Fit Co specialises in the manufacture of a small range of hi-tech products for the fitness market. They are currently considering the development of a new type of fitness monitor, which would be the first of its kind in the market. It would take one year to develop, with sales then commencing at the beginning of the second year. The product is expected to have a life cycle of two years, before it is replaced with a technologically superior product. The following cost estimates have been made.
Note: You should ignore the time value of money.
Required:
(a) Calculate the life cycle cost per unit. (6 marks)
(b) After preparing the cost estimates above, the company realises that it has not taken into account the effect of the learning curve on the production process. The variable manufacturing cost per unit above, of $40 in year 2 and $42 in year 3, includes a cost for 0·5 hours of labour. The remainder of the variable manufacturing cost is not driven by labour hours. The year 2 cost per hour for labour is $24 and the year 3 cost is $26 per hour. Subsequently, it has now been estimated that, although the first unit is expected to take 0·5 hours, a learning curve of 95% is expected to occur until the 100th unit has been completed.
Calculate the revised life cycle cost per unit, taking into account the effect of the learning curve.
Note: the value of the learning co-efficient, b, is –0·0740005. (10 marks)
(c) Discuss the benefits of life cycle costing. (4 marks)