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Fixed and variable cost example

On the first day of the new year to get her business started, the owner/photographer of Exquisite Portraits Inc. paid $200 for business cards, $1,000 for a listing in Yellow Pages, and $250 for an annual business license. She also leased a professional portrait camera and studio lighting equipment by signing an agreement to pay a monthly lease of $1,000 each month for the next 12 months. This lease is ironclad: She must pay for all 12 months and she cannot sublease to anyone else. She rents her office and studio for $1,400 per month that must be paid at the beginning of each month. She does not have a lease on the office/studio, so she can vacate the office/studio at the end of any month should she decide to move to a new location or to go out of business. After she opens the office/studio on the first day of each month, her monthly cost of electricity for lighting the office and running her coffee machine is constant at $45 per month, because she always keeps the lights on in the office and drinks the same amount of coffee no matter how many photos she shoots each month. Additional electricity is required for the portrait studio lights. , which varies directly with the number of hours the lights are used each month for photo sessions. Last year, before starting this business, the owner of Exquisite Portraits Inc. earned a salary of $5,000 per month working at a bank. Answer the following questions about the costs for Exquisite Portraits Inc.

a) What are the monthly fixed costs, quasi-fixed costs, and variable costs for Exquisite Portraits Inc.?

b) If the owner of Exquisite Portraits Inc. wants to close her studio and go out of businesses at the end of August, identify her sunk costs and avoidable costs.

c) At the end of August, what role would the sunk costs play in the owner/photographers decision to go out of business?

d) In making her decision to start her own business, would her decision have been more or less difficult to make if sunk costs were zero at Exquisite Portraits? Explain.

2) At a management luncheon, two managers were overheard arguing about the following statement : â?? A manager should never hire another worker if the new person causes diminishing returns.â? Is this statement correct? If so, why? If not, explain why not?

Solution Preview

a) What are the monthly fixed costs, quasi-fixed costs, and variable costs for Exquisite Portraits Inc.?

Fixed costs do not vary with the amount of photos produced. These costs are the leases, business cards, business licenses, advertisement, and base electricity. The variable costs are the rental of the studio and additional electricity. Quasi fixed costs remain the same for a certain level of production, and then increase. Electricity for Exquisite Portraits is a quasi fixed cost because it has a minimum cost $45 and then varies with production. Variable costs are directly tied to production. For a photography studio, such things as photo paper and ...

Solution Summary

Fixed, quasi-fixed, and variable costs of a photography studio. Sunk vs avoidable costs when going out of business. Diminishing returns and and hiring decisions.

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