Chap00 1b Performance Measurement

Break-Even Analysis
Technique for evaluating

process and equipment
alternatives
Objective is to find the point
in dollars and units at which
cost equals revenue
Requires estimation of fixed
costs, variable costs, and
revenue
2011 Pearson
Education, Inc.
publishing as Prentice
Break-Even Analysis
Fixed costs are costs that
continue even if no units are
produced
Depreciation, taxes, debt,
mortgage payments
Variable costs are costs that

vary with the volume of units
produced
Labor, materials, portion of
utilities
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Education, Inc.
Contribution is the difference
Break-Even Analysis
Assumptions
Costs and revenue are
linear functions
Generally not the case in
the real world
We actually know these

costs
Very difficult to verify
Time value of money is

often ignored
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Education, Inc.
Break-Even Analysis
Total revenue line
900
800
Cost in dollars
700
Break-even point
Total cost = Total revenue
ofi
r
P
600
or
c
t
or
d
ri
Total cost line
500
400
Variable cost
300
ss do
o
L rri
co r
200
100
|
Fixed cost
|
0 100 200 300 400 500 600 700 800 90010001100

Figure
2011S7.5
Pearson
Education, Inc.
Volume (units per period)
Break-Even Analysis
BEPx = breakeven point in
units
BEP$ = breakeven point in
dollars
P = price per
unit (after all
discounts)
Break-even
point occurs when
TR = TC
or
Px = F + Vx
2011 Pearson
Education, Inc.
x = number of
units produced
TR = total revenue
= Px
F = fixed costs
V = variable cost
per unit
TC = total costs = F
+ Vx
F
BEPx =
P-V
Break-Even Analysis
BEP$
=
=
=
BEPx = breakeven point in

units
BEP$ = breakeven point in
dollars
P = price per
= BEP
P
unit
(after xall
discounts)
F P Profit
P-V
=
F
=
(P - V)/P
=
F
1 - V/P
2011 Pearson
Education, Inc.
x = number of
units produced
TR = total revenue
= Px
F = fixed costs
V = variable cost
per unit
TC = total costs = F
+ Vx
= TR - TC
Px - (F + Vx)
Px - F - Vx
(P - V)x - F
Break-Even Example
Fixed costs = $10,000
Direct labor = $1.50/unit
BEP$ =
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Education, Inc.
F
1 -(V/P)
Material = $.75/unit
Selling price = $4.00 per unit
$10,000
1 - [(1.50 + .75)/(4.00)]
Break-Even Example
Fixed costs = $10,000
Direct labor = $1.50/unit
F
1 -(V/P)
BEP$ =
BEPx =
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Education, Inc.
$10,000
.4375
F
P-V
Material = $.75/unit
Selling price = $4.00 per unit
$10,000
1=- [(1.50 + .75)/(4.00)]
= $22,857.14
$10,000
4.00 - (1.50 + .75)
= 5,714
Break-Even Example
50,000
40,000
Revenue
Breakeven point
Dollars
30,000
Total
costs
20,000
10,000
Fixed costs
2,000
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Education, Inc.
4,000
6,000
Units
8,000
10,000
Multiproduct Example
Fixed costs = $3,000 per month
Item
Price
Sandwich
$5.00
Drink
1.50
Baked potato 2.00
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Education, Inc.
Cost
$3.00
.50
1.00
Annual Forecasted
Sales Units
9,000
9,000
7,000
Multiproduct Example
Item
Price
Sandwich
$5.00
Drink
1.50
Baked potato 2.00
Cost
$3.00
.50
1.00
Annual Forecasted
Sales Units
9,000
9,000
7,000
Annual
Forecasted % of
Weighted
SellingVariable
Contribution
Item (i) Price (P)Cost (V)(V/P)1 - (V/P)Sales $ Sales(col 5 x col
Sandwich
$5.00 $3.00
.60
.40 $45,000 .621
.248
7)
Drinks
1.50
.50
.33
.67
13,500 .186
.125
Baked
2.00
1.00
.50
.50
14,000 .193
.096
potato
$72,500 1.000
.469
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Education, Inc.
F
Multiproduct
BEP Example
=
V
1 - P x (W )
$

Item
Price
Sandwich
$5.00
Drink
1.50
Baked potato 2.00
Annual
$3,000 Forecasted
x 12
=
= $76,759
Cost
Sales
.469 Units
$3.00
9,000
.50
9,000
$76,759
Dail
1.00y= 312 days
7,000= $246.02
sale
Annual
Weighted
s
.621
x $246.02
Forecasted
% of
= 30.6 31
$5.00
SellingVariable
Contribution
sandwiches
Item (i) Price (P)Cost (V)(V/P)1 - (V/P)Sales $ Sales(col
5 x col
Sandwich
$5.00 $3.00
.60
.40 $45,000 .621per day
.248
7)
Drinks
1.50
.50
.33
.67
13,500 .186
.125
Baked
2.00
1.00
.50
.50
14,000 .193
.096
potato
$72,500 1.000
.469
2011 Pearson
Education, Inc.
Expected Monetary Value (EMV)

and Capacity Decisions
Determine states of nature
Future demand
Market favorability
Analyzed using decision trees

Hospital supply company
Four alternatives
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Education, Inc.

Market favorable (.4)
La
pla
e
rg
nt
Market unfavorable (.6)

-$90,000
Medium plant
Sm
all
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Education, Inc.
pla
nt
D
o
no
th
in
g
$100,000
$60,000

-$10,000
$40,000

-$5,000
$0

La
pla
e
rg
nt
Medium plant
$100,000

-$90,000
$60,000
Sm Large Plant
-$10,000
all
pla
nt
EMV = D
(.4)($100,000)
o
+ (.6)(-$90,000)
no
$40,000
th
in
g
EMV = -$14,000
-$5,000
2011 Pearson
Education, Inc.
$0

-$14,000
La
pla
e
rg

-$90,000
nt
$18,000
Medium plant
Sm
all
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Education, Inc.
$100,000
$60,000

-$10,000
pla
nt
$13,000
D
o
no
$40,000
th
in
g
-$5,000
$0
Strategy-Driven
Investment
Operations may be
responsible for return-oninvestment (ROI)
Analyzing capacity
alternatives should include
capital investment,
variable cost, cash flows,
and net present value
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Education, Inc.
Net Present Value (NPV)

In general:
F = P(1 + i)N
where
F
P
i
N
=
=
=
=
future value
present value
interest rate
number of years
Solving for P:
F
P=
(1 + i)N
2011 Pearson
Education, Inc.
Net Present Value (NPV)

In general:
F = P(1 + i)N
where
F
P
i
N
=
=
=
=
future value
present value
While this works
interest rate
number offine,
years it is
cumbersome for
larger values of
Solving for P:
N
F
P=
(1 + i)N
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Education, Inc.
NPV Using Factors

P=
F
(1 + i)N
where
Year
14%
Portion
1
of Table
.877
S7.1
2
.769
3
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Education, Inc.
.675
= FX
X = a factor from Table

S7.1 defined as = 1/(1 + i)N
and F = future value
6%
8%
10%
12%
.943
.926
.909
.893
.890
.857
.826
.797
.840
.794
.751
.712
Measuring Supply-Chain
Performance
Typical Firms
Benchmark
Firms
15
Time spent placing an order
42 minutes
15 minutes
Percentage of late deliveries
33%
2%
Percentage of rejected material
1.5%
.0001%
400
Lead time (weeks)
Number of shortages per year
2011 Pearson
Education, Inc.
Table 11.6
Performance
Assets committed to inventory
Percent
invested in
inventory
Total inventory
investment
Total assets
x 100
Investment in inventory = $11.4 billion

Total assets = $44.4 billion
Percent invested in inventory = (11.4/44.4) x 100 = 25.7%
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Education, Inc.
Performance
Inventory as a % of Total Assets
(with exceptional performance)
Manufacturing 15%
(Toyota 5%)
Wholesale 34%
(Coca-Cola 2.9%)
Restaurants 2.9%
(McDonalds .05%)
Retail
27%
(Home Depot 25.7%)
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Education, Inc.
Table 11.7
Performance
Inventory turnover
Inventory
turnover
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Cost of goods sold

=
Inventory investment
Performance
Examples of Annual Inventory Turnover
Food, Beverage, RetailManufacturing
Anheuser Busch
15
Dell Computer
Coca-Cola
14
Johnson Controls
Home Depot
5
Toyota (overall)
McDonalds
112
Nissan (assembly)
90
22
13
150
Table 11.8
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Education, Inc.
Performance
Inventory turnover
Net revenue
Cost of goods sold
Inventory:
Raw material inventory
Work-in-process inventory
Finished goods inventory
Total inventory investment
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Education, Inc.
$32.5
$14.2
$.74
$.11
$.84
$1.69
Performance
Inventory turnover
Net revenue
$32.5
Cost
of
goods
sold
Cost of goods sold
$14.2
Inventory turnover =
Inventory investment
Inventory:
$.74
$.11
= 14.2 / 1.69 $.84
= 8.4
Total inventory investment
$1.69
2011 Pearson
Education, Inc.
Performance
Inventory turnover
Net revenue
$32.5
Cost
of
goods
sold
Cost of goods sold
$14.2
Average
weekly
cost
Inventory turnover =
Inventory
Inventory:
= $14.2 /investment
52 = $.273
of goods sold
$.74
$.11
= 14.2
/ 1.69 $.84
=
8.4
Inventory
investment
Weeks
of supply
=
Total
inventory
investment
Average weekly cost$1.69
of
goods sold
= 1.69 / .273 = 6.19 weeks
2011 Pearson
Education, Inc.

Chap00 1b Performance Measurement

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Chap00 1b Performance Measurement

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Break-Even Analysis

Technique for evaluating

Variable costs are costs that

We actually know these

Time value of money is

Total revenue line

Total cost line

0 100 200 300 400 500 600 700 800 90010001100

Volume (units per period)

BEPx = breakeven point in

Fixed costs = $3,000 per month

Expected Monetary Value (EMV)

Analyzed using decision trees

Expected Monetary Value (EMV)

Market unfavorable (.6)

Market unfavorable (.6)

Market unfavorable (.6)

Expected Monetary Value (EMV)

Market unfavorable (.6)

Expected Monetary Value (EMV)

Market unfavorable (.6)

Market favorable (.4)

Market unfavorable (.6)

Net Present Value (NPV)

Net Present Value (NPV)

NPV Using Factors

X = a factor from Table

Time spent placing an order

Percentage of late deliveries

Percentage of rejected material

Lead time (weeks)

Number of shortages per year

Investment in inventory = $11.4 billion

Cost of goods sold

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