1/20 Operations Management Break-Even Analysis - Lecture 4.2 Dr. Ursula G. Kraus

2/20 Review Merton Truck

3/20 Learning Objectives Decide among capacity investment alternatives Applying the principles learned to a number of practical problems

4/20 Acquiring Capacity: Break-Even Analysis Applied Decision Problems Agenda

5/20 Acquiring Capacity: Break-Even Analysis Break-Even Analysis estimates the income/cost tradeoffs of an organization under different operating conditions. It determines necessary levels of service or production to avoid loss. Fixed Costs (FC) remain constant regardless of volume of output e.g. rental costs, property taxes, equipment cost, heating expenses, certain administrative costs Variable Costs (VC) vary directly with the volume of output (Q) e.g. labor, materials, portion of utilities

6/20 Break-Even Analysis Total Costs (TC) = FC + VC = FC + v * Q Total Revenue (TR) = R * Q where: v = variable costs per unit R = revenue per unit Q = volume of output

7/20 Break-Even Chart Fixed cost Variable cost Total cost line Total revenue line Profit Breakeven point Total cost = Total revenue Volume (units/period) Cost/Revenue in Dollars Loss

8/20 Example: Old-Fashioned Berry Pies The owner of Old-Fashioned Berry Pies, S. Simon, is contemplating adding a new line of pies, which require leasing new equipment for a monthly payment of $6,000. Variable costs would be $2.00 per pie, and pies would retail for $7.00 each. a) How many pies must be sold in order to break even? b) What would the profit (loss) be if 1,000 pies are made and sold a month? c) How many pies must be sold to realize a profit of $ 4,000?

9/20 Break-Even Chart: Old-Fashioned Berry Pies Volume (units/period) Cost/Revenue in Dollars (Thousands)

10/20 Practice Example - Widgets Company ABC sell widgets for $30 a unit. Their fixed cost for equipment is $100,000. Their variable cost is $10 per unit. What is their break-even point?

11/20 Acquiring Capacity: Process Alternatives Fixed cost - Process A Fixed cost - Process B Fixed cost - Process C Total cost - Process C Total cost - Process B Total cost - Process A Process A: low volume, high variety Process B: Repetitive Process C: High volume, low variety Process CProcess BProcess A Volume (units/period) Cost in Dollars (Thousands)

12/20 The manager of a plant must decide whether to make or buy a certain item used in the production of vending machines. It costs $200 per unit to buy the part. Alternatively the company could produce the part in-house. This can either be done by buying a semi-automatic lathe for $80,000 or buying a machine center for $200,000. With the lathe the cost of producing one unit is $75 where with the machine center one unit can be produced for just $15. Which type of equipment should be purchased or should the parts production be outsourced? Example: Vending Machines

13/20 Break-Even Chart: Vending Machines Volume (units/period) Cost/Revenue in Dollars (Thousands)

14/20 Break-Even Chart: Vending Machines

15/20 Practice Example – Company XYZ Company XYZ has to choose between two machines to purchase. They both make the same product which sells for $10 per unit. Machine A has annual costs of $3000 and per unit cost of $5. Machine B has annual costs of $8000 and per unit cost of $2. Which machine should be purchased?

16/20 Practice Example – Company DEF Company DEF has a choice of two machines to purchase: They both make the same product which sells for $10. Machine A has fixed costs of $5,000 and a per unit cost of $5. Machine B has fixed costs of $15,000 and per unit cost of $1. Under what conditions would you select Machine A?

17/20 Summary – Break-Even Analysis  Break-even analysis can be an effective tool in determining the cost effectiveness of a product.  Determines the required quantities to avoid loss.  Use as a comparison tool for making a decision.

18/20 Kristen's Cookies

19/20 Product Mix Decisions: Kristen Cookies offers 2 products Sale Price of Chocolate Chip Cookies:$5.00/dozen Cost of Materials:$2.50/dozen Sale Price of Oatmeal Raisin Cookies:$5.50/dozen Cost of Materials:$2.40/dozen Maximum weekly demand of Chocolate Chip Cookies:100 dozen Maximum weekly demand of Oatmeal Raisin Cookies:50 dozen Total weekly operating expense$270

20/20 Product Mix Decisions Total time available per week: 20 hrs