Alternative Production Procedures and Operating Leverage (LO3, 5)

Assume Paper \late is planning to introduce a new executive pen that can be manufactured using either | Paper Mate a capital-intensive method or a labor-intensive method. The predicted manufacturing costs for each method are as follows:

Capital Labor Intensive Intensive Direcumatenals: perlite vacee cece. es ees cw nt un $ 5.00 $ 6.00 DinrcoulabOmpcUMitmema min sa sisi. sae cae cet $ 5.00 $12.00 Variable manufacturing overhead per unit........... $ 4.00 $ 2.00 Fixed manufacturing overhead per year............. $2,440,000.00 $700,000.00 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.
Required

a. Determine the annual break-even point in units if Paper Mate uses the:
1. Capital-intensive manufacturing method.
2. Labor-intensive manufacturing method.

b. Determine the annual unit volume at which Paper Mate is indifferent between the two manufacturing methods.

c. Management wants to know more about the effect of each alternative on operating leverage.
1. Explain operating leverage and the relationship between operating leverage and the volatility of earnings.
2. Compute operating leverage for each alternative at a volume of 250,000 units.
3. Which alternative has the higher operating leverage? Why?