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! 1 Break-Even Analysis 2 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 • 3 ⮚ 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 4 Break-Even Analysis 5 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 • 7 6 • Is the volume (number of units) at which total costs and total revenue are equal. Very difficult to verify 8 9 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? 10 Break-Even Point Example – in Units Fixed costs = $10,000 Material = $.75/unit Direct labor = $1.50/unit Selling price = $4.00 per unit 11 12 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? 13 Multi-Product Break-Even Analysis 14 Multi-Product Example Multiproduct Case 15 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 16 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 17 18 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? 19 EMV Applied to Capacity Decisions 20 EMV Applied to Capacity Decisions 21 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 22 Time Value of Money and Net Present Value 23 Net Present Value (NPV) 24 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 25 26 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 27 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 28 $7,000 in receipts per year for 5 years Interest rate = 6% 29 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! 31 32 30