E-Z Seats manufactures swlvel seats for customized vans. It currently manufactur
ID: 2519517 • Letter: E
Question
E-Z Seats manufactures swlvel seats for customized vans. It currently manufactures 10,000 seats per year, which it sells for $500 per seat. It incurs variable costs of $200 per seat and fxed costs of $2,000,000. It is considering automating the upholstery process, which is now largely manual. It estimates that if it does so, its fixed costs will be $3,000,000, and its variable costs will decline to $100 per seat. The contribution margin ratio, break-even point in dolars, margin of safety ratio, and degree of operating leverage based on current activity is as follows: Contribution margin ratio Break-even point in dollars Margin of safety ratio Degree of operatig leverage 60.00 % $3333333 33.30 % 3.00 Assuming the new upholstery system is implemented the contribution margin ratio, break-even point in dolars, margin of safety ratio, and degree of operating leverage is as follows 80.00 % Contribution margin ratio Break-even point in dollars Margin of safety ratio Degree of operating leverage $3750000 25.00 % 4.00 Discuss the implications of adopting the new system.Explanation / Answer
With the automation of system, the fixed cost has been increased and variable cost has been decreased.
This can be seen from the CM ratio increase from 60% to 80% and inspite of increase in CM ratio, there has been increase in Break even sales and decrease in margin of safety.
This suggest that the company is more prone to risk at the initial stages of the production as they have strive for the better sales to be break even, which would otherwise lead to losses.
However, on the other hand, Degree of operating leverage has been increased from 3 to 4. This suggests as soon as the fixed cost of the company will be recovered, they will grow at the increased rate of pace.
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