Eng Econ_ Inv an n BEP - L9

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  • Investment analysis: Tools for Evaluating Alternatives OutlineMutually exclusive and independent projectsUse of present, future and annual worth analysis to evaluate alternativesPayback periodRate of returnBenefit-cost ratio

  • Tools for Evaluating AlternativesThere are various tools or methods by which alternatives can be evaluated economically using the factors learned. PurposeCompare mutually exclusive alternatives Basis: present worth, future worth and annual worth analysis

  • Category of projectsTo help formulate alternatives, a project is categorized as one of the following:Mutually exclusive: Only one of the viable projects can be selected by the economic analysisIndependent: More than one viable project may be selected by the economic analysis.

  • Tools for Evaluating alternativesPresent Worth AnalysisFormulating Mutually Exclusive AlternativesPresent Worth Analysis of Equal-life AlternativesPresent worth Analysis of DifferentLife AlternativesFuture Worth AnalysisPayback Period AnalysisAnnual Worth AnalysisRate of Return AnalysisBenefit/Cost Ratio Analysis

  • Present worth Analysis of Equal-Life Alternatives One alternative: Calculate PW at the MARR.If PW 0, the requested MARR is met or exceeded.The alternative is financially viable.Two or more alternatives: Calculate the PW of each alternative.

  • Present worth Analysis of Equal-Life Alternatives Two or more alternatives: Calculate the PW of each alternative at the MARR.Select the alternative with the largest PW valueThis means that select the alternative with less negative or more positive.

  • Selection of alternative following the guideline

    PW1PW2Selected alternative$ -1500$ -5002 -500+10002+2500-5001+2500+15001

  • Present worth Analysis of Equal-Life Alternatives If the projects are independent, the selection guideline is as follows:For one or more independent projects, select all projects with PW 0 at the MARR.

  • Example 5.1Perform a present worth analysis of equal-service machine with costs shown below, if the MARR is 10% per year. Revenue for all the alternatives are expected to be the same.

    Electricpowered Gas poweredSolar poweredFirst cost, $Annual operating cost (AOC), $Salvage value S, $Life, years- 2500 - 900 200 5- 1500 - 700 350 5- 6000 - 50 100 5

  • Example 5.1SolutionThese are service alternatives. The PW of each machine is calculated at i = 10% for n = 5 years. PWE = -2500 - 900(P/A,10%,5) + 200(P/F,10%,5)= $-5788PWG = -3500 - 700(P/A,10%,5) + 350(P/F,10%,5)= $-5936PWS = -6000 - 50(P/A,10%,5) + 100(P/F,10%,5)= $-6127[See the calculations in excel file]The electric-powered machine is selected since the PW of its costs is the lowest, it has numerically the largest PW value.

  • Example 5.2A project engineer with EnvironCare is assigned to start up a new office in a city where a 6-year contract has been finalized to take and to analyze ozone-level readings. Two lease options are available, each with a first cost, annual lease cost, and deposit-return estimates as shown below:

    Location ALocation BFirst cost, $Annual lease cost, $ per yearDeposit return, $Lease term, years- 15,000 -3,500 1,000 6- 18,000 -3,100 2,000 9

  • Example 5.2(a) Determine which lease option should be selected on the basis of a present worth comparison, if the MARR is 15% per year.

    (b) EnvironCare has a standard practice of evaluating all projects over a 5-year period. If a study period of 5 years is used and the deposit returns are not expected to change, which location should be used?

    (c) Which location should be selected over a 6-year study period if the deposit return at location B is estimated to be $6000 after 6 years.

  • Break-Even PointBreakeven AnalysisSingle-Product CaseMultiproduct CaseReference: Operations Management, Heizer & Render, 8th ed (p-287)

  • Learning ObjectivesWhen you complete this topic, you should be able to:Describe or Explain:Break-even analysisAssumptionsGraphical and Algebraic ApproachDetermining BEP for single and multi-product cases

  • Break-Even AnalysisA critical tool for determining capacity a facility must have to achieve profitabilityObjective is to find the point in dollars (or ringgits) and units at which, cost equals revenueRequires estimation of fixed costs, variable costs, and revenue

  • Break-Even Analysis-The Elements

    Fixed costs are costs that continue even if no units are producedDepreciation, taxes, debt, mortgage paymentsVariable costs are costs that vary with the volume of units producedLabor, materials, portion of utilitiesContribution is the difference between selling price and variable cost

  • Break-Even Analysis -The ElementsCosts and revenue are linear functions(In reality, the case is not so)There is no time value of moneyAssumptionsWe actually know that these (variable & fixed) costs are not easy to estimate.

  • Break-Even Analysis

  • Break-Even AnalysisTR = TCorPx = F + VxBreak-even point occurs when

  • Break-Even AnalysisProfit= TR - TC= Px - (F + Vx)= Px - F - Vx= (P - V)x - F

  • Break-Even ExampleFixed costs = $10,000 Material = $.75/unitDirect labor = $1.50/unit Selling price = $4.00 per unit

  • Break-Even ExampleFixed costs = $10,000 Material = $.75/unitDirect labor = $1.50/unit Selling price = $4.00 per unit

  • Break-Even Example

  • Break-Even ExampleMultiproduct CasewhereV= variable cost per unitP= price per unitF= fixed costsW= percent each product is of total dollar salesi= each product

  • Multiproduct BEP ExampleFixed costs = $3,500 per month

  • Multiproduct BEP ExampleFixed costs = $3,500 per month

  • Multiproduct ExampleFixed costs = $3,500 per month

  • Problems for practice (to be solved in the class)Given the following data, calculate BEP(x), BEP ($), and the profit at 100,000 units:P= $8/unit, V = $4/unit and F =$50,000.

    (2) A prolific author is considering starting her own publishing company. She will call it DSI Publishing, Inc. DSIs estimated costs are-------------------------------------------------------------------Fixed$250,000.00Variable cost per book $20.00Selling price per book $30.00

    How many books must DSI sell to break even? What is its break-even point in dollars?

  • Problem #3 (to be solved at home)As manager of a theatre company you have decided that concession sales will support themselves. The following Table provides the info you have been able to put together thus far :Last years manager has advised you to be sure to add 10% of variable cost as a waste allowance for all categories.

    ItemSelling PriceVariable cost% of revenueSoft drink$ 1.00$o.6525Mixed fruit Juice1.750.9525Coffee1.000.3030Candy1.000.3020

  • You estimate labor cost to be $250.00 (5 booths with 3 people each). Even if nothing is sold, your labor cost will be $250.00, so you decide this as fixed cost. Booth rental, which is a contractual cost at $50.00 for each booth per night, is also a fixed cost.(a) What is the break-even volume per evening performance?(b) How much mixed fruit juice would you expect to sell at the break-even point?Problem #3 (to be solved at home)

  • Problem # 4(to be solved and submitted with assignment)

    Jacks Grocery is manufacturing a store brand item that has a variable cost of $0.75 per unit and a selling price of $1.25 per unit. Fixed costs are $12,000. Current volume is 50,000 units. The Grocery can substantially improve the product quality by adding a new piece of equipment at an additional fixed cost of $5,000. Variable cost would increase to $1.00, but their volume should increase to 70,000 units due to the higher quality product.

    Should the company buy the new equipment?

    What are the break-even points ($ and units) for the two processes considered in Problem 4?

    ***This chart introduces breakeven analysis and the breakeven or crossover chart. As you discuss the assumptions upon which this techniques is based, it might be a good time to introduce the more general topic of the limitations of and use of models. Certainly one does not know all information with certainty, money does have a time value, and the hypothesized linear relationships hold only within a range of production volumes. What impact does this have on our use of the models?*This chart introduces breakeven analysis and the breakeven or crossover chart. As you discuss the assumptions upon which this techniques is based, it might be a good time to introduce the more general topic of the limitations of and use of models. Certainly one does not know all information with certainty, money does have a time value, and the hypothesized linear relationships hold only within a range of production volumes. What impact does this have on our use of the models?*This chart introduces breakeven analysis and the breakeven or crossover chart. As you discuss the assumptions upon which this techniques is based, it might be a good time to introduce the more general topic of the limitations of and use of models. Certainly one does not know all information with certainty, money does have a time value, and the hypothesized linear relationships hold only within a range of production volumes. What impact does this have on our use of the models?*This chart introduces breakeven analysis and the breakeven or crossover chart. As you discuss the assumptions upon which this techniques is based, it might be a good time to introduce the more general topic of the limitations of and use of models. Certainly one does not know all information with certainty, money does have a time value, and the hypothesized linear relationships hold only within a range of production volumes. What impact does this have on our use of the models?*This chart introduces breakeven analysis and the breakeven or crossover chart. As you discuss the assumptions upon which this techniques is based, it might be a good time to introduce the more general topic of the limitations of and use of models. Certainly one does not know all information with certainty, money does have a time value, and the hypothesized linear relationships hold only within a range of production volumes. What impact does this have on our use of the models?*This chart introduces breakeven analysis and the breakeven or crossover chart. As you discuss the assumptions upon which this techniques is based, it might be a good time to introduce the more general topic of the limitations of and use of models. Certainly one does not know all information with certainty, money does have a time value, and the hypothesized linear relationships hold only within a range of production volumes. What impact does this have on our use of the models?