Faber Corporation, a basketball hoop manufacturing firm in Hickory, Indiana, plans to branch out and begin producing

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Question:

Faber Corporation, a basketball hoop manufacturing firm in Hickory, Indiana, plans to branch out and begin producing basketballs in addition to basketball hoops. It has a. choice of two different production methods for the basketballs. Method 1 will have variable costs of $6 per ball and fixed costs of $700,000 for the high-tech machinery, which requires little human supervision. Method 2 employs many people to hand-sew the basketballs. It has variable costs of $16.50 per ball, but fixed costs are estimated to be only $100,000. Regardless of which method CEO Norman Dale chooses, the basketballs will sell for $30 each. Marketing research indicates sales in the first year will be 50,000 balls. Sales volume is expected to increase to 60,000 in year 2.

a. Calculate the sales revenue expected in years 1 and 2.

b. Calculate the percentage change in sales revenue.

c. Calculate the earnings before interest and taxes for each year for both production methods.

d. Calculate the percentage change in EBIT for each method.

e. Calculate the year 1 degree of operating leverage for each method, using your answers from parts b and d.

f. Calculate the degree of operating leverage again. This time use only revenue, fixed costs and variable costs from year 1 (your base year) for each production method.

g. Under which production method would EBIT be more adversely affected if the sales volume did not reach the expected levels?

h. What would drive this adverse effect on EBIT?

i. Recalculate the year 1 base year EBIT and the degree of operating leverage for both production methods if year 2 sales are expected to be only 53,000 units.