MB 664 UVG-TAMU May Managerial Managerial Finance MB-664 Investment Climate

MB 664 UVG-TAMU May Today’s Decision Climate Global economy Little or no information lags Sources of risk in making decisions Decisions at the enterprise level Decisions related to expansion Importance of quality information in making decisions

MB 664 UVG-TAMU May Market Forces

MB 664 UVG-TAMU May Expected Commodity Price D = S D S $4 10 $1 $7 D = f(P o, PYD, P x, W, …) S = f(P o, MIC, …)

MB 664 UVG-TAMU May Implications for the Firm Price Quantity D S PEPE QEQE Price O MAX ATCMC The Market The Firm

MB 664 UVG-TAMU May Implications for the Firm Price Quantity D S PEPE QEQE Price O MAX ATCMC The Market The Firm Profit

MB 664 UVG-TAMU May Knowing Your Elasticities Market demand related elasticities Market supply related elasticities Concept of price flexibility Application and implications

MB 664 UVG-TAMU May Price Quantity ∆P Inelastic Market Demand Elastic Market Demand ∆Q %∆P>%∆Q %∆P<%∆Q Identical shift in the supply curve Identical shift in the supply curve

MB 664 UVG-TAMU May Concept of Price Flexibility Price Quantity E P = -.25 If the own price elasticity of demand is equal to.25, then PF = 1/-.25 = -4.0 This means that if the supply coming onto the market is expected to increase by one percent, the price you can expect to receive for your products will fall by 4 percent. -4% +1%

MB 664 UVG-TAMU May Short Run Input Decisions

MB 664 UVG-TAMU May B C D E F G H I J Input Decision for Variable Inputs

MB 664 UVG-TAMU May Least Cost Decision Rule The least cost combination of labor and capital in out example also occurs where: MPP LABOR ÷ wage rate = MPP CAPITAL ÷ rental rate MPP per dollar spent on labor MPP per dollar spent on labor MPP per dollar spent on capital MPP per dollar spent on capital = This decision rule holds for a larger number of inputs as well…

MB 664 UVG-TAMU May Least Cost Input Choice for 100 Units 7 60

MB 664 UVG-TAMU May What Happens if Wage Rate Declines? As a consequence, the firm would desire to use more labor and less capital… As a consequence, the firm would desire to use more labor and less capital…

MB 664 UVG-TAMU May Short Run Enterprise Decisions

MB 664 UVG-TAMU May Combination of Products The profit maximizing combination of two products is found where the slope of the production possibilities frontier (PPF) is equal to the slope of the iso-revenue curve, or where:  Canned fruit Price of vegetables  Canned vegetables Price of fruit = – Slope of an PPF curve Slope of an PPF curve Slope of iso- revenue line Slope of iso- revenue line

MB 664 UVG-TAMU May Output combination X is currently beyond the firm’s existing capacity. The firm would have to expand its manufacturing capacity and labor force to achieve point X. Profit Maximization Product Choice X

MB 664 UVG-TAMU May  Canned fruit Price of vegetables  Canned vegetables Price of fruit  Canned fruit Price of vegetables  Canned vegetables Price of fruit = – Shifting line AB out in a parallel fashion holds both prices constant at their current level Profit Maximization Product Choice

MB 664 UVG-TAMU May The firm would shift from point M on the PPF to point N as a result of the decline in the price of fruit. That is, to maximize profit, the firm would cut back its production of canned fruit and produce more canned vegetables. Profit Maximization Product Choice

MB 664 UVG-TAMU May Long Run Capacity Decisions

MB 664 UVG-TAMU May Growth of the firm…How much should we expand? Is this firm size earning a profit? Page 17 in booklet Page 17 in booklet

MB 664 UVG-TAMU May Growth of the firm…How much should we expand? No. Its average cost exceeds its average revenue at price P. The firm therefore must either expand or cease operation. How much should it expand?

MB 664 UVG-TAMU May Q3Q3 Firm size 2, 3 and 4 would earn a profit at price P…. Firm size 2, 3 and 4 would earn a profit at price P…. Growth of the firm…How much should we expand?

MB 664 UVG-TAMU May Q3Q3 At size #2, the firm’s profit would be the green area shown above… Growth of the firm…How much should we expand?

MB 664 UVG-TAMU May Q3Q3 At size #3, the firm’s profit would be the area shown above… Growth of the firm…How much should we expand?

MB 664 UVG-TAMU May Q3Q3 At size #4, the firm’s profit would be the area shown above… Growth of the firm…How much should we expand?

MB 664 UVG-TAMU May If price were to fall to P LR, only size 3 would not lose money; it would break-even. If price were to fall to P LR, only size 3 would not lose money; it would break-even. Growth of the firm…How much should we expand?

MB 664 UVG-TAMU May Expansion to size #4 runs the risk of having to downsize or idle part of its existing capacity if the industry settled at price P LR Growth of the firm…How much should we expand?

MB 664 UVG-TAMU May Optimal input combination for output=10 Optimal input combination for output=10 Expanding the Firm’s Capacity Page 19 in booklet Page 19 in booklet

MB 664 UVG-TAMU May Two options if doubling output: 1. Point B ? Two options if doubling output: 1. Point B ? Expanding the Firm’s Capacity

MB 664 UVG-TAMU May Two options if doubling output: 1.Point B ? 2.Point C? Two options if doubling output: 1.Point B ? 2.Point C? Expanding the Firm’s Capacity

MB 664 UVG-TAMU May Optimal input combination for output=10 with budget DE Optimal input combination for output=10 with budget DE Optimal input combination for output=20 with budget FG Optimal input combination for output=20 with budget FG Expanding the Firm’s Capacity

MB 664 UVG-TAMU May This combination costs more to produce 20 units of output since budget HI exceeds budget FG This combination costs more to produce 20 units of output since budget HI exceeds budget FG Expanding the Firm’s Capacity

MB 664 UVG-TAMU May Capacity Concepts

MB 664 UVG-TAMU May Definitions Engineering capacity Engineering capacity – maximum output for which enterprise was designed Economic capacity Economic capacity – output given economic objectives and normal operating policy Capacity utilization rate Capacity utilization rate – ratio of actual output to engineering capacity Capacity efficiency rate Capacity efficiency rate – ratio of actual output to economic capacity Desired utilization rate Desired utilization rate – ratio of economic to engineering capacity Bottleneck Bottleneck – constraint on economic capacity

MB 664 UVG-TAMU May S1S1 Engineering capacity Price Concept of Capacity Utilization at Market Level

MB 664 UVG-TAMU May S1S1 Economic capacity Engineering capacity D1D1 Price P1P1 Concept of Capacity Utilization at Market Level

MB 664 UVG-TAMU May S1S1 Economic capacity Actual output Engineering capacity D1D1 Price P1P1 S2S2 Concept of Capacity Utilization at Market Level

MB 664 UVG-TAMU May S1S1 Economic capacity Actual output Engineering capacity D1D1 Price P1P1 P2P2 S2S2 Concept of Capacity Utilization at Market Level

MB 664 UVG-TAMU May S1S1 Economic capacity Actual output Engineering capacity Bottleneck D1D1 Price P1P1 P2P2 S2S2 Concept of Capacity Utilization at Market Level

MB 664 UVG-TAMU May Market Price/Quantity Relationships

MB 664 UVG-TAMU May Stochastic Relationship Between Output and Price An example of potential market outcomes

MB 664 UVG-TAMU May An interpretation of potential price variability

MB 664 UVG-TAMU May Pro Forma Analysis of Future Trends A necessary element to evaluating potential investment alternatives.

MB 664 UVG-TAMU May Evaluation Methods Stochastic analysis of commodity prices and unit input costs Risk and required rates of return Risk adjusted capital budgeting Pro forma financial statement analysis