Decison Making

The unit sales volume when there is no difference between the two methods is 242500. If sales are expected to exceed that level, the capital intensive method would be preferable. On the other hand, if sales are expected to be below that level, the labor intensive method would be preferable. Since the fixed costs are higher for capital intensive method, it is advantage when the sales volume is greater than the threshold (242500) number. For volumes greater than that, variable costs are less and hence it is beneficial to use the capital intensive method. Similarly for volumes less than 242500, the fixed costs are less and the combined costs is less than the capital intensive method. The Capital intensive manufacturing method has the greater amount of fixed cost ($3,010,000 versus $2,040,000) and thus utilizes a greater degree of operating leverage. Operating leverage refers to the use of fixed costs in an organization’s overall cost structure. It is a measure at a level of sales, of how a percent change in sales volume will affect profits. An organization with a relatively high proportion of fixed costs and a low proportion of variable costs would have a higher degree of operating leverage than an organization with a relatively low proportion of fixed and a high proportion of variable costs. As the business increases its sales, with each sale contributing a very slight margin, is said to be less leveraged. As the volume of sales in a business increases, each new sale contributes less to fixed costs and more to profitability. Hence it is profitable to use the capital intensive method as sales increases.