Reference no: EM132460213
Alternative Production Procedures and Operating Leverage
Assume Paper Mate is planning to introduce a new executive pen that can be manufactured using either a capital-intensive method or a labor-intensive method. The predicted manufacturing costs for each method are as follows:
Capital IntensiveLabor IntensiveDirect materials per unit$5.00$6.00Direct labor per unit$5.00$12.00Variable manufacturing overhead per unit$4.00$2.00Fixed manufacturing overhead per year$2,720,000.00$860,000.00
Paper Mate's market research department has recommended an introductory unit sales price of $30. The incremental selling costs are predicted to be $500,000 per year, plus $2 per unit sold.
Question (a) Determine the annual break-even point in units if Paper Mate uses the:
1. Capital-intensive manufacturing method.
2. Labor-intensive manufacturing method.
Question (b) Determine the annual unit volume at which Paper Mate is indifferent between the two manufacturing methods.
Question (c) Management wants to know more about the effect of each alternative on operating leverage.
Problem 1. Explain operating leverage and the relationship between operating leverage and the volatility of earnings.
- They have little or no correlation because they are unrelated.
- They are positively correlated, with increases in operating leverage accompanied by increases in the volatility of earnings.
- They are negatively correlated, with increases in operating leverage accompanied by decreases in the volatility of earnings.
Problem 2. Compute operating leverage for each alternative at a volume of 270,000 units. Round your answers two decimal places.
- Capital-Intensive operating leverage
- Labor-Intensive operating leverage
Problem 3. Which alternative has the higher operating leverage? Why?
- The capital intensive method has a higher operating leverage because of the greater use of fixed assets.
- The labor intensive method has a higher operating leverage because of higher variable conversion costs.
- The labor intensive method has a higher operating leverage because of lower variable manufacturing overhead.
- The capital intensive method has a higher operating leverage because of the higher variable manufacturing overhead.
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