Source A
GreenGrow Ltd is a small manufacturer of eco-friendly gardening tools based in the UK. The company has recently expanded its production capacity by investing in new machinery and hiring additional staff. As a result, GreenGrow Ltd is experiencing both economies and diseconomies of scale. The company's fixed costs, such as rent and salaries, have increased, but variable costs per unit, like materials and labour, have decreased due to bulk purchasing and improved efficiency. However, the company is also facing challenges such as poor communication among departments and a lack of commitment from some new employees. The management is considering raising the price of its products to improve profitability, but they are concerned about the potential impact on sales.
Source B
| Item | Amount |
|---|---|
| Fixed costs | 120,000 |
| Variable cost per unit | 8.00 |
| Selling price per unit | 15.00 |
| Expected output (units) | 20,000 |
| Actual output (units) | 18,000 |
(a) Define the following terms:
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(i) Fixed costs are costs that do not change with the level of output, such as rent and salaries. (ii) Economies of scale are the cost advantages that a business gains as it increases in size and production, such as bulk purchasing and improved efficiency. (iii) Break-even output is the level of production at which total revenue equals total costs, meaning the business makes neither a profit nor a loss.
(b) Using the data in Source B, calculate:
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(i) Total variable costs = Variable cost per unit × Actual output = £8.00 × 18,000 = £144,000 (ii) Total costs = Fixed costs + Total variable costs = £120,000 + £144,000 = £264,000 (iii) Total revenue = Selling price per unit × Actual output = £15.00 × 18,000 = £270,000
(c) Explain two economies of scale and two diseconomies of scale that GreenGrow Ltd might experience as it expands. [6]
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Economies of scale: 1. Purchasing economies: As GreenGrow Ltd increases its production, it can buy materials in larger quantities at a discount, reducing the variable cost per unit. 2. Managerial economies: With growth, the business can afford to hire specialist managers who can improve efficiency and productivity. Diseconomies of scale: 1. Poor communication: As the business grows, communication between departments can become less effective, leading to misunderstandings and inefficiencies. 2. Lack of commitment: New employees may not be as committed to the business as the original staff, leading to lower productivity and morale.
(d) Using the data in Source B and your answer to part (b), construct a break-even chart for GreenGrow Ltd. On your chart, show the break-even output and the margin of safety. [6]
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Break-even output = Fixed costs / (Selling price per unit - Variable cost per unit) = £120,000 / (£15.00 - £8.00) = 12,000 units Margin of safety = Actual output - Break-even output = 18,000 - 12,000 = 6,000 units The break-even chart should show the break-even output at 12,000 units and the margin of safety as the distance between the actual output (18,000 units) and the break-even output on the x-axis.
(e) Using your break-even chart and the data in Source B, analyse the financial situation of GreenGrow Ltd. [4]
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GreenGrow Ltd is currently making a profit as its total revenue (£270,000) is greater than its total costs (£264,000). The break-even chart shows that the business has a margin of safety of 6,000 units, meaning it can sell 6,000 units less than its actual output and still cover its costs. However, the business is not utilising its full production capacity, as it is only producing 18,000 units out of a possible 20,000. This could be due to the diseconomies of scale it is experiencing, such as poor communication and lack of commitment from employees.