Consider this situation.A friend of yours has decided to start a small business. They have some money to invest, but do not have unlimited funds.The business will be a specialty pet food supplier, catering to customers who are willing to pay a premium for anything related to their pets. The company expects to sell 500 units per month for the first six months, then 1,000 units per month for six months, and then 2,000 on an ongoing basis. The contribution margin on each unit will be $2.

The business requires an operating space, equipment for mixing and cooking the pet food, and of course labour.Your friend has a choice of purchasing the equipment, or leasing it.The lease would be $1000 per month, and the equipment could be returned on one months notice.To purchase the equipment would require an immediate outlay of $19,000.The equipment would have a useful life of five years, and can produce 3,000 units per month.

Required:

In the space below, write friend an advisory memo, explaining the concept of operating leverage, break even point, margin of safety, and any other concepts you have learned in the course that may help him in his decision making about his business.