Chapter 1

Introduction

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 Table of Contents
Special Products Break-Even Analysis (Section 1.2) 1.2 – 1.6
The Relationship Between Analytics &
Management Science (Section 1.3)1.7 – 1.9

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 Special Products Break-Even
Analysis
The Special Products Company produces expensive and unusual
gifts.
The latest new-product proposal is an iWatch with wireless
internet.
Data:
• If they go ahead with this product, a fixed cost of $10 million is
incurred.
• The variable cost is $1000 per iWatch produced.
• Each iWatch sold would generate $2000 in revenue.
• A sales forecast will be obtained.

Question: Should they produce the iWatch, and if so, how many?

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 Expressing the Problem
Mathematically
Decision variable:
• Q = Number of iWatches to produce.
Costs:
• Fixed Cost = $10 million (if Q > 0).
• Variable Cost = $1000 Q.
• Total Cost =
• 0, if Q = 0.
• $10 million + $1000 Q, if Q > 0.
Profit:
• Profit = Total revenue – Total cost.
• Profit = 0, if Q = 0.
• Profit = $2000Q – ($10 million + $1000Q) = –$10 million + $1000Q, if Q > 0.
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 Special Products Co.
Spreadsheet 1

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 Analysis of the Problem

Access the long description slide.

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 Special Products Co. Spreadsheet 2

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 What Is Analytics?
Analytics is a broad term that includes both management science and
all the other quantitative decision sciences, such as mathematics,
statistics, computer science, data science, industrial engineering, etc. By
drawing on any of these tools to analyze the available data, analytics
can be defined as the scientific process of transforming data into insight
for making better decisions.

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 Three Categories of Analytics
Descriptive Analytics
• Uses innovative techniques to locate the relevant data and identify
the interesting patterns in order to describe and understand what is
going on now.
Predictive Analytics
• Applies predictive models to historical data and perhaps external
data to predict future events or trends.
• Statistical forecasting methods (Chapter 10) and computer
simulation (covered in Chapters 12 and 13) are useful for this.
Prescriptive Analytics
• Involves applying sophisticated models to the data to prescribe what
should be done in the future.
• The powerful optimization models and techniques of managements
science are commonly used here.
• This is the most advanced category. 1.9
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 Some Examples of Using
Analytics
The Obama campaign of 2012
• The campaign management hired a multi-disciplinary team of
statisticians, predictive modelers, data-mining experts,
mathematicians, sofware programmers, and management scientists.
• With all this analytics input, the Obama team leveraged massive
amounts of data to directly micro-target potential voters and donors
with tailored messages.

The Oakland Athletics

• The book Moneyball and subsequent 2011 movie tell the story of
how the Oakland Athletics baseball team achieved great success,
despite a small budget.
• They used nontraditional data (referred to as saber metrics) to better
evaluate the potential of players.

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 Analysis of the Problem Long
Description
Total cost is an upward-sloping line from (0, 10) through (25, 35).
Total revenue is an upward-sloping line from (0, 0) to (25, 50).
Fixed cost is horizontal at 10. The area between the total cost and
total revenue lines is shaded. Below the break-even point (10,
20), the shaded area between the lines is labeled loss. Above the
break-even point, the shaded area is labeled profit.

Return to slide containing original image.

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Problem -1
Suppose that a manufacturer needs to produce a
custom aluminum housing for a special customer
order. Because it currently does not have the
equipment necessary to make the housing, it would
have to acquire machines and tooling at a fixed cost
(net of salvage value after the project is completed)
of $250,000. The variable cost of production is
estimated to be $20 per unit. The company can
outsource the housing to a metal fabricator at a cost
of $35 per unit. The customer order is for 12,000
units. What should they do?

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Problem -2
A firm is evaluating the alternative of manufacturing a
part that is currently being outsourced from a supplier.
The relevant information is provided below:
  For in-house manufacturing
Annual fixed cost = $45,000
Variable cost per part = $140
  For purchasing from supplier (outsourced)
Purchase price per part = $160
 Determine the break-even quantity for which the firm
would be indifferent between manufacturing the part in-
house or outsourcing it.
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Solution (1)
VC1 = Variable cost/unit if produced = $20
VC2 = Variable cost/unit if outsourced = $35
FC = fixed costs associated with producing the part = $250,000
Q = quantity produced

Using Equation 2.1 we obtain:

Q = 250,000/($35 - $20) = 16,667

In this case, because the customer order is for only 12,000 units, which is less than
the break-even point, the least cost decision is to outsource the component.

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Solution –Problem (2)
Using Equation 2.1 we compute
 
Q* = FC = $45,000 = 2,250 parts
VC2 - VC1 $160 - $140
 
If demand is greater than 2,250 produce in-house (make)
If demand is less than or equal to 2,250 outsource

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1) A product is currently made in a process-focused shop, where
fixed costs are $9,000 per year and variable cost is $50 per unit.
The firm sells the product for $200 per unit. What is the break-
even point for this operation? What is the profit (or loss) on a
demand of 200 units per year?
 

2) A fabrication company wants to increase capacity by adding a

new machine. The firm is considering proposals from vendor A
and vendor B. The fixed costs for machine A are $90,000 and for
machine B, $75,000. The variable cost for A is $15.00 per unit and
for B, $18.00. The revenue generated by the units processed on
these machines is $21 per unit. If the estimated output is 5000
units, which machine should be purchased?

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Answer:
1) BEP = 60 units; TR = $40,000, TC = $19,000, therefore Profit =
$21,000.

2) ) no purchase because neither machine yields a profit at that

volume

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EXERCISES:
1. A company has two alternatives for meeting a customer
requirement for 9,000 units of a specialty molding. If done in-
house, fixed cost would be $350,000 with variable cost at $30
per unit. Alternative two is to outsource for a total cost of $80
per unit. Determine the break-even quantity and determine if
they should make the item in-house or outsource it.

2. Two alternatives are being considered for a customer's order

whose anticipated volume is not yet known. If the firm produces
in-house, the fixed cost is $340,000 and variable cost is $2.90 per
unit. If the firm chooses to outsource, it will incur a fixed of
$275,000 and variable cost is $3.50 per unit. Determine the
breakeven quantity and a decision rule of when to outsource.

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ANSWER
1. A company has two alternatives for meeting a customer
requirement for 9,000 units of a specialty molding. If done in-
house, fixed cost would be $350,000 with variable cost at $30 per
unit. Alternative two is to outsource for a total cost of $80 per unit.
Determine the break-even quantity and determine if they should
make the item in-house or outsource it.
 ANS:
VC1 = $30
VC2 = $80
FC = $350,000
Break-even point = Q* = $350,000/($80 - $30) = 7,000 units. Since
the anticipated volume is 9,000 units and is greater than the
breakeven quantity, the firm should produce the part in-house and
not outsource.

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Answer (Prob 2)

The total cost of in-house production is 2.9Q + 340000

The total cost of outsourcing is 3.5Q + 275000
Setting these equal to each other, we have:
2.9Q + 340000 = 3.5Q + 275000
65000 = 0.6Q
Q = 108,333 units
If the volume is less than 108,333 units, the firm should outsource;
if the volume is larger than this, it should produce the order in-
house.

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