California State University, East
Review from Last Lecture
Lecture Overview
Bay
College of Business and
⮚ Break-even analysis
➢ Defining Capacity:
Economics
• Design, Effective, and Actual Capacity
MGMT 360
Operations Management
• Single-product case
• Multi-product case
➢ Measuring Capacity
⮚ Applying Expected Monetary Value (EMV) to Capacity
Decisions
• Capacity Utilization and Capacity Efficiency
Jenny Gallagher, Instructor
➢ Capacity Analysis
Chapter 7 Supplement, Part 2
⮚ Applying Investment Analysis to Strategy-Driven
Investments
• Bottleneck Analysis, Throughput Time
• Parallel Processes, Simultaneous Processes
Welcome!
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Break-Even Analysis
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Break-Even Analysis
Break-Even Analysis
⮚ Fixed costs are costs that continue even if no units are produced
⮚ Technique for evaluating process and equipment
alternatives
⮚ Objective is to find the point in dollars and units at
which cost equals revenue
⮚ Requires estimation of fixed costs, variable costs, and
revenue
•
⮚ Revenue is function of unit price and number of units
sold
Depreciation, taxes, debt, mortgage payments
⮚ Variable costs are costs that vary with the volume of units
produced
•
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⮚ Where the revenue function crosses the total cost line is
the break-even point
Labor, materials, portion of utilities
⮚ Contribution is the difference between selling price and variable
cost
•
The amount a product or service “contributes” to covering fixed costs and
achieving profits
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Break-Even Analysis
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Break-even Analysis
Break-Even Analysis
Basic Break-Even Point
⮚ Break-even (cost volume) analysis
Potentially Misleading Assumptions
• Focuses on relationships between cost, revenue, and volume of
output.
⮚ Costs and revenue are linear functions
•
Generally not the case in the real world
⮚ Break-even point (BEP)
⮚ We actually know these costs
•
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• Is the volume (number of units) at which total costs and total
revenue are equal.
Very difficult to verify
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Break-Even Point Example – in Dollars
Fixed costs = $10,000
Material = $.75/unit
Direct labor = $1.50/unit
Selling price = $4.00 per unit
Break-Even Point Example – in Dollars
Break-Even Point Example – in Units
Fixed costs = $10,000
Material = $.75/unit
Fixed costs = $10,000
Material = $.75/unit
Direct labor = $1.50/unit
Selling price = $4.00 per unit
Direct labor = $1.50/unit
Selling price = $4.00 per unit
What is the BEP in dollars?
What is the BEP in units?
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Break-Even Point Example – in Units
Fixed costs = $10,000
Material = $.75/unit
Direct labor = $1.50/unit
Selling price = $4.00 per unit
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Group Breakout – Exercise 1
Break-Even Point Example
A restaurant has a capacity of 100 seats. Business at lunch is fair, but
business for dinner from Thursday through Saturday is excellent. On
Thursdays, the restaurant turns away 15 customers and has a maximum
wait time of 40 minutes. On Fridays, the restaurant turns away 60
customers and has a maximum wait time of 90 minutes. On Saturdays,
the restaurant turns away 45 customers and has a maximum wait time of
80 minutes.
The owner is considering adding a dining room with a seating capacity of
50 to use for dinner. The building's owner has agreed to build the addition
for extra 50 seats. This addition will cost $64,200 annually (rent of the
new addition, decorations and fixtures, maintenance, utilities, wages,
etc.). Variable cost per visitor (food, drinks, miscellaneous) is $7.40. An
average price per dinner is $18.
X
Should the restaurant do the expansion?
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Multi-Product Break-Even Analysis
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Multi-Product Example
Multiproduct Case
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Multi-Product Example
Fixed costs = $3,000 per month
Break-even point in dollars
Item
Where V = variable cost per unit
P = price per unit
F = fixed costs
W = percent each product is of total dollar sales
expressed as a decimal
i = each product
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Annual Forecasted Sales
Units
Price
Variable
Costs
Sandwich
9,000
$5.00
$3.00
Drink
9,000
1.50
.50
Baked potato
7,000
2.00
1.00
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Group Breakout - Exercise 2
Multi-Product Example
EMV Applied to Capacity Decisions
Maria’s Bike Shop is considering selling the following components
that are used in bicycle production:
• The spoke, which is priced at $0.80, variable costs of $0.50 and
demand forecast of 100,000 units
• The rim, priced at $15.50, with variable costs of $6.50 and
demand forecast of 5,000 units.
• The handle-bar, priced at $12.30, with $5.30 in variable costs
and demand forecast of 5,000
⮚Determine states of nature
•
Future demand
•
Market favorability
⮚Assign probability values to states of nature to determine
expected value
The fixed costs are $60,000 annually.
What is the weekly break-even point in dollars?
What is the weekly break-even point in units?
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EMV Applied to Capacity Decisions
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EMV Applied to Capacity Decisions
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Strategy-Driven Investments
Southern Hospital Supplies capacity expansion
⮚ Option 1 - Build a large plant
EMV (large plant)
= (.4)($100,000)+(.6X)(-$90,000)
= -$14,000
⮚ Operations managers may have to decide among
various financial options
EMV (medium plant)
= (.4)($60,000)+(.6X)(-$10,000)
= +$18,000
⮚ Analyzing capacity alternatives should include capital
investment, variable cost, cash flows, and net present
value
EMV (small plant)
= (.4)($40,000)+(.6X)(-$5,000)
= +$13,000
EMV (do nothing)
= $0
• 40% probability of earning $100K
• 60% probability of losing $90K
⮚ Option 2 - Build a medium plant
• 40% probability of earning $60K
• 60% probability of losing $10K
⮚ Option 3 - Build a small plant
• 40% probability of earning $40K
• 60% probability of losing $5,
⮚ Option 4 - do nothing
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Time Value of Money and Net Present Value
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Net Present Value (NPV)
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Net Present Value Using Factors
In general:
The time value of money (TVM) is the concept that a sum of
money is worth more now than the same sum will be at a
future date due to its earnings potential in the interim.
Where F = future value
P = present value
i = interest rate
N = number of years
The net present value (NPV) is the value in the present of a
sum of money, in contrast to some future value it will have
when it has been invested at compound interest.
where X = a factor from Table S7.2 defined as
and F = future value
Present Value of $1
Solving for P:
While this works fine, it is cumbersome for larger values of N
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Year
6%
8%
10%
12%
14%
1
.943
.926
.909
.893
.877
2
.890
.857
.826
.797
.769
3
.840
.794
.751
.712
.675
4
.792
.735
.683
.636
.592
5
.747
.681
.621
.567
.519
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Present Value of an Annuity
Present Value of an Annuity
An annuity is an investment or series of payments made at equal
intervals.
Present Value of an Annuity Example
Present Value of an Annuity of $1
S = RX
where X = factor from Table S7.3
S = present value of a series of uniform annual receipts
R = receipts that are received every year of the life of the
investment
River Road Medical Clinic equipment investment
Year
6%
8%
10%
12%
14%
1
.943
.926
.909
.893
.877
2
1.833
1.783
1.736
1.690
1.647
3
2.673
2.577
2.487
2.402
2.322
4
3.465
3.312
3.170
3.037
2.914
5
4.212
3.993
3.791
3.605
3.433
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$7,000 in receipts per year for 5 years Interest rate = 6%
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Present Value of an Annuity Example
River Road Medical Clinic equipment investment
$7,000 in receipts per year for 5 years Interest rate = 6%
From Table S7.3 X =
4.212
See you next time!
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