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Calculating BEP and DOL in the given case

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(c) From the DOL formula, you can see that a manufacturing plant with higher fixed costs and lower variable costs will have a higher DOL relative to a plant with higher variable costs and lower fixed costs i.e. a capital intensive production process will have a higher DOL than a labor intensive process which means that a capital intensive production process will increase profits at a faster rate (relative to quantity) than a labor intensive process. Suppose a company is currently producing 1000 units of a bottled power drink priced at $5. It is using a manufacturing process with a fixed cost of $1450 and variable cost of $2.75 per unit (i.e. AVC).
i. Calculate the DOL and the break even point for this produc- tion process. Is the company breaking even yet?

BE= Fixed Costs
-------------------
Price- Variable Cost Per Unit

$1450
------
$5- 2.75 = 644.44

ii. If the company installs updated machinery its fixed costs rise to $2000 and AVC drops to $2.25. Calculate the DOL and break even point.

iii. At what production level should the company switch from the old machinery to the upgraded one?
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Solution Summary

Solution depicts the steps to calculate BEP and DOL in the given cases.

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Break-even point and degree of leverage

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