14. 14Break-even charts
  15. 15Margin of safety
  16. 16Using break-even to make decisions
  17. 17Limitations of break-even analysis

1. Fixed and variable costs

A fixed cost is a cost that does not change with output or sales. A variable cost is a cost that changes with output.

Rent and electricity are typical fixed costs. Raw materials are a typical variable cost. A cost is fixed because it does not change with output, not because it changes very little.

Examiner insight

“Some candidates stated that fixed costs would never change rather than not change with output.” “Most candidates could identify at least one fixed cost with rent or electricity typical responses. A common mistake was to identify variable costs such as wages or raw materials.”

Worked example 14 marks

Kofi's Bakery sells loaves in Accra. It pays textdollar800 rent each month. Flour and yeast cost textdollar0.40 a loaf.

Explain why the rent is a fixed cost and the flour and yeast are a variable cost.

  1. 1

    Knowledge: a fixed cost does not change with output [1]

  2. 2

    Application: the rent stays at textdollar800 whether Kofi bakes 1 000 or 5 000 loaves [1]

  3. 3

    Knowledge: a variable cost changes with output [1]

  4. 4

    Application: the flour and yeast bill rises with every extra loaf, at textdollar0.40 a loaf [1]

2. Total cost

Total cost is all the costs of producing a given output: the fixed costs plus the total variable cost.

Total variable cost is the variable cost per unit multiplied by the output. Multiply first, then add the fixed costs.

total variable cost = variable cost per unit × output

total cost = fixed costs + total variable cost

Examiner insight

“Most candidates correctly defined total cost. A common mistake was to confuse the term with average cost or start-up capital.” “However, weaker responses forgot to add fixed cost to total variable cost or did not multiply variable cost per person by the number of people attending the event.”

Worked example 12 marks

Lagos Lamps makes lamps. Its fixed costs are textdollar6 000 a month. The variable cost is textdollar12 for each lamp. In March it makes 400 lamps.

Calculate the total cost for March.

  1. 1

    total variable cost = 400 × textdollar12 = textdollar4 800 [1]

  2. 2

    total cost = textdollar6 000 + textdollar4 800 = textdollar10 800 [1]

3. Average cost

Average cost (unit cost) is the total cost divided by the output. It is the cost of making one unit.

When output rises, total cost usually rises. Average cost can still fall, because the fixed costs are shared between more units.

average cost = (total cost)/output

Examiner insight

“The strongest responses often provided the formula: total costs divided by total output. A common mistake was to repeat the word 'average'.” “Vague comments such as costs are lower were often present when in fact total costs are likely to be higher with the increased output and it is average or unit costs that are lower.”

Worked example 14 marks

Nile Notebooks makes 2 000 notebooks in May at a total cost of textdollar9 000. In June it makes 3 000 notebooks at a total cost of textdollar12 000. Its fixed costs do not change.

Calculate the average cost in each month and explain what has happened to it.

  1. 1

    Application: May: average cost = textdollar9 000 ÷ 2 000 = textdollar4.50 [1]

  2. 2

    Application: June: average cost = textdollar12 000 ÷ 3 000 = textdollar4.00 [1]

  3. 3

    Analysis: average cost has fallen by textdollar0.50 a notebook even though total cost has risen by textdollar3 000 [1]

  4. 4

    Analysis: the same fixed costs are shared between more notebooks [1]

4. Using cost data to compare options

A business can use cost data to choose between options. It works out the total cost and the average cost of each and compares them. When the options make different outputs, compare average cost, because the bigger output will usually have the bigger total cost.

Profit is total revenue minus total costs. A business can compare profit only when it knows the selling price.

The figures are not the decision. Say what they mean for this business and what could go wrong.

total revenue = price × quantity sold

profit = total revenue - total costs

Examiner insight

“As the selling price was not provided in the data candidates could not justify the choice of one location based on profits.” “Many candidates accurately explained that a cheaper supplier would result in lower total cost and therefore average cost would fall but this would not be a wise choice if the quality of supplies was inferior.”

Worked example 16 marks

Green Valley Juice sells 10 000 bottles a month. It must choose between two machines. Machine A has fixed costs of textdollar8 000 a month and a variable cost of textdollar1.00 a bottle. Machine B has fixed costs of textdollar5 000 a month and a variable cost of textdollar1.50 a bottle.

Which machine should it buy? Justify your answer.

  1. 1

    Knowledge: total cost = fixed costs + (variable cost per unit × output) [1]

  2. 2

    Application: Machine A: textdollar8 000 + (textdollar1.00 × 10 000) = textdollar18 000 [1]

  3. 3

    Application: Machine B: textdollar5 000 + (textdollar1.50 × 10 000) = textdollar20 000 [1]

  4. 4

    Analysis: A has the lower total cost and the lower average cost (textdollar1.80 against textdollar2.00) at 10 000 bottles [1]

  5. 5

    Evaluation: recommend Machine A at this output [1]

  6. 6

    Evaluation: below 6 000 bottles Machine B would be cheaper, so A is the better buy only if sales stay high [1]

5. Stop or continue production

To decide whether to stop or continue, a business compares total revenue with total costs. If revenue is below total costs, it makes a loss.

A loss does not settle the decision. Variable costs change with output, so they stop when output stops. Fixed costs do not change with output, so a fixed cost such as rent under a contract is still paid when output is zero.

So compare the loss from continuing with the loss from stopping, then judge what else could change.

Examiner insight

“Others did not go beyond calculating total revenue and total costs and lost the opportunity for higher marks by not going on to calculate profit.” “Some candidates could calculate all the relevant figures but they did not understand what the figures meant.”

Worked example 18 marks

Hassan's Handcrafts makes leather bags. Each month it sells 150 bags at textdollar40 each. Its only fixed cost is textdollar4 000 a month rent for a workshop, on a contract with 12 months left. The variable cost is textdollar25 a bag.

Should Hassan stop making bags? Justify your answer.

  1. 1

    Knowledge: fixed costs do not change with output, variable costs do [1]

  2. 2

    Application: revenue = 150 × textdollar40 = textdollar6 000 [1]

  3. 3

    Application: total variable cost = 150 × textdollar25 = textdollar3 750 [1]

  4. 4

    Application: total cost = textdollar4 000 + textdollar3 750 = textdollar7 750 [1]

  5. 5

    Analysis: revenue is below total cost, so there is a loss of textdollar1 750 a month [1]

  6. 6

    Analysis: if he stops, the textdollar4 000 rent is still paid, so the loss is textdollar4 000 a month [1]

  7. 7

    Evaluation: continue, because the loss is smaller than the loss from stopping [1]

  8. 8

    Evaluation: when the contract ends, stop unless a higher price or lower cost removes the loss [1]

Recap

  • A fixed cost does not change with output. A variable cost changes with output.
  • Total cost = fixed costs + total variable cost. Total variable cost = variable cost per unit × output.
  • Average cost = total cost ÷ output. Total cost can rise while average cost falls.
  • Profit = total revenue − total costs. With no selling price, compare total cost and average cost.
  • Stop or continue: compare the loss from continuing with the loss from stopping. Fixed costs are still paid at zero output.
  • Always apply the figures to the business, then make a decision and give a reason.

6. What economies of scale are

Economies of scale are the reductions in average cost (cost per unit) that a business gains as it grows and its output increases. Total costs rise as output rises. It is the cost of each unit that falls.

The syllabus examples are purchasing, marketing, financial, managerial and technical economies. Name the economy, say how it works, then finish on lower average cost.

Write about the business in the question. Name what it buys, makes or borrows for.

Examiner insight

“The majority of candidates could not explain that each of the economies lead to lower average cost.” “To gain full marks candidates should have contextualised their responses, such as buying components to produce agricultural equipment.”

Worked example 12 marks

BRK is a copper mining business which operates in the primary sector. It is a multinational company (MNC) with mines in 15 countries. As a large business BRK benefits from economies of scale. Identify two economies of scale.

  1. 1

    Knowledge: one economy of scale, such as purchasing [1]. [1]

  2. 2

    Knowledge: a second, different economy, such as financial or technical [1]. [1]

7. Purchasing economies of scale

A large business buys in bulk. Suppliers give it discounts on large orders, so each unit of raw material costs less. The average cost of each unit made therefore falls.

Stopping at ‘bulk buying gives discounts’ is only the knowledge point. The analysis is the final link to a lower cost per unit.

Do not turn the answer into a problem with storage. The question asks for the benefit.

Examiner insight

“Purchasing economy was the best understood of the three, but answers often did not go beyond stating that raw materials would be purchased in bulk leading to discounts. The final link to lower average or unit costs was rarely made.” “Weak responses focused on the possible extra costs of storage and food deteriorating rather than why unit costs would fall.”

Worked example 14 marks

Millbrook Bakery makes bread for 40 shops. It plans to double its output and will need twice as much flour. Explain one economy of scale that Millbrook Bakery could gain.

  1. 1

    Knowledge: a purchasing economy, as it can buy flour in bulk at a discount [1]. [1]

  2. 2

    Application: it will need twice as much flour, so its order is twice as large [1]. [1]

  3. 3

    Analysis: the flour for each loaf costs less [1]. [1]

  4. 4

    Analysis: the average cost of each loaf falls [1]. [1]

8. Technical and financial economies of scale

A technical economy comes from the use of specialised equipment. A large business can use advanced machines that increase the speed of production. More units are made in the same time, so the average cost falls.

A financial economy comes from borrowing. A large business can find it easier to obtain loans at a lower rate of interest. This gives a lower cost of borrowing for each unit it makes.

In each case the explanation must end at lower unit costs. Do not write about breakdowns or the price of the machine.

Examiner insight

“Technical economy was about increased use of specialised equipment, but the link was rarely made to increased speed of production leading to lower unit costs.” “Financial economy was often just seen as easier to obtain loans at a lower interest rate, but few candidates went on to link this to a lower cost of borrowing.”

Worked example 16 marks

Stanton Tiles makes ceramic tiles in one factory. It plans to build a second factory and to buy a new high-speed machine. It will borrow money to pay for both. Explain one technical and one financial economy of scale that Stanton Tiles could gain.

  1. 1

    Knowledge: a technical economy, as it can use specialised equipment [1]. [1]

  2. 2

    Application: the new high-speed machine in its factory makes more tiles each hour [1]. [1]

  3. 3

    Analysis: the speed of production increases, so the average cost of each tile falls [1]. [1]

  4. 4

    Knowledge: a financial economy, as a larger business can borrow at a lower rate of interest [1]. [1]

  5. 5

    Application: the loan for the second factory could carry a lower rate [1]. [1]

  6. 6

    Analysis: the cost of borrowing for each tile is lower, so average cost falls [1]. [1]

9. Managerial and marketing economies of scale

Managerial and marketing economies are the other two syllabus examples. Most candidates can name them. Few can explain how they arise.

Use the case material to say where the saving comes from, such as the management of factory workers on many production lines. Then link the point to how it reduces average cost.

That final link is what reaches the higher levels of the mark scheme.

Examiner insight

“The majority of candidates were able to identify economies of scale with marketing, managerial, purchasing, technical and financial being the most popular answers. However, few could accurately explain how all the economies arise.” “For financial and managerial economies of scale, it was important to link the point made to how it would result in reducing average cost.”

Worked example 14 marks

Harbour Juice sells bottled juice in 30 shops. After a merger it will sell in 90 shops. The marketing manager says the cost of one advertising campaign will now be shared across the sales of 90 shops, not 30. Explain one marketing economy of scale that Harbour Juice could gain.

  1. 1

    Knowledge: a marketing economy [1]. [1]

  2. 2

    Application: the cost of one advertising campaign is shared across the juice sold in 90 shops, not 30 [1]. [1]

  3. 3

    Analysis: the marketing cost of each bottle sold is lower [1]. [1]

  4. 4

    Analysis: so the average cost of each bottle falls [1]. [1]

10. Diseconomies of scale

Diseconomies of scale are problems of growing too large that make the average cost of each unit rise. The syllabus examples are poor communication, lack of commitment from employees and weak coordination.

Explain why the problem raises the cost of each unit. Poor communication can come from a longer chain of command, so messages are distorted and work is not carried out efficiently.

A diseconomy is not an economy turned upside down. ‘Needing more employees’ is not a problem. The problem is the extra cost of paying them.

Examiner insight

“Strong responses could explain why the diseconomy would result in higher unit costs for the business.” “Rather than using vague words such as ‘manage’, responses needed to be more specific, such as explaining that it would be difficult to control or coordinate the business.”

Worked example 16 marks

Pavlos Parcels delivers parcels in one city with 20 drivers. It has opened depots in 12 more cities and now has 400 drivers. Explain two diseconomies of scale that Pavlos Parcels may now face.

  1. 1

    Knowledge: poor communication [1]. [1]

  2. 2

    Application: managers in 13 depots cannot pass instructions quickly to 400 drivers [1]. [1]

  3. 3

    Analysis: messages are distorted, so deliveries are late and the cost of each parcel rises [1]. [1]

  4. 4

    Knowledge: lack of commitment from employees [1]. [1]

  5. 5

    Application: drivers in distant depots may feel they are only a number in a large business [1]. [1]

  6. 6

    Analysis: they work less hard, so fewer parcels are delivered per driver and average cost rises [1]. [1]

11. Weighing economies against diseconomies

Growth has two sides. A business that grows gains economies of scale that lower average cost. If it grows too far it meets diseconomies of scale that raise average cost again.

A longer answer ends with a judgement. Say which point gives the greater benefit. Then say, in context, why the other points matter less.

Answer the question set. A question on diseconomies is not a question on location, and a list of general factors for growth earns nothing.

Examiner insight

“Those candidates who did give a reason why one economy of scale would have more effect on profits seldom discussed why this would have more effect than the other alternatives and instead candidates simply discussed why one economy of scale would have the biggest effect.” “Stronger answers included a conclusion that explained the greater benefit of one economy of scale and then justified, in context, why the other two economies of scale would have less benefit.”

Worked example 16 marks

Delmar Chocolates makes chocolate bars in one factory. Its owner plans to double output by opening a second factory 300 km away. Do you think the average cost of Delmar Chocolates will fall if it opens the second factory? Justify your answer.

  1. 1

    Knowledge: a purchasing economy from buying in bulk [1]. [1]

  2. 2

    Analysis: it will buy twice as much cocoa and sugar, so suppliers may give discounts and the cost of each bar falls [1]. [1]

  3. 3

    Knowledge: a diseconomy of scale, weak coordination [1]. [1]

  4. 4

    Analysis: the factories are 300 km apart, so the owner cannot control both, work is not carried out efficiently and the cost of each bar rises [1]. [1]

  5. 5

    Evaluation: a decision, such as average cost will fall [1]. [1]

  6. 6

    Evaluation: a reason that weighs the two, such as the discount applies to every bar made, while coordination can be improved by appointing a manager at each factory [1]. [1]

Recap

  • Economies of scale are falls in average (unit) cost as a business grows. Total costs still rise.
  • Syllabus examples: purchasing, marketing, financial, managerial and technical.
  • Purchasing: buying in bulk gives discounts, so each unit costs less.
  • Technical: specialised equipment speeds up production, so unit cost falls.
  • Financial: a lower rate of interest means a lower cost of borrowing.
  • Diseconomies of scale: poor communication, lack of commitment from employees and weak coordination raise average cost.
  • Weigh both sides. Say which matters more, and why the others matter less.

12. What break-even means

Break-even output is the level of output at which total revenue equals total costs. At this point the business makes no profit and no loss.

Below break-even output, total costs are higher than revenue, so the business makes a loss. Above it, revenue is higher than total costs, so the business makes a profit. Break-even output is counted in units, not in money.

A business uses it to find how much it must sell to cover all of its costs, fixed and variable.

Examiner insight

“The best responses were able to provide a precise definition recognising that it was where total costs equal revenue.” “The weakest answers simply repeated the term ‘break even’ in their definition without offering an alternative explanation.”

Worked example 12 marks

Marlow Mugs makes handmade ceramic mugs in a small workshop. The owner says she cannot pay herself a wage until the business reaches break-even output. Define ‘break-even output’.

  1. 1

    Knowledge: the level of output at which total revenue equals total costs [1]. [1]

  2. 2

    Knowledge: so the business makes neither a profit nor a loss [1]. [1]

13. Calculating break-even output

Fixed costs do not change with output. Variable costs rise with every unit made. Each unit sold brings in its selling price and uses up its variable cost. What is left pays towards the fixed costs.

So break-even output is the fixed costs divided by what each unit leaves over. Write the formula and show the working. Then give the answer in units: candles, beds or tables.

A dollar sign on the answer turns a number of units into money and loses the mark.

break-even output = (fixed costs)/(selling price per unit - variable cost per unit)

Examiner insight

“Some made a mistake by representing the answer as a financial value, by adding the dollar sign ($) so could not be awarded the second mark.”

Worked example 12 marks

Tolland Candles makes scented candles. Its fixed costs are 9 000 dollars a year. Each candle sells for 12 dollars and the variable cost of making it is 7.50 dollars. Calculate Tolland’s break-even output. Show your working.

  1. 1

    Knowledge: break-even output = fixed costs ÷ (selling price − variable cost per unit) [1]. [1]

  2. 2

    Application: 9 000 ÷ (12 − 7.50) = 9 000 ÷ 4.50 = 2 000 candles [1]. [1]

14. Break-even charts

A break-even chart has output on the horizontal axis and costs and revenue on the vertical axis. It draws a fixed costs line, a total costs line and a total revenue line.

The fixed costs line is flat. The total costs line starts at the fixed costs figure, not at zero, and rises with output. The total revenue line starts at the origin. Where the two cross is the break-even point. Read down to the axis for break-even output.

To the left of the point the business makes a loss. To the right it makes a profit. To amend a chart, change only the line that the new information affects.

Examiner insight

“Common errors were drawing the line from the origin, or trying to change fixed cost as well.” “A common error was to state that break-even would show the profit made, rather than the potential profit at any level of output.”

Worked example 14 marks

This is the break-even chart for Tolland Candles. State Tolland’s break-even output. Calculate Tolland’s profit when it makes 4 000 candles.

  1. 1

    Knowledge: break-even is where the total revenue and total costs lines cross [1]. [1]

  2. 2

    Application: the lines cross at 2 000 candles [1]. [1]

  3. 3

    Application: at 4 000 candles revenue is 48 000 dollars and total costs are 39 000 dollars [1]. [1]

  4. 4

    Analysis: profit = 48 000 − 39 000 = 9 000 dollars, the gap between the lines [1]. [1]

15. Margin of safety

The margin of safety is how far current output is above break-even output. It shows how much output can fall before the business makes a loss.

A large margin of safety means a safer business. A small margin means a small fall in sales could push it into a loss.

Find it by subtracting break-even output from current output. The answer is in units, not money.

margin of safety = current output - break-even output

Examiner insight

“Many candidates divided the values rather than subtracting the break-even output from the current output.” “Many candidates thought incorrectly that the margin of safety was the difference between maximum output and break-even output.”

Worked example 12 marks

KYX is a public limited company. It manufactures beds in country Y. The operations manager is reviewing KYX’s output data as he wants to calculate the margin of safety. Calculate KYX’s margin of safety. Show your working.

Extract from KYX’s output dataunits
current output13 000
break-even level of output10 000
  1. 1

    Knowledge: margin of safety = current output − break-even output = 13 000 − 10 000 [1]. [1]

  2. 2

    Application: 3 000 beds [1]. [1]

16. Using break-even to make decisions

A business can use break-even analysis to decide how much it must sell, to set a target, and to see the effect of price and cost changes on break-even output.

A higher price means each unit leaves more to pay the fixed costs, so break-even output falls. A fall in variable costs has the same effect. A rise in costs does the opposite: break-even output rises.

Say what happens to break-even output, not only to profit. A break-even chart assumes all output is sold, so it cannot show whether a higher price loses customers.

Examiner insight

“For part (ii) whilst many candidates scored some marks by suggesting price increases and cost reductions as suitable ways to reduce the break-even output many focused their explanation on profit rather than the impact on the break-even output and hence limited their access to higher marks.” “Other candidates focused on the impact of higher prices on sales - forgetting that a break-even chart assumes all items are sold.”

Worked example 14 marks

Tolland Candles has fixed costs of 9 000 dollars a year and a variable cost of 7.50 dollars a candle. It sells each candle for 12 dollars. The owner is thinking of raising the price to 13.50 dollars. Explain how this would affect Tolland’s break-even output.

  1. 1

    Knowledge: a higher price means each candle leaves more to pay the fixed costs, so break-even output falls [1]. [1]

  2. 2

    Application: each candle leaves 6 dollars (13.50 − 7.50) instead of 4.50 dollars [1]. [1]

  3. 3

    Application: new break-even output = 9 000 ÷ 6 = 1 500 candles [1]. [1]

  4. 4

    Analysis: break-even output falls by 500 candles, from 2 000, so Tolland covers its costs at a lower output [1]. [1]

17. Limitations of break-even analysis

Break-even analysis rests on assumptions. The main one is that all output is sold. It also assumes that no inventories are held, so output made is the same as output sold.

A chart covers one product. A business with several products needs a separate chart, and a separate forecast, for each.

The figures are forecasts, so the chart is only as reliable as the forecasts behind it. Name the assumption and say why it may not hold. ‘Inaccurate’ on its own earns nothing.

Examiner insight

“Weak responses simply mentioned that break-even was not always accurate. A more specific answer was needed.” “Incorrect answers often focused on vague statements about it being ‘time-consuming’ or ‘inaccurate’ which were not awardable.”

Worked example 14 marks

Harbour Bakery bakes bread fresh each morning. It also sells cakes and pies. The owner uses a break-even chart for her bread. Outline two limitations of break-even analysis for Harbour Bakery.

  1. 1

    Knowledge: break-even analysis assumes all output is sold [1]. [1]

  2. 2

    Application: Harbour bakes fresh loaves each morning, and any left unsold go stale [1]. [1]

  3. 3

    Knowledge: a separate chart is needed for each product [1]. [1]

  4. 4

    Application: Harbour also sells cakes and pies, so it needs three charts, each with its own forecast [1]. [1]

Recap

  • Break-even output: total revenue equals total costs, so no profit and no loss.
  • Break-even output = fixed costs ÷ (selling price − variable cost per unit). Answer in units.
  • Chart: total costs start at fixed costs, total revenue starts at zero. They cross at the break-even point.
  • Margin of safety = current output − break-even output. Subtract, in units.
  • Higher price or lower costs lower break-even output. Higher costs raise it.
  • Limitations: all output sold, no inventories, one chart per product, forecasts. Never just ‘inaccurate’.

End-of-chapter exercise

Test yourself on the whole chapter. Work through these before moving on.

  1. Define 'fixed cost'.2 marks
  2. Zara's Taxis pays textdollar300 insurance each month, however far its cars are driven. It buys fuel for every kilometre driven. Identify one fixed cost and one variable cost.2 marks
  3. Define 'average cost'.2 marks
  4. Maple Crafts makes candles. Its fixed costs are textdollar2 000 a month. The variable cost is textdollar3 a candle. It makes 800 candles a month. Calculate the total cost and the average cost for a month.4 marks
  5. Sunrise Bakery has fixed costs of textdollar3 000 a month. The variable cost is textdollar2 a loaf. It raises its output from 1 000 to 2 000 loaves a month. Explain, using calculations, what happens to its total cost and its average cost.4 marks
  6. Lena's Print Studio rents its shop for textdollar900 a month on a contract. Each poster costs textdollar0.50 in paper and ink. This month it prints no posters. Explain what happens to its costs.4 marks
  7. Tariq's Tiles makes 5 000 tiles a month. Its fixed costs are textdollar4 000 a month. Clay costs textdollar2.00 a tile and is its only variable cost. A supplier offers cheaper clay at textdollar1.60 a tile. Should Tariq buy the cheaper clay? Justify your answer.6 marks
  8. Farid's Fruit Stall earns textdollar2 500 revenue a month. Its variable costs are textdollar1 500 a month. Its only fixed cost is textdollar1 200 a month for the stall, under a contract. Should Farid stop trading? Justify your answer.6 marks
  9. Baraka Ice makes blocks of ice for fishing boats. It must rent one of two freezer plants. Plant X has fixed costs of textdollar3 000 a month and a variable cost of textdollar0.50 a block. It would make 6 000 blocks a month. Plant Y has fixed costs of textdollar1 800 a month and a variable cost of textdollar0.60 a block. Power cuts mean it would make only 4 000 blocks a month. Baraka has not yet set its price. Which plant should Baraka choose? Justify your answer.8 marks
  10. Northlight Candles makes two candles in one rented workshop. The rent of textdollar3 000 a month is its only fixed cost, and the lease has a year left. The owner shares the rent equally between the two candles, finds that lavender makes a loss, and wants to stop making it. Vanilla sales would not change. Her sales manager forecasts that a lavender price of textdollar3.60 would cut lavender sales to 1 600 a month. Use the table. Advise the owner whether to continue as now, stop the lavender candle, or raise its price. Justify your decision. | Candle | Sales a month | Price | Variable cost per candle | | --- | --- | --- | --- | | Lavender | 2 000 | textdollar3.00 | textdollar2.50 | | Vanilla | 1 500 | textdollar6.00 | textdollar3.00 |12 marks
  11. Define ‘economies of scale’.2 marks
  12. Ferndale Foods is growing fast. Identify two economies of scale that Ferndale Foods may gain.2 marks
  13. A clothing business has grown from 30 to 900 employees. Identify two diseconomies of scale it may face.2 marks
  14. Orchard Lane Cafe has opened five more branches. It now buys milk, coffee and cakes for all six. Explain one economy of scale the cafe may gain.4 marks
  15. Tidewater Taxis has grown from 10 drivers in one city to 90 drivers in four cities. The owner still runs the business from one office. Outline two diseconomies of scale Tidewater Taxis may face.4 marks
  16. Brightwell Printing has moved to a larger factory and bought a high-speed printing machine. Explain one technical economy of scale for Brightwell Printing.4 marks
  17. Crestview Furniture is doubling its factory. It will borrow $2 million and buy twice as much wood. Explain one financial and one purchasing economy of scale for Crestview Furniture.6 marks
  18. Nordic Cycles has grown from one workshop to 12 workshops in different cities. Explain two diseconomies of scale that Nordic Cycles may face.6 marks
  19. Vireo Translations translates documents for other businesses. It buys almost no materials. It has grown from 15 translators in one office to 200 translators in offices in six countries. It will borrow $3 million to open two more offices. Identify and explain one economy of scale and one diseconomy of scale for Vireo Translations as it expands.8 marks
  20. Kestrel Glass makes glass bottles. It plans to raise output from 2 million to 5 million bottles a year. It will borrow $2 million to buy a specialised furnace. The table gives the managing director’s forecasts. Consider the purchasing, technical and financial economies of scale Kestrel Glass could gain. Which one will reduce average cost the most? Justify your answer. | Forecast | Now | After expansion | | --- | --- | --- | | Output (million bottles a year) | 2 | 5 | | Materials cost per bottle ($) | 0.10 | 0.09 | | Labour cost per bottle ($) | 0.06 | 0.04 | | Interest rate on a bank loan (%) | 10 | 7 |12 marks
  21. Sunvale Juice makes bottled orange juice. Its owner says, ‘This month we reached break-even.’ Explain what this means for Sunvale Juice.2 marks
  22. Orchard Soaps makes handmade soap. Its fixed costs are 7 200 dollars a month. It sells each bar for 6 dollars and the variable cost is 2.40 dollars a bar. Calculate break-even output. Show your working.2 marks
  23. Orchard Soaps has a break-even output of 2 000 bars. Last month it sold 2 600 bars. Calculate its margin of safety.2 marks
  24. Dunmore Dairy makes cheese. The break-even chart is for one of its cheeses. (a) State the break-even output. (b) Calculate the profit when Dunmore makes 1 500 kg.4 marks
  25. Dunmore Dairy’s fixed costs rise from 6 000 dollars to 9 000 dollars a year. The selling price stays at 10 dollars a kilogram and the variable cost stays at 4 dollars. (a) Calculate the new break-even output. (b) Describe how the total costs line on the break-even chart changes.4 marks
  26. Wexley Wheels makes children’s scooters. Its fixed costs are 12 000 dollars a year, the variable cost is 15 dollars a scooter and the price is 25 dollars. The owner wants to raise the price to 30 dollars. Explain how this affects break-even output.4 marks
  27. Corran Cakes makes wedding cakes to order. The design, size and price of every cake differ. The owner is thinking of using break-even analysis. Outline two limitations of break-even analysis for Corran Cakes.4 marks
  28. Pellam Pottery sells hand-painted plates from a rented workshop. Its margin of safety is small. Explain two ways Pellam Pottery could increase its margin of safety.6 marks
  29. Stonebridge Brewery makes craft ale. It can make up to 10 000 bottles a year and sold 8 000 last year. The owner has two options. Option A raises the price, and she forecasts that sales will fall. Option B buys a bottling machine, which cuts the variable cost but adds to fixed costs. Evaluate which option the owner should choose. Use break-even output and margin of safety in your answer. | | Now | Option A | Option B | | --- | --- | --- | --- | | Price per bottle (dollars) | 8 | 9.50 | 8 | | Variable cost per bottle (dollars) | 5 | 5 | 4 | | Fixed costs per year (dollars) | 18 000 | 18 000 | 22 000 | | Forecast sales per year (bottles) | 8 000 | 5 600 | 8 000 |8 marks
  30. Redfern Roasters sells bags of coffee beans to cafés. It plans to launch a new blend with a bank loan, and the bank wants to see a break-even analysis. The sales manager wants to launch at 9 dollars a bag, not 10 dollars, because more bags would be sold. Evaluate whether Redfern Roasters should launch the new blend, and at which price. Justify your decision. | Redfern Roasters: new blend | Price 10 dollars | Price 9 dollars | | --- | --- | --- | | Fixed costs per year (dollars) | 30 000 | 30 000 | | Variable cost per bag (dollars) | 6 | 6 | | Forecast sales in the first year (bags) | 9 000 | 11 000 |12 marks

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