With regards to Operating Leverage, please explain why a company with HIGH Operating Leverage faces greater financial risk in a declining sales period compared to a company with LOW Operating Leverage.
With regards to Operating Leverage, please explain why a company with HIGH Operating Leverage faces greater financial risk in a declining sales period compared to a company with LOW Operating Leverage.
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Alternative Production Procedures and Operating Leverage
Assume Paper Mate is planning to introduce a new executive pen thatcan be manufactured using either a capital-intensive method or alabor-intensive method. The predicted manufacturing costs for eachmethod are as follows:
| Capital Intensive | Labor Intensive | |
|---|---|---|
| Direct materials per unit | $5.00 | $6.00 |
| Direct labor per unit | $5.00 | $12.00 |
| Variable manufacturing overhead per unit | $4.00 | $2.00 |
| Fixed manufacturing overhead per year | $2,020,000.00 | $460,000.00 |
Paper Mate's market research department has recommended anintroductory unit sales price of $30. The incremental selling costsare predicted to be $500,000 per year, plus $2 per unit sold.
(a) Determine the annual break-even point in units if Paper Mateuses the:
1. Capital-intensive manufacturing method.
Answer units
2. Labor-intensive manufacturing method.
Answer units
(b) Determine the annual unit volume at which Paper Mate isindifferent between the two manufacturing methods.
Answer units
(c) Management wants to know more about the effect of eachalternative on operating leverage.
1. Explain operating leverage and the relationship betweenoperating leverage and the volatility of earnings.
They have little or no correlation because they areunrelated.
They are positively correlated, with increases in operatingleverage accompanied by increases in the volatility ofearnings.
They are negatively correlated, with increases in operatingleverage accompanied by decreases in the volatility ofearnings.
2. Compute operating leverage for each alternative at a volume of220,000 units. Round your answers two decimal places.
Capital-Intensive operating leverage Answer
Labor-Intensive operating leverage Answer
3. Which alternative has the higher operating leverage? Why?
The labor intensive method has a higher operating leveragebecause of lower variable manufacturing overhead.
The capital intensive method has a higher operating leveragebecause of the higher variable manufacturing overhead.
The labor intensive method has a higher operating leveragebecause of higher variable conversion costs.
The capital intensive method has a higher operating leveragebecause of the greater use of fixed assets.
Alternative Production Procedures and Operating Leverage
Assume Paper Mate is planning to introduce a new executive pen thatcan be manufactured using either a capital-intensive method or alabor-intensive method. The predicted manufacturing costs for eachmethod are as follows:
| Capital Intensive | Labor Intensive | |
|---|---|---|
| Direct materials per unit | $5.00 | $6.00 |
| Direct labor per unit | $5.00 | $15.00 |
| Variable manufacturing overhead per unit | $7.00 | $2.00 |
| Fixed manufacturing overhead per year | $3,140,000.00 | $1,100,000.00 |
Paper Mate's market research department has recommended anintroductory unit sales price of $33. The incremental selling costsare predicted to be $500,000 per year, plus $2 per unit sold.
(a) Determine the annual break-even point in units if Paper Mateuses the:
1. Capital-intensive manufacturing method.
Answer units
2. Labor-intensive manufacturing method.
Answer units
(b) Determine the annual unit volume at which Paper Mate isindifferent between the two manufacturing methods.
Answer units
(c) Management wants to know more about the effect of eachalternative on operating leverage.
1. Explain operating leverage and the relationship betweenoperating leverage and the volatility of earnings.
They have little or no correlation because they areunrelated.
They are negatively correlated, with increases in operatingleverage accompanied by decreases in the volatility ofearnings.
They are positively correlated, with increases in operatingleverage accompanied by increases in the volatility ofearnings.
2. Compute operating leverage for each alternative at a volume of300,000 units. Round your answers two decimal places.
Capital-Intensive operating leverage Answer
Labor-Intensive operating leverage Answer
3. Which alternative has the higher operating leverage? Why?
The capital intensive method has a higher operating leveragebecause of the higher variable manufacturing overhead.
The labor intensive method has a higher operating leveragebecause of higher variable conversion costs.
The capital intensive method has a higher operating leveragebecause of the greater use of fixed assets.
The labor intensive method has a higher operating leveragebecause of lower variable manufacturing overhead.
Alternative Production Procedures and OperatingLeverage
Assume Paper Mate is planning to introduce a new executive pen thatcan be manufactured using either a capital-intensive method or alabor-intensive method. The predicted manufacturing costs for eachmethod are as follows:
Capital Intensive | Labor Intensive | |
|---|---|---|
Direct materials per unit | $ 5.00 | $ 8.00 |
Direct labor per unit | $ 5.00 | $ 12.00 |
Variable manufacturing overhead per unit | $ 4.00 | $ 2.00 |
Fixed manufacturing overhead per year | $ 2,440,000 | $ 700,000 |
Paper Mate's market research department has recommended anintroductory unit sales price of $40. The incremental selling costsare predicted to be $500,000 per year, plus $2 per unit sold.
(a) Determine the annual break-even point in units if Paper Mateuses the:
1. Capital-intensive manufacturing method.
Answer 93,846 units is incorrect
2. Labor-intensive manufacturing method.
Answer 38,889 units is incorrect
(c) Management wants to know more about the effect of eachalternative on operating leverage.
1. Explain operating leverage and the relationship betweenoperating leverage and the volatility of earnings. Answer choicesare either A or B.
A. They have little or no correlation because they areunrelated.
B. They are positively correlated, with increases in operatingleverage accompanied by increases in the volatility ofearnings.
They are negatively correlated, with increases inoperating leverage accompanied by decreases in the volatility ofearnings. This choice is incorrect.
2. Compute operating leverage for each alternative at a volume of250,000 units. Round your answers two decimal places.
Capital-Intensive operating leverage Answer 1.6 isincorrect
Labor-Intensive operating leverage Answer 1.18 isincorrect
