Lecture Fundamentals of operations management (4/e): Chapter 7 - Davis, Aquilano, Chase

Chapter 6 Financial analysis in operations management, after studying this chapter you will be able to: Introduce various cost definitions and demonstrate how they are applied in operations management; demonstrate how break-even analysis is used within an operations management context; demonstrate how concepts of obsolescence, depreciation, and taxes impact the decision-making process with an operations management context;...

DAVIS F   O   U   R   T   H       E   D   I   T   I   O   N AQUILANO CHASE supplement Financial Analysis in  Operations Management © The McGraw-Hill Companies, Inc., 2003 PowerPoint Presentation by Charlie Cook Supplement Objectives Supplement Objectives • Introduce various cost definitions and demonstrate how they are applied in operations management • Demonstrate how break-even analysis is used within an operations management context • Demonstrate how concepts of obsolescence, depreciation, and taxes impact the decision-making process with an operations management context • Introduce and demonstrate how the time value of money can be used as a financial tool in the decisionmaking process with respect to various types of operations management issues.© The McGraw­Hill  Fundamentals of Operations  Companies, Inc., 2003 Management 4e  S5–2 Chapter Objectives (cont’d) Chapter Objectives (cont’d) • Demonstrate the use of various financial functions that are available on Excel Fundamentals of Operations  Management 4e  © The McGraw­Hill  Companies, Inc., 2003 S5–3 Cost Definitions Cost Definitions • Fixed Costs –Expenses such as rent that remain constant over a wide range of output volumes • Variable Costs –Expenses such as material and direct labor that vary proportionately with changes in output • Sunk Costs –Expenses already incurred that have no salvage value Fundamentals of Operations  Management 4e  © The McGraw­Hill  Companies, Inc., 2003 S5–4 Fixed and Variable Cost Components  Fixed and Variable Cost Components  of Total Costs of Total Costs Fundamentals of Operations  Management 4e  © The McGraw­Hill  Companies, Inc., 2003 Exhibit S5.1 S5–5 Cost Definitions (cont’d) Cost Definitions (cont’d) • Opportunity Costs –Profits lost when one alternative is chosen over another that would have provided greater financial benefits • Avoidable Costs –Expenses such as higher labor costs resulting from poor productivity incurred if an investment is not made • Out-of-Pocket Costs –Actual cash outflows associated with a © The McGraw­Hill  particular alternative Fundamentals of Operations  Companies, Inc., 2003 Management 4e  S5–6 Cost Definitions (cont’d) Cost Definitions (cont’d) • Cost of Capital –Usually expressed as a percentage rate, it reflects the cost of the money invested in a project –Comparisons: • The cost of borrowing money to finance the project • Interest lost on short-term notes • Opportunity cost of forgoing one of several other projects that require funding FundamentalsofOperations Management4e âTheMcGrawưHill Companies,Inc.,2003 S57 ActivityưBasedCosting ActivityưBasedCosting ã Activity-Based Costing –An accounting technique that allocates overhead costs in actual proportion to the overhead consumed by the activity • Stage 1: Assign overhead costs to activity pools • Stage 2: Assign costs from pools to activities Fundamentals of Operations  Management 4e  © The McGraw­Hill  Companies, Inc., 2003 S5–8 Traditional and Activity­Based Costing Traditional and Activity­Based Costing Fundamentals of Operations  Management 4e  © The McGraw­Hill  Companies, Inc., 2003 Exhibit S5.2 S5–9 Overhead Allocation by Activity Approach Overhead Allocation by Activity Approach Fundamentals of Operations  Management 4e  © The McGraw­Hill  Companies, Inc., 2003 Exhibit S5.3a S5–10 Source: Ray Garrison, Managerial Accounting, 6th ed (Homewood, IL: Richard D Irwin, 1991), p.94 Overhead Allocation by Activity Approach  Overhead Allocation by Activity Approach  (cont’d) (cont’d) Fundamentals of Operations  Management 4e  © The McGraw­Hill  Companies, Inc., 2003 Exhibit S5.3b S5–11 Source: Ray Garrison, Managerial Accounting, 6th ed (Homewood, IL: Richard D Irwin, 1991), p.94 Break­Even Analysis Break­Even Analysis • Break-Even Analysis –Determination of product volume where revenues equal total costs or costs associated with two alternative processes are the same Fundamentals of Operations  Management 4e  © The McGraw­Hill  Companies, Inc., 2003 S5–12 Break­Even Analysis (cont’d) Break­Even Analysis (cont’d) • Revenues versus Costs (Assumptions) –The selling price per unit is constant –Variable costs per unit remain constant –Fixed costs remain constant Selling price (per unit) = SP Variable costs (per unit) = VC Fixed costs (total) = FC BE units FC total SPunit VC unit © The McGraw­Hill  Fundamentals of Operations  Management 4e  Companies, Inc., 2003 S5–13 Break­Even Analysis for Revenues versus  Break­Even Analysis for Revenues versus  Costs Costs Fundamentals of Operations  Management 4e  © The McGraw­Hill  Companies, Inc., 2003 Exhibit S5.4 S5–14 Break­Even Analysis (cont’d) Break­Even Analysis (cont’d) • Choice of Processes –Used to choose from among alternative processes a company can use –Break-even point is defined as that volume where we are indifferent with respect to the costs of the alternative processes   Total cost  Variable cost Volume Fixed cost = TC = VC = X = FC Fundamentals of Operations  Management 4e  TC1 VC1 X TC FC VC X TC1 TC © The McGraw­Hill  VC1Companies, Inc., 2003 X FC VC X S5–15 Break­Even Analysis for  Break­Even Analysis for  Alternative Types of Processes Alternative Types of Processes Fundamentals of Operations  Management 4e  © The McGraw­Hill  Companies, Inc., 2003 Exhibit S5.5a S5–16 Break­Even Analysis for  Break­Even Analysis for  Alternative Types of Processes Alternative Types of Processes Fundamentals of Operations  Management 4e  © The McGraw­Hill  Companies, Inc., 2003 Exhibit 5S.5b S5–17 Obsolescence, Depreciation, and Taxes Obsolescence, Depreciation, and Taxes • Obsolete –The status of an asset when it has worn out or been surpassed by a superior performing asset • Economic Life –The useful life of an asset in which it provides the best method of operation to an organization Fundamentals of Operations  Management 4e  © The McGraw­Hill  Companies, Inc., 2003 S5–18 Types of Depreciation Types of Depreciation • Straight-Line –Asset’s book value is reduced in uniform annual amounts over its estimated useful life Annual amount to be depreciated Cost - Salvage Estimated useful life • Sum-of-the-Years’-Digits (SYD) –Asset’s book value is reduced rapidly in the early years of its estimated useful life and at a lower rate in its later years Annual depreciation percentage Fundamentals of Operations  Management 4e  Year © The McGraw­Hill  Sum of years' digits Companies, Inc., 2003 S5–19 Types of Depreciation (cont’d) Types of Depreciation (cont’d) • Declining-Balance Method –Asset’s book value is reduced annually by a constant percentage rate that approximately matches its useful life • Double-Declining-Balance Method –Asset’s book value is reduced by twice the straight line rate over the life of the item • Depreciation-by-Use Method –Asset’s book value is reduced in proportion to its use; assumes it will perform an estimated © The McGraw­Hill  number of operations before wearing out Fundamentals of Operations  Companies, Inc., 2003 Management 4e  S5–20 Types of Economic Decisions Types of Economic Decisions Purchase of new equipment or facilities Replacement of existing equipment or facilities Make-or-buy decisions Lease-or-buy decisions Temporary shutdown or plant-closing decisions Addition or elimination of a product or product line Fundamentals of Operations  Management4e âTheMcGrawưHill Companies,Inc.,2003 S521 FinancialDefinitions FinancialDefinitions ã Compound Value of a Single Amount • Compound Value of an Annuity • Present Value of a Future Single Payment • Present Value of an Annuity ã Discounted Cash Flow FundamentalsofOperations Management4e âTheMcGrawưHill Companies, Inc., 2003 S5–22 Methods for Evaluating  Methods for Evaluating  Investment Alternatives Investment Alternatives • Net Present Value –The present value of a stream of future cash flows • Payback Period –The time necessary for a firm to recover its initial investment by the return of earnings from the investment • Internal Rate of Return –The interest rate that equates present value of future cash flows with the cost of an investment © The McGraw­Hill  Fundamentals of Operations  Companies, Inc., 2003 Management 4e  S5–23 Application of Excel to Determine Net Present  Application of Excel to Determine Net Present  Value and Internal Rate of Return Value and Internal Rate of Return Fundamentals of Operations  Management 4e  © The McGraw­Hill  Companies, Inc., 2003 Exhibit S5.6 S5–24 ... © The McGraw­Hill  number of operations before wearing out Fundamentals? ?of? ?Operations? ? Companies, Inc., 2003 Management? ?4e  S5–20 Types? ?of? ?Economic Decisions Types? ?of? ?Economic Decisions Purchase of new equipment... respect to various types of operations management issues.© The McGraw­Hill  Fundamentals? ?of? ?Operations? ? Companies, Inc., 2003 Management? ?4e  S5–2 Chapter? ?Objectives (cont’d) Chapter? ?Objectives (cont’d)... percentage Fundamentals? ?of? ?Operations? ? Management? ?4e  Year © The McGraw­Hill  Sum of years' digits Companies, Inc., 2003 S5–19 Types? ?of? ?Depreciation (cont’d) Types? ?of? ?Depreciation (cont’d) • Declining-Balance