Operating Leverage

Local Corp. runs a food services business and is considering borrowing a large amount to invest in more efficient production.

The basic inputs are as follows: The new equipment would cost $30K paid in cash, and last for 1 year. It is specialised to purpose and will be unsaleable on the 2 nd hand market. Cash is currently invested at 10% per year. With the new production efficiency, variable costs would fall from $12 per unit to $4 per unit. Budgeted production is 100 units per week. Current salary costs are $200K per year and are fixed for the next year by contract. Current prices achieved for this production average $20 per unit.

1. Show relevant calculations and give a recommendation based on your results should the business invest in the new equipment or not? 2. If the business believes that trade volume could fall because of a new competitor and might be as low as 50 units per week in the next year, which production method is better at that volume?