Ch 5(B) : Capacity Planning: Break-Even Analysis

1. Ch 5(B) : Capacity Planning: Break-Even Analysis • Operation costs are divided into 2 main groups: • Fixed costs • Variable costs

2. Fixed Costs Include rent, property tax, property insurance, wages of permanent employees, depreciation (except in working hour depreciation). The total fixed cost is fixed throughout the year. It does not depend on the production level. When we have a plant, then the above costs are fixed, no matter if we produce one unit or one million units.

3. Total Fixed Cost and Fixed Cost per Unit of Product Fixed cost per unit of product (F/Q) Total fixed cost (F) Production volume (Q) Production volume (Q)

4. Variable Costs Costs of raw material, packaging material, direct labor, production W&P are the main variable costs. Variable cost is fixed per unit of production. The total variable costs depend on the volume of production. The higher the production level, the higher the total variable costs.

5. Variable Cost per Unit and Total Variable Costs Variable costs Per unit of product Total Variable costs (VQ) (V) Production volume (Q) Production volume (Q)

6. Total Costs Amount ($) Total cost = F+VQ Total variable cost (VQ) Total Fixed cost (F) 0 Q (volume in units)

7. Total Revenue It is assumed that the price of the product is fixed, and we sell whatever we produce. Total sales revenue depends on the production level. The higher the production, the higher the total sales revenue.

8. Break-Even Point Profit Total revenue Amount ($) Total cost Loss 0 BEP units Q (volume in units)

9. Break-Even Computations

10. Example $500,000 total yearly fixed costs. $150 per unit variable costs $200 per unit sale price QBEP=500,000/(200-150) =10,000 units If our market research indicates that the present demand is > 10,000, then this manufacturing system is economically feasible.

11. A Simple technology • An Intermediate technology • An Advanced technology • General purpose machines • Multi-purpose machines • Special purpose machines • Low F high V • In between • High F Low V BEA for Multiple Alternatives Break-even analysis for multiple alternatives: Such an analysis is implemented to compare cases such as In general, when we move from a simple technology to an advanced technology; F  V

12. BEA for Multiple Alternatives CIM CNCs Universal Q1 Q2

13. BEA for Multiple Alternatives I can buy 1) A General Purpose machine Total Fixed Cost F = $10,000, Variable cost V = $10 per unit 2) A Multi Purpose machine Total Fixed Cost F = $60,000, Variable cost V = $5 per unit 3) A Single Purpose machine Total Fixed Cost F = $150,000, Variable cost V = $2 per unit Tell me what to do: In terms of the range of demand and the preferred choice…

14. BEA for Alternatives (1) and (2) 2 1 Q 1

15. Q = Break-Even for Alternatives (1) and (2) F1=10000 V1=10 F2=60000 V2=5 Break-even of 1 and 2 F1+ V1 Q = F2+ V2 Q 10000+10Q = 60000 + 5Q

16. BEA for Alternatives (2) and (3) 3 2 Q 2

17. Q = Break-Even for Alternatives (2) and (3) F2=60000 V2=5 F3=150000 V3=2 Break-even of 2 and 3 F2+ V2 Q = F3+ V3 Q 60000 + 5Q = 150000+2Q

18. Recommendations to Management and Marketing DemandRecommended Alternative D < 10000 Alternative 1 10000 < D < 30000 Alternative 2 30000 < D Alternative 3 We also need to know Price and Revenue!

19. Assignment 3: Problem 1 A firm plans to begin production of a new small appliance. Management should decide whether to make the small engine for this product in-plant, or buy it from an outside source. If management decides to make the engine, then there are 2 alternatives: (1) Built it with a simple manufacturing systemFixed Cost: $10,000/yearVariable Cost: $8 per unit (2) Built it with an advanced manufacturing system.Fixed Cost: $30,000/yearVariable Cost: $5 per unit The purchase price of the engine is $10 per unit.

20. BEP for the Three Alternatives and Recommendations Prepare a table similar to the following table, to summarize your recommendations. Demand Recommendation Q <= ? ? ? < Q < = ? ? ? < Q ?

21. Assignment 3: Problem 2 A manager has the option of purchasing 1, 2 or 3 machines. The capacity of each machine is 300 units. Fixed costs are as follows: Number of Machines Fixed cost Total Capacity 1 $9,600 1-300 2 $15,000 301-600 3 $20,000 601-900 Variable cost is $10 per unit, and the sales price of product is $40 per unit. Tell management what to do!

22. BEP for the Three Alternatives and Recommendations Prepare an executive summary similar the following: Q<= ?  ? ?<Q<=? ? Q>? ? Now it is up to the Marketing Department to provide an Executive Summary regarding the demand.

23. Assignment 3: Problem 3 You are the production manager and are given the option to purchase either 1, 2 or 3 machines. Each machine has a capacity of 500 units. Fixed costs are as follows: Number of Machines Fixed cost Total Capacity 1 $19,200 1- 500 2 $30,000 501-1000 3 $40,000 1001-1500 Variable cost is $35 per unit, and the sales price of product is $69 per unit. Determine the best option!

24. BEP for the Three Alternatives and Recommendations Prepare an executive summary similar the following: Q<= ?  ? ?<Q<=? ? Q>? ?