William Severs has been the manager for two years of the production department of a company manufacturing toys made of plastic-coated cardboard. One of the toys is paper dolls, whose “clothes” are made of acetate, and stay on the doll with static electricity. The company’s sales were mainly to large educational institutions until last year, when the dolls were sold for the first time to a large discount retailer. The dolls were sold out immediately, and enough orders received to keep the department at full capacity for the immediate future.
The fixed costs for the department are $50,000, with $1 per unit variable costs. The dolls and one set of clothes sells for $3. The maximum volume is 80,000 units. With the increased volume, Mr. Severs is considering two options to improve profitability. One would reduce variable costs to $0.75, and the other would reduce fixed costs to $35,000.
Given the fact that sales are increasing, make a recommendation to Mr. Severs about which option he should choose? Support your recommendation with a clear explanation and calculations showing him how profitability will change with each option..