Your company wants to expand the production capacity for one of its products. Two plant sizes are under consideration -- one small, the other much larger.
Low-capacity plant:
TFC = $600,000
AVC = $60
Product selling price P = $90
High-capacity plant:
TFC = $1,500,000
AVC = $45
Product selling price P = $85
a) If your company builds the low-capacity plant and wants a 8% return (profit) on its fixed cost investment, how many units must it sell?
b) If your company builds the high-capacity plant and wants a 10% return (profit) on its fixed cost investment, how many units must it sell?
c) Why do you think that your company’s strategic planning team used a lower selling price when analyzing the high-capacity plant?
d) Comment on operating leverage in this problem – that is, how does breakeven Q change when higher FC and lower AVC are substituted for lower FC and higher AVC? Address the issue of operating risk in your answer.