Question

Erosion costs. Fat Tire Bicycle Company currently sells 39 comma 000 bicycles per year. The current bike is a standard​ balloon-tire bike selling for ​$120​, with a production and shipping cost of ​$35. The company is thinking of introducing an​ off-road bike with a projected selling price of ​$375 and a production and shipping cost of ​$250. The projected annual sales for the​ off-road bike are 17 comma 000. The company will lose sales in​ fat-tire bikes of 9 comma 000 units per year if it introduces the new​ bike, however. What is the erosion cost from the new​ bike? Should Fat Tire start producing the​ off-road bike? What is the erosion cost from the new​ bike?

Answer 1

Answer:

Erosion cost from the new bike is equal to the profit lost from existing bike

= 9,000 x (120 - 35)

= $765,000

Benefit from new bike = 17,000 x (375 - 250)

= $2,125,000

Net Benefit = $2,125,000 - $765,000

= $1,360,000

Since there is net benefit from new bike, Fat Tire should start producing the​ off-road bike