Upscale Hides sells its only product, a leather coat for $3,000 each. The production process is highly labor intensive with almost the entire coat being hand cut and stitched by a single craftsmen. Currently the company's very skilled craftsmen are paid on a finished coat basis. Current variable costs (including labor) per coat are $1,200 and total fixed operating costs for the company are $4,000,000. Fixed interest charges are $500,000.
Upscale is contemplating a change in how it pays its craftsmen. If they are each paid a guaranteed fixed annual salary, total fixed operating costs will rise to $6,400,000 but variable costs per coat will drop to only $400 a coat.
{a} Compute the degree of operating leverage at a sales level of $9,000,000 under both the present pay system and the proposed new one.
{b} Explain why there is a difference between your two values in {a}.
{c} How does the forecasted volatility of future years' sales impact Upscale's decision?