Yes, you are correct.
Let’s consider a manufacturing company, ABC Corp., that recently completed a major expansion of its production facility.
Before the expansion, ABC Corp. had a capacity of 10,000 units per month with fixed costs of Rs. 100,000 and variable costs of Rs. 10 per unit.
After the capex, the company increased its capacity to 20,000 units per month, but the fixed costs remain Rs. 100,000, and variable costs remain Rs. 10 per unit.
Scenario 1: Before Capex
- Units produced and sold: 10,000
- Revenue (at Rs. 20 per unit): Rs. 200,000
- Total Variable Costs: Rs. 100,000
- Fixed Costs: Rs. 100,000
- Operating Income: Rs. 200,000 – Rs. 100,000 – Rs. 100,000 = Rs. 0
Scenario 2: After Capex (utilizing increased capacity)
- Units produced and sold: 20,000
- Revenue (at Rs. 20 per unit): Rs. 400,000
- Total Variable Costs: Rs. 200,000
- Fixed Costs: Rs. 100,000
- Operating Income: Rs. 400,000 – Rs. 200,000 – Rs. 100,000 = Rs. 100,000
In the second scenario, because the fixed costs remain the same, the increase in production volume directly translates to a significant increase in operating income, demonstrating operating leverage.
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