boz_ch08ism

CHAPTER 8

Managing Capacity

PROBLEMSAdditional homework problems are available at www.prenhall.com/bozarth. These problems use Excel to generate customized problems for different class sections or even different students.(* = easy; ** = moderate; *** = advanced)

1. (*) The Shelly Group has leased a new copier that costs $700 per month plus $0.10 for each copy. What is the total cost if Shelly makes 5,000 copies a month? 10,000 copies? What is the per-copy cost at 5,000 copies? At 10,000 copies?

TC = FC + VC*X Eq 8-1

FC = $700VC = $.10/copy

TC = 700 + (.10*5000)TC = $1200

TC = 700 + (.10*10,000)TC = $1,700

Per copy price = TC/# of copies

PPC = 1200/5000PPC = $0.24 @ 5000 copies

PPC = 1700/10000PPC = $0.17 @ 10,000 copies

http://www.prenhall.com/bozarth

Chapter 8: Managing Capacity

2. Arktec Manufacturing must choose between two capacity options, shown below:

Fixed cost (per year) Variable cost (per unit)Option 1 $500,000 $2 per unitOption 2 $100,000 $10 per unit

a. (*) What would the cost be for each option if the demand level is 25,000 units per year? 75,000?


Option 1FC = $500,000VC = $2.00 per unit

TC = 500,000 + (2*25,000)TC = $550,000 for Option 1 (25,000 units)


Option 2FC = $100,000VC = $10/unit

TC = 100,000 + 250,000TC = $350,000 for Option 2 (25,000 units)


b. (**) In general, which option do you think would be better as volume levels increase? Decrease? Why?

As the volume increases – Option 1 become more desirable because the variable costs associated with each unit are significantly less.

c. (*) What is the indifference point?

TC(1) = TC (2)

FC + VC*X = FC + VC*X500,000 + (2X) = 100,000 + (10X)400,000 = 8X50,000 units is the indifference point

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Instructor’s Solutions Manual

3. (*) Suppose the Shelly Group (Problem 1) has identified two possible demand levels for copies per month:

Copies (per month) Probability5,000 copies 50%10,000 copies 50%

What is the expected cost, given the fixed and variable costs in Problem 1?

Using information from problem #1 Expected cost = (Option 1 cost * probability) + (Option 2 cost * probability)Expected cost = $1200(50%) + 1700(50%)Expected cost = 600 + 850Expected cost = $1450

4. Consider the two capacity options for Arktec Manufacturing, shown in Problem 2. Suppose the company has identified three possible demand scenarios:

Demand (per year) Probability25,000 units 30%60,000 40%100,000 30%

a. (**) What is the expected value of each option? Which option would you choose, based on this information?


= Eq 8-2

Option 1 TC = 500,000 + (2*25,000) = $550,000TC = 500,000 + (2*60,000) = $620,000TC = 500,000 + (2*100,000) = $700,000

EV = 550,000(.3) + 620,000(.4) + 700,000(.3)EV = $623,000 for Option 1 in costs

Option 2TC = 100,000 + (10*25,000) = 350,000TC = 100,000 + (10*60,000) = 700,000TC = 100,000 = (10*100,000) = 1,100,000

EV = 350,000(.3) + 700,000(.4) + 1,100,000(.3) EV = $715,000 for Option 2 in costs

I would choose Option 1 – costs are less at this point.

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b. (**) Suppose the lowest and highest demand levels were updated to 40,000 and 110,000. Recalculate the expected values. What happened?

Option 1 TC = 500,000 + (2*40,000) = $580,000TC = 500,000 + (2*60,000) = $620,000TC = 500,000 + (2*110,000) = $720,000

EV = 580,000(.3) + 620,000(.4) + 720,000(.3)EV = $572,000 for Option 1 in costs

Option 2TC = 100,000 + (10*40,000) = 400,000TC = 100,000 + (10*60,000) = 700,000TC = 100,000 = (10*110,000) = 1,200,000


Costs rose for Option 2 while they decreased for Option 1 – again it is a larger volume and this would be expected.

5. Problem 2 identified two capacity options for Arktec Manufacturing, while Problem 4 identified three possible demand outcomes.

a. (**) Draw the decision tree for Arktec Manufacturing. When drawing your tree, assume that management must select a capacity option before they know what the demand level will actually be.

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b. (**) Calculate the expected value for each decision branch. Which option would you prefer? Why?

Option 1 TC = 500,000 + (2*25,000) = $550,000TC = 500,000 + (2*60,000) = $620,000TC = 500,000 + (2*100,000) = $700,000

EV = 550,000(1/3) + 620,000(1/3) + 700,000(1/3)EV = $623,333 for Option 1 in costs

Option 2TC = 100,000 + (10*25,000) = 350,000TC = 100,000 + (10*60,000) = 700,000TC = 100,000 = (10*100,000) = 1,100,000


I would choose Option 1 – costs are less at this point. (Based on answers from problem 5a.)

Select Capacity Option

Option 1EV = $623,333In costs

Option 2EV = $716,667In costs

25,000 units

60,000 units

100,000 units

25,000 units

60,000 units

100,000 units

Each leg has an equal probability = 33.333% = 1/3, use capacity estimates from 4a.EV1 = 550,000(1/3) + 620,000(1/3) + 700,000(1/3) = $623,333.33EV2 = 350,000(1/3) + 700,000(1/3) + 1,100,000(1/3) = $716,666.67

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$550,000

$620,000

$700,000

$1,100,000

$700,000

$350,000


6. You are the new CEO of Dualjet, a company that makes expensive, premium kitchen stoves for home use. You must decide whether to assemble the stoves in-house, or have a Mexican company do it. The fixed and variable costs for each option are shown below:

Fixed VariableCost Cost

Assemble in-house $55,000 $620Mexican assembler $0 $880

a. (**) Suppose DualJet’s premium stoves sell for $2500. What is the break-even volume point for doing it in-house?

eq 8-3

FC = 55,000VC = 620R = 2500

BEP = (55,000)/(2500 – 620)BEP = 29.2 units or 30 to break even

b. (*) At what volume level do the two capacity options have identical costs?

FC + (VC*X) = FC + (VC*X)55,000 + 620X = 0 + 880X55,000 = 260X211.54 units

c. (**) Suppose the expected demand for stoves is 3,000. Which capacity option would you prefer from a cost perspective?

I would use the in-house option. If the expected sales quantity is greater than 211 units, I will make a better profit building them in-house.

7. Emily Watkins, a recent college graduate, faces some tough choices. Emily must decide whether to accept an offer for a job that pays $35,000, or hold out for another job that pays $45,000 a year. Emily figures there is a 75% chance she will get an offer for the higher paying job. The problem is, Emily has to make a decision on the lower paying job within the next few days, and she will not know about the higher paying job for two weeks.

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a. (**) Draw out the decision tree for Emily Watkins.

b. (**) What is the key decision facing Emily? What is the expected value of each decision branch?

Which job to take is Emily’s decision? Is a job in hand better than a probability of a higher paying job? EV for the higher paying job is $33,750 and the EV of the lower paying job is $35,000.

c. (**) What other factors might Emily consider, other than expected value?

She might go ahead and take the lower paying job and then quit if she gets the higher paying job. The decision tree only accounts for taking one job or the other not taking both. She may also consider yet another higher paying job – how long is too long to wait for employment.

8. (*) Philip Neilson owns a fireworks store. Philip’s fixed costs are $12,000 a month, and each fireworks assortment he sells costs, on average, $8. The average selling price for an assortment is $25. What is the break-even point for Philip’s fireworks store?

eq 8-3

BEP = 12,000/(25-8)BEP = 705.88 or 706 units

9. Suppose Philip Neilson (Problem 8) decides to expand his business. His new fixed expenses will be $20,000, but the average cost for a fireworks assortment will fall to just $5 due to Philip’s higher purchase volumes.

a. (*) What is the new break-even point?

eq 8-3

BEP = 20,000/(25-5)BEP = 1000 units

b. (**) At what volume level is Philip indifferent to the two capacity alternatives outlined in Problems 8 and 9?

FC + (VC*X) = FC + (VC*X)12,000 + 8X = 20,000 + 5X3X = 8,0002666.67 or 2667 units

10. Merck is considering the launch of a new drug called Laffolin. Merck has identified two possible demand scenarios, shown below:

Demand level Probability1,000,000 patients 30%

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Select Job

Option 1Higher paying jobEV = $33,750

Option 2Lower paying jobEV = $35,000

45,000 * 75%

0 * 25%

35,000 * 100%

45,000 * 0%


2,000,000 patients 70%

Merck also has the following information:

Revenue: $140 per patientFixed costs to manufacture & sell Laffolin: $70 millionVariable costs to manufacture & sell Laffolin: $80 per patientMaximum number of patients that Merck can handle: 3,000,000

a. (*) How many patients must Merck have in order to break even?

eq 8-3

BEP = 70,000,000/(140 – 80)BEP = 1166666.67 or 1,166,667 patients

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b. (**) How much money will Merck make if demand for Laffolin is 1,000,000 patients? If demand is 2,000,000 patients?

Profit = Revenue/patient – Costs per patientProfit = 140,000,000 – (FC + VC*X)Profit = 140,000,000 – 150,000,000Profit = - $10,000,000 it is a loss at 1,000,000 patients

Profit = 280,000,000 – (230,000,000)Profit = $50,000,000 at 2,000,000 patients

c. (**) What is the expected value of making Laffolin?

EV = (-10,000,000)*.3 + (50,000,000)*.7EV = $32,000,000

d. (**) Draw the decision tree for the Laffolin decision, showing the profits for each branch (Total revenues – total variable costs – fixed cost) and all expected values.

Drug

Make Laffolin EV = $32,000,000

Not make LaffolinEV = 0

- $10,000,000

$50,000,000

0

1 million patients

2 million patients

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11. Clay runs a small hotdog stand in downtown Chapel Hill. Clay can serve about 30 customers an hour. During lunch time, customers randomly arrive at the rate of 20 per hour.

a. (*) What percentage of the time is Clay busy?

[8-5]

= 20/30

= 66.7%

b. (*) On average, how many customers are waiting to be served? How many are in the system (waiting and being served)?

[8-6]

average number of customers waiting to be served

[8-7]

customers, on average, in the system

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c. (*) On average, how long will a customer wait to be served? How long will a customer be in the system?

[8-8]

hours average time spent waiting or 4 minutes

[8-9]

hours average time spent in the system or 6 minutes

12. Peri Thompson is the sole dispatcher for Thompson Termite Control. Peri’s job is to take customer calls, schedule appointments, and in some cases resolve any service or billing questions while the customer is on the phone. Peri can handle about 15 calls an hour.

a. (*) Typically, Peri gets about 10 calls an hour. Under these conditions, what is the average number of customers waiting, and what is the average waiting time?

[8-6]

average number of customers waiting to be served.

[8-8]

hours average time spent waiting or 8 minutes average time waiting

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b. (**) Monday mornings, however, are unusually busy. During these peak times, Peri will receive around 13 calls an hour, on average. Recalculate the average number of customers waiting, and the average waiting time. What can you conclude?

[8-6]

average number of customers waiting to be served.

[8-8]

hours average time spent waiting or 26 minutes average time waiting

Peri needs help on Monday mornings or customers will get tired of waiting on the phone for 26 minutes.

13. Benson Racing is training a new pit crew for its racing team. For their first practice run, the pit crew is able to complete all the tasks in exactly thirty seconds – not exactly world-class. The second time around, they shave 4.5 seconds off their time.

a. (*) Estimate the learning rate for the pit crew, based on the times for the first two practice runs.

Learning rate = 25.5/30Learning rate = .85 or 85%

b. (**) Mark Benson, owner of Benson Racing, says that the pit crew must be able to complete all the tasks in less than 15 seconds in order to be competitive. Based on your answer to Part a, how many times will the pit crew need to practice before they break the 15 second barrier?

[8-11]

.5 =

ln .5 = ln

-.693147 = -.234465 ln 2.956 = ln 19.22 or 20 practices needed to get to 15 seconds

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c. (**) Is it realistic to expect the pit crew to experience learning improvements indefinitely? Explain.

No, while it is possible mathematically tasks can only be performed so fast. It will always take some amount of time.

14. Wake County has a special emergency rescue team. The team is practicing rescuing dummies from a smoke-filled building. The first time they tried, it took 240 seconds (4 minutes). The second time took 180 seconds (3 minutes).

a. (*) What is the estimated learning rate for the rescue team, based on the information above?

Learning rate = 180/240Learning rate = .75 or 75%

b. (**) Suppose the team's learning rate for the rescue exercise is 80%. How many times will they need to repeat the exercise until the time is less than 120 seconds (50% of the original time)?

[8-11]

.5 =

ln .5 = ln

-.693147 = -.3219 ln 2.153 = ln 8.61 or 9 repeats to get the time below 120 seconds at the 80% learning rate.

c. (**) How long would it take the emergency team to perform their 20th rescue if the learning rate is 80%?

[8-11]

= 240 * .381 (from Table 8-6)

= 91.44 seconds

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Problems 15 through 17: TriangCom

15. After graduating from college, some friends and you start an Internet auction service called TriangCom. Business has been fantastic, with 10 million customer visits -- or "hits" -- to the site in the last year. You have several capacity decisions to consider. One key decision involves the number of computer servers needed. You are considering putting in 10, 20, or 30 servers. Costs and capacity limits are as follows:

No. of Servers Fixed cost per year Variable cost per hit Maximum hits per yr.10 $50,000 $.005 20 million20 $90,000 $.003 40 million30 $120,000 $.002 60 million

In addition, Marketing has developed the following demand scenarios:

Yearly demand Probability15 million hits 30%30 million hits 60%45 million hits 10%

Finally, TriangCom generated $5 million last year based on 10 million "hits.” Put another way, each "hit" generated, on average, $0.50 in revenue.

a. (**) Calculate the break-even point for each capacity alternative.

eq 8-3

= 101,010 hits

= 181,086 hits

= 240,963 hits

b. (**) At what demand level would you be indifferent to having either 10 or 20 servers?

50,000 + (.005*X) = 90,000 + (.003*X).002X = 40,00020 million hits, which is the high end for 10 servers leaving no room for error.

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c. (***) Calculate the expected value for each capacity alternative. (Hint: Don't forget about capacity constraints that can limit the number of “hits” each capacity alternative can handle.) Which alternative would you prefer if you wanted to maximize the expected value?


= Eq 8-2

Option 1 (10 servers and 20,000,000 hit limitation)EV=(((50,000+(.005*15,000,000))*.3)+(((50,000+(.005*20,000,000))*.6)+(((50,000+(.005*20,000,000))*.1)EV = (37,500)+(90,000)+(15,000)EV for option 1 is $142,500 in costs

EV=(((15,000,000*.5)-(37,500))*.3)+(((20,000,000*.5)-(90,000))*.6) + (((20,000,000*.5)-(90,000))*.1)EV=(2,238,750)+(5,946,000)+(991,000)EV for Option 1 is $9,175,750 in net profits

Option 2 (20 servers and 40,000,000 hit limitation)EV=(((90,000+(.003*15,000,000))*.3)+(((90,000+(.003*30,000,000))*.6)+(((90,000+(.003*40,000,000))*.1)EV = (27,013.50)+(108,000)+(21,000)EV for option 2 is $156,013.50 in costs

EV=(((15,000,000*.5)-(27,013.50))*.3)+(((30,000,000*.5)-(108,000))*.6) + (((30,000,000*.5)-(21,000))*.1)EV=(2,241,895.95)+(8,935,200)+(1,497,900)EV for Option 2 is $12,674,995.95 in net profits

Option 3 (30 servers and 60,000,000 hit limitation)EV=(((120,000+(.002*15,000,000))*.3)+(((120,000+(.002*30,000,000))*.6)+(((120,000+(.002*45,000,000))*.1)EV = (45,000)+(108,000)+(129,000)EV for option 1 is $282,000 in costs

EV=(((15,000,000*.5)-(45,000))*.3)+(((30,000,000*.5)-(108,000))*.6) + (((45,000,000*.5)-(129,000))*.1)EV=(2,236,500)+(8,935,200)+(2,237,100)EV for Option 3 is $13,408,800 in net profits

Using Expected CostsOption 1 maximizes your investment dollars but does not realize your potential dollars. Since you have a 30% probability of 15 million hits and a 60% probability of 30 million, I would use Option 2, it will cover over 90% of the hit probability.

Using Expected Net ProfitOption 3

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16. TriangCom has hired Donna Olway to code programs. Donna completes her first job in 5 weeks and her second job in 4 weeks. Assuming that 1) Donna continues to learn at this rate, and 2) her time improvements will follow a learning curve:

a. (**) How long would you expect Donna to take to complete her 6th job?

[8-11]

learning curve is 80% (4weeks/5weeks)

= 5 weeks * .562 (from Table 8-6)

= 2.81 weeks or a little more than 14 days (five day weeks)

b. (**) How long would you expect Donna to take to complete the next five jobs (Jobs 3 through 7)?


= 3.51 weeks or 7.55 days (five day weeks) for Job 3.


= 3.20 weeks or 16 days (five day weeks) for Job 4.







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17. With thousands of customers, TriangCom has established a hot-line to take customer calls. The hot-line is staffed by one person, 24 hours a day. You have the following statistics:

Service rate for calls 15 per hour, on averageArrival rate for calls 11 per hour, on average

As part of your customer service policy, you have decided that the average waiting time should not exceed 2.5 minutes.

a. (*) What is the average number of callers being served?

[8-5]

= 11/15

= 73.3%

b. (*) On average, how many callers are waiting to be served?

[8-6]

average number of customers waiting to be served

c. (**) What is the average waiting time for a customer? Is this acceptable, given the customer service policy?

[8-8]

hours average time spent waiting or 11 minutes - no this is not acceptable by the

company policy.

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Problems 18 through 20: Sawyer Construction

Rich Sawyer runs a landscaping firm. Each year, Rich contracts for labor and equipment hours from a local construction company. The construction company has given Rich three different capacity options, shown below:

Capacity Options Labor hours Equipment hoursHigh capacity 9000 6000

Medium capacity 6750 4500Low capacity 4500 3000

Cost per labor hour: $10 per hourCost per equipment hour: $20 per hour

Once Rich has chosen a capacity option, he cannot change it later. In addition, the cost for each capacity option is fixed. That is, Rich must pay for all labor and equipment hours he contracted for, even if he doesn't need it all. Therefore, there are essentially no variable costs. Rich also has information concerning the amount of revenue, labor and equipment hours needed for the "typical" landscaping job:

Job Revenue: $2,000 per jobLabor hours per job: 30 hoursEquip. hours per job: 20 hours

Finally, Rich has identified three possible demand levels. These demand levels, with their associated probabilities, are shown below:

Demand Level # Jobs ProbabilityHigh demand 300 30%

Medium demand 200 40%Low demand 120 30%

18. (***) Determine the total fixed cost and break-even point for each capacity option. What is the maximum number of jobs that can be handled under each capacity option?

Capacity Options Labor hours Equipment hours FCHigh capacity 9000 10 6000 20 $210,000

Medium capacity 6750 10 4500 20 $157,500Low capacity 4500 10 3000 20 $105,000

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FC = (labor hours * $10/hour) + (equipment hours * $20/hour)

Capacity Options FC VC Revenue BEP (in jobs)High capacity 210,000 0 2000 105

Medium capacity 157,500 0 2000 78.75 or 79Low capacity 105,000 0 2000 52.5 or 53

Capacity Options Labor hours Equipment hours JobsHigh capacity 9000/30 300 6000/20 300 300

Medium capacity 6750/30 225 4500/20 225 225Low capacity 4500/30 150 3000/20 150 150

19. (***) Draw a decision tree for Sawyer. What are the nine possible outcomes Rich is facing? (Hint: One is "Rich subcontracts for low capacity and demand turns out to be low.") What is the profit (Revenue - fixed costs) associated with each of the nine outcomes? Be sure to consider the capacity limits of each alternative when calculating revenues.


= Eq 8-2

EV = FC for costs

Net Profit = Revenue - Costs

Capacity Options

Demand Options

Jobs Revenue ($)

FC ($)

Profit ($)(jobs*revenue)-FC

High (300) High 300 2000 210,000 390,000Medium 200 2000 210,000 190,000

Low 120 2000 210,000 30,000Medium (225) High 225 2000 157,500 292,500

Medium 200 2000 157,500 242,500Low 120 2000 157,500 240,000

Low (150) High 150 2000 105,000 195,000Medium 150 2000 105,000 195,000

Low 120 2000 105,000 135,000

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Capacity Options

Demand Options

Profit Prob. (%)

EV Profit * Probability

High (300) High 390,000 30 117,000Medium 190,000 40 76,000

Low 30,000 30 9,000Medium (225) High 292,500 30 87,750

Medium 242,500 40 97,000Low 240,000 30 72,000

Low (150) High 195,000 30 58,500Medium 195,000 40 78,000

Low 135,000 30 40,500

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20. (***) Using the information from Problem 19, calculate the expected profit of each capacity alternative. Which option would Rich prefer if he wanted to maximize expected profit?

High Capacity = $202,000Medium Capacity = $256,750Low Capacity = $177,000

I would choose option #2. Option 2, medium capacity, will cover up to 225 jobs. The expected increase in costs to improve capacity an additional 75 jobs will cause Rich to lose money in the long term.

21. (***) (Microsoft Excel problem). The figure below shows an expanded version of the Excel spreadsheet described in the section, Using Excel in Capacity Management. In addition to the break-even and indifference points, the expanded spreadsheet calculates financial results for three capacity options under three different demand scenarios. Re-create this spreadsheet in Excel. You should develop the spreadsheet so that the results will be recalculated if any of the values in the highlighted cells are changed. Your formatting does not have to be exactly the same, but the numbers should be. (As a test, see what happens if you change the “max output” and variable cost for Capacity Option A to 250 units and $35, respectively. Your new expected value for Capacity Option A should be $14,218.75.)

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Chapter 8: Managing Capacity94

1

2

345

6789

10

11121314151617

18192021222324

25262728

A B C D E F

Evaluating Alternative Capacity Options(Enter inputs in shaded cells)

Revenue per unit of output: $100.00

Capacity Option Fixed cost

Variable cost per unit of

output Max. outputOption A $0.00 $30.00 200Option B $1,250.00 $15.00 300Option C $4,000.00 $7.50 400

Demand Scenario Demand level Probability

Low 125 25%Medium 275 55%High 425 20%

Total: 100%

**** Indifference Points ******* Break-even

point *** Option A Option B Option COption A 0.00 ---Option B 14.71 83.33 ---Option C 43.24 177.78 366.67 ---

*** Results for different capacity / demand combinations ***

Low Medium High*** Expected

value ***Option A $8,750.00 $14,000.00 $14,000.00 $12,687.50Option B $9,375.00 $22,125.00 $24,250.00 $19,362.50Option C $7,562.50 $21,437.50 $33,000.00 $20,281.25


CASE STUDY - Forster’s Market

Introduction

Forster’s Market is a retailer of specialty food items, including premium coffees, imported crackers and cheeses, and the like. Last year, Forster’s sold 14,400 pounds of coffee. Forster’s pays a local supplier $3 per pound, and then sells the coffees for $7 a pound.

The Roaster Decision

While Forster’s makes a handsome profit on the coffee business, owner Robbie Forster thinks he can do better. Specifically, Robbie is considering investing in a large industrial-sized coffee roaster that can roast up to 40,000 pounds per year. By roasting the coffee himself, Robbie would be able to cut his coffee costs down to $1.60 a pound. The drawback is that the roaster would be quite expensive; fixed costs (including the lease, power, training, and additional labor) would run about $35,000 a year.

The roaster capacity would also be significantly more than the 14,400 pounds that Forster’s needs. However, Robbie thinks he would be able to sell coffee to area restaurants and coffee shops for $2.90 a pound. Robbie has outlined three possible demand scenarios:

Low demand: 18,000 pounds per yearMedium demand: 25,000 poundsHigh demand: 35,000 pounds

These numbers include the 14,400 pounds sold at Forster’s Market. In addition, Robbie thinks all three scenarios are equally likely.

Questions

1. What are the two capacity options that Robbie needs to consider? What are their fixed and variable costs? What is the indifference point for the two options? What are the implications of the indifference point?

Two capacity options: buy a roaster or continue as now.

No RoasterFC = $0VC = $3.00/poundRoaster FC = $35,000VC = $1.60/pound

FC + (VC*X) = FC + (VC*X)0 + (3X) = 35,000 + 1.6X1.4X = 35,000X = 25,000

25,000 pounds of coffee is the indifference point.

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2. Draw the decision tree for the roaster decision. If Forster’s does not invest in the roaster, does Robbie need to worry about the different demand scenarios outlined above? Why or why not?

3. Calculate the expected value for the two capacity options. Keep in mind that, for the roaster option, any demand above 14,400 pounds would generate revenues of only $2.90 a pound. Update the decision tree to show your results.

Demand Original SalesR = $7.00/lb

Restaurant Sales (R* = 2.90/lb)

FC VC per lb.

Profit (R + R*) - FC - VC

Low 14,400 3,600 35,000 1.60 100,800+10,440-35,000-28,800 = $47,440

Medium 14,400 10,600 35,000 1.60 100,800+30,740-35,000-40,000 = $56,540

High 14,400 20,600 35,000 1.60 100,800+59,740-35,000-56,000 = $69,540

See tree for EV results.

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Roaster

Purchase Roaster EV = $59,440

Not purchase roasterEV = $57,600

14,400 pounds

$57,600

Total sales = 18,000 lbs Profit = $52,240



33%

33%

33%


4. What is the worst possible financial outcome for Forster’s? The best possible financial outcome? What other factors – core competency, strategic flexibility, etc. – should Robbie consider when making this decision?

The worst possible outcome is that Robbie invests in the new roaster and demand is only 15,000 lbs. In that case, he makes $52,240. The best case is that Robbie invests in the roaster and demand is 35,000 lbs., in which case he makes $69,540. All in all, though, if the demand estimates are reasonably accurate, Robbie should make money regardless of what he does.Of course, there is the question of strategic flexibility and core competency. Does Robbie want to get into the roasting business? If he does invest, it reduces his flexibility to use his time and money somewhere else.

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