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CaseStudy
NOTE: Enter Inputs in Yellow-Shaded Cells.
Revenue per unit of output (first 14,400 lbs): $7.00
Revenue per unit of output (after 14,400 lbs): $2.90
Capacity Option Fixed Cost Variable Cost Per Unit of Output Max. Output
No Roaster $0.00 $3.00 14,400
Buy Roaster $35,000.00 $1.60 40,000
Demand Scenario Demand Level (pounds) Probability
Low 18,000 33%
Medium 25,000 33%
High 35,000 33%
Total: 100%
*** Break-Even and Indifference Points ***
Break-Even Point Indifference Point
No Roaster 0 ---
Buy Roaster 6,482 25,000
*** Results for Different Capacity/Demand Combinations ***
Low Medium High Expected Value
No Roaster $57,600.00 $57,600.00 $57,600.00 $57,600.00
Buy Roaster $47,440.00 $56,540.00 $69,540.00 $57,840.00
Question 1.)
The two capacity options that Robbie needs to consider are buying vs. not buying a coffee roaster. The costs of not buying a roaster are $0.00 (Fixed) and $3.00 (Variable) while the costs of buying a roaster are $35,000 (Fixed) and $1.60 (Variable). The indifference point for the two options is 25,000 pounds of coffee. Since the indifference point is higher than the 14,400 that Robbie will use internally, the implication is that he will need to sell coffee externally if he buys the roaster.
Demand Level Probability Profit
18,000 33% $47,440
Demand Level Probability Expected Value
25,000 33% $56,540
Yes
Demand Level Probability Profit
EV = 35,000 33% $69,540
$57,840
No Demand Level Probability Profit
25,000 100% $57,600
EV =
$57,600
Question 2.)
The demand scenarios do not make a difference in the expected profit if Forster's does not invest in the roaster since all of the demand scenarios are greater than the 14,400 maximum that Forster's will sell in-house.
Question 3.)
The decision tree reflects the total expected values for each of the two capacity options.
Question 4.)
The worst possible financial outcome for Forster's is that they decide to invest in the roaster and the demand is low. The best possible financial outcome is if they invest in the roaster and the demand is high. Other factors that Robbie should consider are that the difference between the expected value of buying vs. not buying the roaster are only $240 for the year and buying a roaster ties up $35,000 of capital. Also, if selling coffee is the core competency of the company, then roasting coffee would be a significant strategic realignment.
Buy Roaster?
Demand Outcome
Demand Outcome
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