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Operations Management
Break-Even Analysis - Lecture 4.2
Dr. Ursula G. Kraus
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Review
• Merton Truck
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• Acquiring Capacity: Break-Even Analysis• Applied Decision Problems
Agenda
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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
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Break-Even Analysis
Total Costs (TC) = FC + VC = FC + v * Q
Total Revenue (TR) = R * Q
where:v = variable costs per unitR = revenue per unitQ = volume of output
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Break-Even Chart
Fixed cost
Variable cost
Total cost line
Total revenue line
ProfitBreakeven pointTotal cost = Total revenue
Volume (units/period)
Cos
t/R
even
ue
in D
olla
rs
Loss
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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?
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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?
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Acquiring Capacity: Process Alternatives
Fixed cost - Process A
Fixed cost - Process B
Fixed cost - Process CTotal cost - Process C
Total cost - Process B
Total
cost
- Pro
cess
A
Process A: low volume, high variety
Process B: RepetitiveProcess C: High volume, low variety
Process CProcess BProcess AVolume (units/period)
Cos
t in
Dol
lars
(T
hou
san
ds)
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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
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Break-Even Chart: Vending Machines
Volume (units/period)
Cos
t/R
even
ue
in D
olla
rs (
Th
ousa
nd
s)
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Break-Even Chart: Vending Machines
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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?
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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?
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Kristen's Cookies
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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
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Product Mix Decisions
Processing Times
Mix & Spoon
Load & Set Timer
Bake Cool Pack Payment Total
Chocolate Chip
8 mins. (6+2/doz)
1 9 5 2/ doz 1 26
Oatmeal Raisin
5 mins. (3+2/doz)
1 14 2 2/ doz 1 25
Resource You RM+Oven Oven RM RM
Total time available per week: 20 hrs