COST VOLUME PROFIT Suppose a company decided to automate a production line. Explain what effects this would ha

Question

Suppose a company decided to automate a production line. Explain what effects this would have on a company’s cost structure using CVP terminology. Could these changes have any possible negative effect on the firm?

Answer 1

Cost structure refers to the relative proportion of fixed and variable costs in an organization. Investing in automated equipment increases fixed costs and reduces variable labor costs.

Comparison of cost structures:

"A company with higher fixed costs and lower variable costs will experience wider swings in net operating income as sales fluctuate, with greater profits in good years and greater losses in bad years.

A company with lower fixed costs and higher variable costs will enjoy greater profit stability and will be more protected from losses during bad years, but at the cost of lower net operating income in good years."

So, in this case, if the company automates and then experiences a downturn in sales of the product, it will sustain higher losses than it would have if the production line was labor based.