ABC Ltd. Produces electronic components with a selling price per of Rs.100. Fixed cost amount to
Rs.2,00,000/-
5000 units are produced and sold each year. Annual profits amount to Rs.50,000/-. The company’s all equity financed assets are Rs.5,00,000/-. The company proposes to change its production process, adding Rs.4,00,000/- to investment and Rs. 50,000/- to fixed operational costs.
The consequences of such a proposal are:
(i) Reduction in variable cost per unit by Rs.10/-
(ii) Increase in output by 2000 units.
(iii) Reduction in selling price per unit to Rs.95/-
(a) Assume an average cost of capital 10%. Examine the above proposal and advise whether or not the company should make the change.
(b) Also work out the degree of operating leverage.