OPIM101

Decision Analysis

AY 2016/2017 Term 1

Topic: Breakeven Analysis and Economic Order Quantity

Before you begin to work on the homework questions, you should read the
interesting (I hope) examples in Section A and make sure you understand the class
exercises in Section B.
Section A: Daily Encounters
1) Why did you choose to have a university degree?
The annual full fees for local (Singapore Citizens and Permanent Residents) are
S$21,200 for the first year and S$22,000 from Academic Year 2008/09 onwards. []
Our top 20% graduate employees take home an average salary of more than
S$4,630 per month.
Other option:
Store Assistant with minimum N or O Level
Starting Salary: S$1,200

Lets focus on financial impact and Compare it with an alternative

Which is better? How many years before you break even?

Question: What are some of the pitfalls of the analysis?

- often make oversimplifying assumptions
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OPIM101

Decision Analysis

AY 2016/2017 Term 1

- tend to downplay the value of qualitative information

2) How much money should be put inside the ATM machine and how often should
the money in the machine to be replenished
MS Bank is requested to install an ATM machine near a casino to serve the
customers. Its estimated that the cash withdrawal is roughly consistent at a rate of
$5000 per 5 min. The replenishment cost is $100 per trip regardless of the amount
of money carried. For MS Bank, the capital cost is 10%.
How much money should MS Bank place in the ATM machine(s) to minimize the total
cost?
- Use Economic Order Quantity (EOQ) Model: A technique for inventory control
- How much money to put in ATM? How often to do this replenishment?
- If small amount of money, then lower capital holding cost, but higher
replenishment cost
- Trade-off: Replenishment Cost versus Holding Cost
D: Annual demand for the cash from the ATM
$5,000* (60 min/5 min)* 24 hr/day *360 day= $518,400,000.
S: Replenishment cost per placement in ATM
$100
H: Capital holding cost per $1 put in ATM
$1*10% = $0.1
Q: How much money to put in ATM?
Minimize annual total replenishment and holding cost
We can write the total cost in terms of decision variable Q and parameters S, H, D
-The optimal solution can be derived:

Q* = $1,018,233.76
Question: WHAT IF demand quadruples (not D but 4D)?

Section B: Class Exercise

3. The Retread tire company recaps tires. The fixed annual cost of the
recapping operation is $60,000. The variable cost of recapping a tire is $9.
The company charges $25 to recap a tire.
a. For an annual volume of 12,000 tires, determine the total cost, total
revenue, and profit
b. Determine the annual break-even volume for the Retrend Tire Company
operations
c. Graphically illustrate the break-even volume
(This question is taken from pg 40, no.2&5)

Answer:
a.
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OPIM101

Decision Analysis

AY 2016/2017 Term 1

v 12,000, cf $60,000, cv $9,

p $25; TC cf vcv

b.

60,000 (12,000)(9)
$168,000;
cf
60,000
(12,000)($25)
$300,000;
vTR
vp
3,750
tiresperyear
p cv
25 9
Z $300,000 168,000 $132,000 peryear

REMEMBER: units!!!

c.

REMEMBER: Label the axes

4. The purchasing manager for the Atlantic Steel Company must determine a policy
for ordering coal to operate 12 converters. Each converter requires exactly 5 tons of
coal per day to operate , and the firm operates 360 days per year. The purchasing
manager has determined that the ordering cost is $80 per order and the cost of
holding coal is 20% of the average dollar value of inventory held. The purchasing
manager has negotiated a contract to obtain the coal for $12 per ton for the coming
year.

a. Determine the optimal quantity of coal to receive in each order.

b. Determine the total inventory- related costs associated with the optimal
ordering policy (do not include the cost of the coal).
c. If 5 days of lead time are required to receive an order of coal, how much
coal should be on hand when an order is placed?*

Operates 360 days/year

12 converters
5 tons coal/day/converter
D = (5 tons)(12 converters)(360 days) = 21,600 tons/year
Co = $80
Cc = (.20)($12) = $2.40
a) Q

2Co D

Cc

2(80)(21,600)
2.4

1, 440,000 1,200 tons

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OPIM101

b)

TC Cc

Decision Analysis

Q
D
Co
2
Q

AY 2016/2017 Term 1

= 1,440 + 1,440 = $2,880

c) Demand over the lead time = (12*5) per day *5 days

NOTE: the definition of holding cost

Section C: Homework
Aug 2016
Name:
____________________________
Marks:_____________

Due Date: 29th

Group: ___________

5. Consider a model in which two products, x and y , are produced. There are 100
pounds of material and 80 hours of labor available. It requires 2 pounds of material
and 1 hour of labor to produce a unit of x , and 4 pounds of material and 5 hours of
labor to produce a unit of y . The profit for x is $30 per unit, and the profit for y is
$50 per unit. If we want to know how many units of x and y to produce to
maximize profit, the model is

Use logic to determine the solution to this problem and

explain your answer.
Answer:
The solution is computed by solving simultaneous equations,
x = 30, y = 10, Z = $1,400
It is the only, i.e., optimal solution because there is only one set of values for x and
y that satisfy both constraints simultaneously.
6. Breakeven Analysis (Taylor, Ch. 1, pg40, no. 4)
Evergreen Fertilizer Company produces fertilizer. The company's fixed monthly cost
is $25,000, and its variable cost per pound of fertilizer is $0.15. Evergreen sells the
fertilizer for $0.40 per pound. Determine the monthly break-even volume for the
company. Graphically illustrate the break-even volume for the Evergreen Fertilizer
Company determined
Answer:
Draw the graph. Remember to label your axes

OPIM101

Decision Analysis

AY 2016/2017 Term 1

cf $25,000, p $.40, cv $.15,

v

cf
25,000

100,000 lbpermonth
p cv .40 .15

7. EOQ
Suppose a gift shop in Myrtle Beach has an annual demand for 15,000 units for a
souvenir kitchen magnet it buys for $0.50 per unit. Assume it costs $10 to place an
order, and the inventory carrying cost is 25% of the items unit cost. Determine the
optimal order quantity if the company wants to minimize the total cost of procuring
this tem. What is the total cost associated with this order quantity? (Ragsdale, Ch.8,
pg 387, no.14)
Answer:
a.
b.
c.

1549
$7,693
Ordering cost = $96.82, Holding cost = $96.82. Total cost = $96.82*2

8. EOQ
BIM Computers Inc. sells its popular PC-PAL model to distributors at a price
of $1,250 per unit. BIMs profit margin is 20%. Factory orders average 400
units a week. Currently, BIM works in a batch mode and produces a 4-week
supply in each batch. BIMs production process involves three stages:
* cost price = $1250/100*80 = $1000; Q = 4*400 = 1600

PC board assembly (the automatic insertion of parts and the manual

loading, wave soldering, and laser bonding of electronic components
purchased from outside sources),
Final assembly, and
Testing.

When the firm wants to change production from one model to another, it
must shut down its assembly line for half a way. The company estimates that
downtime costs one-half hour of supervisory time and an additional $2,000 in
lost production; and wages paid to workers directly involved in changeover
operations. Salaries for supervisory personnel involved amount to $1,500 a
day.
* setup cost (in manufacturing) = $2000 + ($1500 * / 8) same as order
cost in the purchasing setting
Although BIM products are generally regarded as high quality, intense price
competition in the industry has forced the firm to embark on a cost-cutting
and productivity-improvement campaign. In particular, BIM wants to operate
with leaner inventories but without sacrificing customer service. Releasing
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OPIM101

Decision Analysis

AY 2016/2017 Term 1

some of the funds tired up in outputs inventory would allow BIM to invest in a
new product development project that is expected to yield a risk-adjusted
return of 20%. Assume 50 workweeks in a year, 5 working days in a week and
8 working hours per day.
* carrying cost = 0.20* cost price = $200
a Determine BIMs total annual cost of production and inventory control.
b Compute the economic batch size and the resulting cost savings.
Answer:
a Q = 4 wks supply = 1,600 units, instead of computing the EOQ, u r given
the batch size Q (which may or may not give the lowest cost)
d = 400 units/wk => D = 400*50= 20,000 units/yr,
Purchase cost per unit C = $l,250(l-20%) = $l,000,
Thus, holding cost H = (r+h)C = $200/unit/yr.
Switch over or setup cost S = $2,000 + 1/2hr $1,500/day 1day/8hr =
$2,093.75.
Thus, # of setups per year D/Q = 20,000 / 1600 = 12.5.
Annual setup cost = (D/Q)S = 12.5 $2,093.75 = $26,172
Annual holding cost= (Q/2)H= 800$200= $160,000
Thus, total annual controllable cost TCC(Q) $26,172 + $160,000 =
$186,172

Q*

2 RS
2 20, 000 2, 093.75

647 units.
H
200

b
Annual setup cost = (R/Q*)S = (20,000/647) $2,093.75 = $64,722
Annual holding cost = (Q*/2)H= 323.5$200 = $64,700
Thus, total annual controllable cost TCC(Q*) = $64,722 + $64,700 =
$129,422
TCC (Q* ) 2 RSH 2 20, 000 2093.75 200= $129,422
Alternatively,
Annual savings = $186,172 - $129,422 = $56,750.