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Kaplan kit questions
If a company that currently pays its workforce on a piece rate system were to automate its production line which of the
following responses would it expect of operating risk?The answer is increase.
The explanation tells me as automation takes place repair and maintenance costs increases which is fixed costs but Variable costs decreases.
But my question is where the fixed costs in the question it tells increase in fixed cost is more than decrease in variable costs.
Assumption here is flawed. As a result of automation maybe contribution will increase as variable cost decreases. But what about hypothetical fixed costs repair and maintenance.It is not flawed.
Operating risk increases if fixed costs as a proportion of total costs increases. It is nothing to do with the contribution directly and nothing to do with the actual amount of the increase or decrease of the two costs in $’s.
Have you watched my free lecture on this? I explain what is happening and why the risk increases with an example. Risk increases with more fixed payments in exactly the same way as more fixed interest payments increase the gearing risk.
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