Operations Management, 12e (Heizer/Render/Munson)
Supplement 7 Capacity and Constraint Management
Section 1 Capacity
1) Utilization is the number of units a facility can hold, receive, store, or produce in a period of time.
Answer: FALSE
Diff: 2
Key Term: Utilization
Objective: LO S7.2 Determine design capacity, effective capacity, and utilization
Learning Outcome: Explain options for managing bottlenecks and managing capacity in service and manufacturing processes
2) Design capacity is the theoretical maximum output of a system in a given period under ideal conditions.
Answer: TRUE
Diff: 2
Key Term: Design capacity
Objective: LO S7.2 Determine design capacity, effective capacity, and utilization
Learning Outcome: Explain options for managing bottlenecks and managing capacity in service and manufacturing processes
3) Capacity decisions are based on technological concerns, not demand forecasts.
Answer: FALSE
Diff: 1
Key Term: Capacity
Objective: LO S7.1 Define capacity
Learning Outcome: Explain options for managing bottlenecks and managing capacity in service and manufacturing processes
4) Effective capacity is typically larger than design capacity.
Answer: FALSE
Diff: 2
Objective: LO S7.2 Determine design capacity, effective capacity, and utilization
Learning Outcome: Explain options for managing bottlenecks and managing capacity in service and manufacturing processes
5) Price changes are useful for matching the level of demand to the capacity of a facility.
Answer: TRUE
Diff: 2
Objective: LO S7.1 Define capacity
Learning Outcome: Explain options for managing bottlenecks and managing capacity in service and manufacturing processes
6) A useful tactic for increasing capacity is to redesign a product in order to facilitate more throughput.
Answer: TRUE
Diff: 2
Key Term: Capacity
Objective: LO S7.1 Define capacity
Learning Outcome: Explain options for managing bottlenecks and managing capacity in service and manufacturing processes
7) Effective capacity × Efficiency equals:
- A) efficient capacity.
- B) utilization.
- C) actual capacity.
- D) expected output.
- E) design capacity.
Answer: D
Diff: 2
Objective: LO S7.2 Determine design capacity, effective capacity, and utilization
Learning Outcome: Explain options for managing bottlenecks and managing capacity in service and manufacturing processes
8) Effective capacity is the:
- A) maximum output of a system in a given period.
- B) capacity a firm expects to achieve given the current operating constraints.
- C) average output that can be achieved under ideal conditions.
- D) minimum usable capacity of a particular facility.
- E) sum of all of the organization's inputs.
Answer: B
Diff: 2
Key Term: Effective capacity
Objective: LO S7.2 Determine design capacity, effective capacity, and utilization
Learning Outcome: Explain options for managing bottlenecks and managing capacity in service and manufacturing processes
9) Which of the following represents an aggressive approach to demand management in the service sector when demand and capacity are not particularly well matched?
- A) lower resort hotel room prices on Wednesdays
- B) appointments
- C) reservations
- D) first-come, first-served rule
- E) none of the above
Answer: A
Diff: 3
Objective: LO S7.1 Define capacity
Learning Outcome: Explain options for managing bottlenecks and managing capacity in service and manufacturing processes
10) Utilization will always be lower than efficiency because:
- A) effective capacity is less than design capacity.
- B) effective capacity is greater than design capacity.
- C) effective capacity equals design capacity.
- D) expected output is less than actual output.
- E) expected output is less than rated capacity.
Answer: A
Diff: 2
AACSB: Analytical thinking
Objective: LO S7.2 Determine design capacity, effective capacity, and utilization
Learning Outcome: Explain options for managing bottlenecks and managing capacity in service and manufacturing processes
11) The Academic Computing Center has five trainers available in its computer labs to provide training sessions to students. Assume that the design capacity of the system is 1900 students per semester and that effective capacity equals 90% of design capacity. If the number of students who actually got their orientation session is 1500, what is the efficiency of the system?
- A) 1350 students
- B) 1710 students
- C) 78.9%
- D) 87.7%
- E) 90%
Answer: D
Diff: 2
Key Term: Efficiency
AACSB: Analytical thinking
Objective: LO S7.2 Determine design capacity, effective capacity, and utilization
Learning Outcome: Explain options for managing bottlenecks and managing capacity in service and manufacturing processes
12) Christopher's Cranks uses a machine that can produce 100 cranks per hour. The firm operates 12 hours per day, five days per week. Due to regularly scheduled preventive maintenance, the firm expects the machine to be running during approximately 95% of the available time. Based on experience with other products, the firm expects to achieve an efficiency level for the cranks of 85%. What is the expected weekly output of cranks for this company?
- A) 5100
- B) 5700
- C) 4845
- D) 969
- E) 6783
Answer: C
Diff: 2
Key Term: Efficiency
AACSB: Analytical thinking
Objective: LO S7.2 Determine design capacity, effective capacity, and utilization
Learning Outcome: Explain options for managing bottlenecks and managing capacity in service and manufacturing processes
13) The staff training center at a large regional hospital provides training sessions in CPR to all employees. Assume that the capacity of this training system was designed to be 1200 employees per year. Since the training center was first put into use, the program has become more complex, so that 1050 now represents the most employees that can be trained per year. In the past year, 950 employees were trained. The efficiency of this system is approximately ________ and its utilization is approximately ________.
- A) 79.2 percent; 90.5 percent
- B) 90.5 percent; 79.2 percent
- C) 87.5 percent; 950 employees
- D) 950 employees; 1050 employees
- E) 110.5 percent; 114.3 percent
Answer: B
Diff: 2
AACSB: Analytical thinking
Objective: LO S7.2 Determine design capacity, effective capacity, and utilization
Learning Outcome: Explain options for managing bottlenecks and managing capacity in service and manufacturing processes
14) Which of the following represents a common way to manage capacity in the service sector?
- A) appointments
- B) reservations
- C) changes in staffing levels
- D) first-come, first-served service rule
- E) "early bird" specials in restaurants
Answer: C
Diff: 2
Key Term: Capacity
Objective: LO S7.1 Define capacity
Learning Outcome: Explain options for managing bottlenecks and managing capacity in service and manufacturing processes
15) Adding a complementary product to what is currently being produced is a demand management strategy used when:
- A) demand exceeds capacity.
- B) capacity exceeds demand for a product that has stable demand.
- C) the existing product has seasonal or cyclical demand.
- D) price increases have failed to bring about demand management.
- E) efficiency exceeds 100 percent.
Answer: C
Diff: 2
Learning Outcome: Explain options for managing bottlenecks and managing capacity in service and manufacturing processes
16) An organization whose capacity is on that portion of the average unit cost curve that falls as output rises:
- A) has a facility that is below optimum operating level and should build a larger facility.
- B) has a facility that is above optimum operating level and should reduce facility size.
- C) is suffering from diseconomies of scale.
- D) has utilization higher than efficiency.
- E) has expected output higher than rated capacity.
Answer: A
Diff: 2
AACSB: Reflective thinking
Learning Outcome: Explain options for managing bottlenecks and managing capacity in service and manufacturing processes
17) ________ is the number of units a facility can hold, store, receive, or produce in a period of time.
Answer: Throughput or Capacity
Diff: 2
Key Term: Capacity
Objective: LO S7.1 Define capacity
Learning Outcome: Explain options for managing bottlenecks and managing capacity in service and manufacturing processes
18) ________ is actual output as a percent of design capacity.
Answer: Utilization
Diff: 2
Key Term: Utilization
Objective: LO S7.2 Determine design capacity, effective capacity, and utilization
Learning Outcome: Explain options for managing bottlenecks and managing capacity in service and manufacturing processes
19) ________ is actual output as a percent of effective capacity.
Answer: Efficiency
Diff: 2
Key Term: Efficiency
Objective: LO S7.2 Determine design capacity, effective capacity, and utilization
Learning Outcome: Explain options for managing bottlenecks and managing capacity in service and manufacturing processes
20) In the service sector, scheduling customers is a type of ________ management, while scheduling the workforce is a type of ________.
Answer: demand; capacity
Diff: 2
Learning Outcome: Explain options for managing bottlenecks and managing capacity in service and manufacturing processes
21) What is the fundamental distinction between design capacity and effective capacity? Provide a brief example.
Answer: Design capacity is the theoretical maximum output of a system in a given period under ideal conditions. Effective capacity, on the other hand, is the capacity that a firm expects to achieve given the current operating constraints. Effective capacity is often lower than design capacity because the facility may have been designed for an earlier version of the product or a different product mix than is currently being produced. Most firms operate at less than design capacity because they don't want to be stretching their resources to the limit. As an example, a restaurant might have 100 seats, but it only opens up 60 every night because it cannot find enough qualified servers.
Diff: 2
Objective: LO S7.2 Determine design capacity, effective capacity, and utilization
Learning Outcome: Explain options for managing bottlenecks and managing capacity in service and manufacturing processes
22) Distinguish between utilization and efficiency.
Answer: Both are ratios, not item counts. Both use actual output in the ratio numerator. Utilization is the ratio of actual output to design capacity, so it measures output as a fraction of ideal facility usage. Efficiency is the ratio of actual output to effective capacity, so it measures output as a fraction of the practical or current limits of the facility. Utilization will be lower than efficiency.
Diff: 2
Objective: LO S7.2 Determine design capacity, effective capacity, and utilization
Learning Outcome: Explain options for managing bottlenecks and managing capacity in service and manufacturing processes
23) Why is the capacity decision important?
Answer: The capacity decision is important for several reasons. First, capacity costs represent a large portion of fixed costs. Second, a facility of the wrong size means that costs are not as low as they could be. If a facility is too large, and portions of it remain idle, the firm's costs are too high because of the higher fixed costs. If a plant is too small, costs are again higher than they might be due to inefficiencies of working in cramped and crowded spaces. Further, a facility too small may lead to lost sales, perhaps even lost markets.
Diff: 2
Key Term: Capacity
AACSB: Reflective thinking
Objective: LO S7.1 Define capacity
Learning Outcome: Explain options for managing bottlenecks and managing capacity in service and manufacturing processes
24) A good capacity decision requires that it be tightly integrated with the organization's strategy and investments. But there are four other special "considerations" to making a good capacity decision. Identify them.
Answer: (1) Forecast demand accurately. (2) Match technology increments and sales volume. (3) Find the optimum operating size (volume). (4) Build for change.
Diff: 3
Key Term: Capacity
Learning Outcome: Explain options for managing bottlenecks and managing capacity in service and manufacturing processes
25) Identify the six tactics for matching capacity to demand.
Answer:
- Making staffing changes (increasing or decreasing the number of employees or shifts),
- Adjusting equipment (purchasing additional machinery or selling or leasing out existing equipment),
- Improving processes to increase throughput,
- Redesigning products to facilitate more throughput,
- Adding process flexibility to better meet changing product preferences, and
- Closing facilities.
Diff: 3
Learning Outcome: Explain options for managing bottlenecks and managing capacity in service and manufacturing processes
26) The staff training center at a large regional hospital provides training sessions in CPR to all employees. Assume that the capacity of this training system was designed to be 1800 employees per year. Since the training center was first put in use, the program has become more complex, so that 1400 now represents the most employees that can be trained per year. In the past year, 1350 employees were trained. Calculate the efficiency and the utilization of this system.
Answer: Efficiency = 1350 / 1400 = .964 or 96.4 percent; utilization = 1350 / 1800 = .75 or 75 percent
Diff: 2
AACSB: Analytical thinking
Objective: LO S7.2 Determine design capacity, effective capacity, and utilization
Learning Outcome: Explain options for managing bottlenecks and managing capacity in service and manufacturing processes
27) An executive conference center has the physical ability to handle 1,100 participants. However, conference management personnel believe that only 1,000 participants can be handled effectively for most events. The last event, although forecasted to have 1,000 participants, resulted in the attendance of only 950 participants. What are the utilization and efficiency of the conference facility?
Answer: Design Capacity = 1,100 participants
Effective Capacity = 1,000 participants
Actual Output = 950 participants
Utilization = = = 86.4%
Efficiency = = = 95.0%
Diff: 2
AACSB: Analytical thinking
Objective: LO S7.2 Determine design capacity, effective capacity, and utilization
Learning Outcome: Explain options for managing bottlenecks and managing capacity in service and manufacturing processes
28) A fleet repair facility has the capacity to repair 800 trucks per month. However, due to scheduled maintenance of their equipment, management feels that they can repair no more than 600 trucks per month. Last month, two of the employees were absent several days each, and only 400 trucks were repaired. What are the utilization and efficiency of the repair shop?
Answer: Design Capacity = 800 trucks
Effective Capacity = 600 trucks
Actual Output = 400 trucks
Utilization = = = 50.0%
Efficiency = = = 66.7%
Diff: 2
AACSB: Analytical thinking
Objective: LO S7.2 Determine design capacity, effective capacity, and utilization
Learning Outcome: Explain options for managing bottlenecks and managing capacity in service and manufacturing processes
29) The efficiency of a factory is 75% and its utilization 50%. If effective capacity is 1000 find design capacity.
Answer: Output = Efficiency ∗ Effective Capacity = Utilization ∗ Design Capacity. Solving gives .75(1000) = .50 (Design Capacity), Design Capacity = 1500
Diff: 2
AACSB: Analytical thinking
Objective: LO S7.2 Determine design capacity, effective capacity, and utilization
Learning Outcome: Explain options for managing bottlenecks and managing capacity in service and manufacturing processes
30) A factory produces 1000 units a month. If design capacity is 3000 and efficiency is 50% find utilization and effective capacity.
Answer: Output = Utilization ∗ Design Capacity gives 1000 = utilization ∗ 3000, utilization =
33.33%. Next use output = efficiency ∗ effective capacity to get 1000 = .5(effective capacity), effective capacity =
2000 units.
Diff: 2
AACSB: Analytical thinking
Objective: LO S7.2 Determine design capacity, effective capacity, and utilization
Learning Outcome: Explain options for managing bottlenecks and managing capacity in service and manufacturing processes
Section 2 Bottleneck Analysis and the Theory of Constraints
1) The bottleneck time is always at least as long as the throughput time.
Answer: FALSE
Diff: 2
AACSB: Reflective thinking
Objective: LO S7.3 Perform bottleneck analysis
Learning Outcome: Explain options for managing bottlenecks and managing capacity in service and manufacturing processes
2) To find the throughput time with simultaneous processes, compute the time over all paths and choose the shortest path through the system.
Answer: FALSE
Diff: 2
Key Term: Throughput time
Objective: LO S7.3 Perform bottleneck analysis
Learning Outcome: Explain options for managing bottlenecks and managing capacity in service and manufacturing processes
3) The theory of constraints is a body of knowledge that deals with anything that limits an organization's ability to achieve its goals.
Answer: TRUE
Diff: 1
Key Term: Theory of constraints (TOC)
Objective: LO S7.3 Perform bottleneck analysis
Learning Outcome: Explain options for managing bottlenecks and managing capacity in service and manufacturing processes
4) Substantial research has proved that the only successful method of dealing with bottlenecks is to increase the bottleneck's capacity.
Answer: FALSE
Diff: 2
Key Term: Bottleneck
Objective: LO S7.3 Perform bottleneck analysis
Learning Outcome: Explain options for managing bottlenecks and managing capacity in service and manufacturing processes
5) Consider a production line with five stations. Station 1 can produce a unit in 9 minutes. Station 2 can produce a unit in 10 minutes. Station 3 has two identical machines, each of which can process a unit in 12 minutes (each unit only needs to be processed on one of the two machines. Station 4 can produce a unit in 5 minutes. Station 5 can produce a unit in 8 minutes. Which station is the bottleneck station?
- A) Station 1
- B) Station 2
- C) Station 3
- D) Station 4
- E) Station 5
Answer: B
Diff: 3
Key Term: Bottleneck
AACSB: Analytical thinking
Objective: LO S7.3 Perform bottleneck analysis
Learning Outcome: Explain options for managing bottlenecks and managing capacity in service and manufacturing processes
6) A tortilla chip workstation produces 1,000 chips in 20 seconds. What is its bottleneck time?
- A) .02 seconds per chip
- B) 50 chips per second
- C) 20 seconds
- D) 6000 chips per minute
- E) 20,000 seconds
Answer: A
Diff: 2
Key Term: Bottleneck time
AACSB: Analytical thinking
Objective: LO S7.3 Perform bottleneck analysis
Learning Outcome: Explain options for managing bottlenecks and managing capacity in service and manufacturing processes
7) A work system has five stations that have process times of 5, 9, 4, 9, and 8. What is the throughput time of the system?
- A) 4
- B) 9
- C) 18
- D) 35
- E) 7
Answer: D
Diff: 2
Key Term: Throughput time
AACSB: Analytical thinking
Objective: LO S7.3 Perform bottleneck analysis
Learning Outcome: Explain options for managing bottlenecks and managing capacity in service and manufacturing processes
8) A work system has five stations that have process times of 5, 9, 4, 9, and 8. What is the bottleneck time?
- A) 4
- B) 9
- C) 18
- D) 35
- E) 7
Answer: B
Diff: 2
Key Term: Bottleneck time
AACSB: Analytical thinking
Objective: LO S7.3 Perform bottleneck analysis
Learning Outcome: Explain options for managing bottlenecks and managing capacity in service and manufacturing processes
9) An assembly line has 10 stations with times of 1, 2, 3, 4, …, 10, respectively. What is the bottleneck time?
- A) 18.18% of the throughput time
- B) 100% of the throughput time
- C) 550% of the throughput time
- D) 50% of the throughput time
- E) 1.82% of the throughput time
Answer: A
Diff: 2
AACSB: Analytical thinking
Objective: LO S7.3 Perform bottleneck analysis
Learning Outcome: Explain options for managing bottlenecks and managing capacity in service and manufacturing processes
10) Which of the following is not one of the four principles of bottleneck management?
- A) Release work orders to the system at the bottleneck's capacity pace.
- B) Lost time at the bottleneck is lost system capacity.
- C) Increasing capacity at non-bottleneck stations is a mirage.
- D) Increased bottleneck capacity is increased system capacity.
- E) Bottlenecks should be moved to the end of the system process.
Answer: E
Diff: 2
Key Term: Bottleneck
Objective: LO S7.3 Perform bottleneck analysis
Learning Outcome: Explain options for managing bottlenecks and managing capacity in service and manufacturing processes
11) The Theory of Constraints (TOC) was popularized by:
- A) Goldratt and Cox.
- B) Ford.
- C) Taguchi.
- D) Deming.
- E) Motorola and GE.
Answer: A
Diff: 2
Key Term: Theory of constraints (TOC)
Objective: LO S7.3 Perform bottleneck analysis
Learning Outcome: Explain options for managing bottlenecks and managing capacity in service and manufacturing processes
12) The Theory of Constraints (TOC) strives to reduce the effect of constraints by:
- A) offloading work from constrained workstations.
- B) increasing constrained workstation capability.
- C) changing workstation order to reduce throughput time.
- D) A and B
- E) A, B, and C
Answer: D
Diff: 2
Key Term: Theory of constraints (TOC)
AACSB: Reflective thinking
Objective: LO S7.3 Perform bottleneck analysis
Learning Outcome: Explain options for managing bottlenecks and managing capacity in service and manufacturing processes
13) The theory of constraints has its origins in:
- A) linear programming theory.
- B) the theory of economies of scale.
- C) material requirements planning.
- D) the theory of finite capacity planning.
- E) Goldratt and Cox's book, The Goal: A Process of Ongoing Improvement.
Answer: E
Diff: 1
Key Term: Theory of constraints (TOC)
Objective: LO S7.3 Perform bottleneck analysis
Learning Outcome: Explain options for managing bottlenecks and managing capacity in service and manufacturing processes
14) Which of the following techniques is NOT a technique for dealing with a bottleneck?
- A) Schedule throughput to match the capacity of the bottleneck.
- B) Increase the capacity of the constraint.
- C) Have cross-trained employees available to keep the constraint at full operation.
- D) Develop alternate routings.
- E) All are techniques for dealing with bottlenecks.
Answer: E
Diff: 2
Key Term: Bottleneck
AACSB: Reflective thinking
Objective: LO S7.3 Perform bottleneck analysis
Learning Outcome: Explain options for managing bottlenecks and managing capacity in service and manufacturing processes
15) In "drum, buffer, rope," what provides the schedule, i.e. the pace of production?
- A) drum
- B) buffer
- C) rope
- D) all three of the above in combination
- E) none of the above
Answer: A
Diff: 2
Key Term: Theory of constraints (TOC)
Objective: LO S7.3 Perform bottleneck analysis
Learning Outcome: Explain options for managing bottlenecks and managing capacity in service and manufacturing processes
16) Consider the assembly line below. The three fabrication operations run in parallel, such that each batch of 20 units only needs to go through one of the three fabrication operations. After that, each batch needs to go through both assembly operations, which occur simultaneously (specifically, 10 components are made for each unit in the fabrication stage—some components are then assembled in the Assembly 1 area while others are assembled in the Assembly 2 area). The units are packaged and made ready for shipment in the final stage.
What is the throughput time per batch of this operation?
- A) 88 min.
- B) 8 min.
- C) 40 min.
- D) 34 min.
- E) 33 min.
Answer: D
Diff: 2
Key Term: Throughput time
AACSB: Analytical thinking
Objective: LO S7.3 Perform bottleneck analysis
Learning Outcome: Explain options for managing bottlenecks and managing capacity in service and manufacturing processes
17) Consider the assembly line below. The three fabrication operations run in parallel, such that each batch of 20 units only needs to go through one of the three fabrication operations. After that, each batch needs to go through both assembly operations, which occur simultaneously (specifically, 10 components are made for each unit in the fabrication stage—some components are then assembled in the Assembly 1 area while others are assembled in the Assembly 2 area). The units are packaged and made ready for shipment in the final stage.
What is the bottleneck time per batch of this operation?
- A) 24 min.
- B) 8 min.
- C) 88 min.
- D) 34 min.
- E) 3 min.
Answer: B
Diff: 2
Key Term: Bottleneck time
AACSB: Analytical thinking
Objective: LO S7.3 Perform bottleneck analysis
Learning Outcome: Explain options for managing bottlenecks and managing capacity in service and manufacturing processes
18) Consider the simple 3-station assembly line illustrated below, where the 2 machines at Station 1 are parallel, i.e., the product only needs to go through one of the 2 machines before proceeding to Station 2.
What is the bottleneck time of this process?
- A) 12 min.
- B) 20 min.
- C) 38 min.
- D) 6 min.
- E) 10 min.
Answer: A
Diff: 3
Key Term: Bottleneck time
AACSB: Analytical thinking
Objective: LO S7.3 Perform bottleneck analysis
Learning Outcome: Explain options for managing bottlenecks and managing capacity in service and manufacturing processes
19) Consider the simple 3-station assembly line illustrated below, where the 2 machines at Station 1 are parallel, i.e., the product only needs to go through one of the 2 machines before proceeding to Station 2.
What is the throughput time of this process?
- A) 12 min.
- B) 20 min.
- C) 38 min.
- D) 18 min.
- E) 58 min.
Answer: C
Diff: 3
Key Term: Throughput time
AACSB: Analytical thinking
Objective: LO S7.3 Perform bottleneck analysis
Learning Outcome: Explain options for managing bottlenecks and managing capacity in service and manufacturing processes
20) In "drum, buffer, rope," the ________ acts like signals between workstations.
Answer: rope
Diff: 2
Key Term: Theory of constraints (TOC)
Objective: LO S7.3 Perform bottleneck analysis
Learning Outcome: Explain options for managing bottlenecks and managing capacity in service and manufacturing processes
21) Describe the theory of constraints in a sentence.
Answer: The theory of constraints is the body of knowledge that deals with anything that limits an organization's ability to achieve its goals.
Diff: 2
Key Term: Theory of constraints (TOC)
Objective: LO S7.3 Perform bottleneck analysis
Learning Outcome: Explain options for managing bottlenecks and managing capacity in service and manufacturing processes
22) Identify, in proper sequence, the steps in the process of recognizing and managing constraints.
Answer: The five-step process of the theory of constraints includes:
Step 1: Identify the constraints.
Step 2: Develop a plan for overcoming the identified constraints.
Step 3: Focus resources on accomplishing Step 2.
Step 4: Reduce the effects of the constraints by offloading work or by expanding capability. Make sure that the constraints are recognized by all those who can have an impact on them.
Step 5: When one set of constraints is overcome, go back to Step 1 and identify new constraints.
Diff: 3
Key Term: Theory of constraints (TOC)
Objective: LO S7.3 Perform bottleneck analysis
Learning Outcome: Explain options for managing bottlenecks and managing capacity in service and manufacturing processes
23) Explain the importance of a bottleneck operation in a production sequence.
Answer: A bottleneck operation is the one that limits output in the production sequence. Consequently, to increase throughput of the facility, the bottleneck output must be increased.
Diff: 2
Key Term: Bottleneck
Objective: LO S7.3 Perform bottleneck analysis
Learning Outcome: Explain options for managing bottlenecks and managing capacity in service and manufacturing processes
Section 3 Break-Even Analysis
1) Fixed costs are those costs that continue even if no units are produced.
Answer: TRUE
Diff: 2
Objective: LO S7.4 Compute break-even
Learning Outcome: Explain options for managing bottlenecks and managing capacity in service and manufacturing processes
2) Break-even analysis identifies the volume at which fixed costs and revenue are equal.
Answer: FALSE
Diff: 2
Key Term: Break-even analysis
AACSB: Reflective thinking
Objective: LO S7.4 Compute break-even
Learning Outcome: Explain options for managing bottlenecks and managing capacity in service and manufacturing processes
3) Break-even analysis is a powerful analytical tool, but is useful only when the organization produces a single product.
Answer: FALSE
Diff: 2
Key Term: Break-even analysis
Objective: LO S7.4 Compute break-even
Learning Outcome: Explain options for managing bottlenecks and managing capacity in service and manufacturing processes
4) Break-even is the number of units at which:
- A) total revenue equals price times quantity.
- B) total revenue equals total variable cost.
- C) total revenue equals total fixed cost.
- D) total profit equals total cost.
- E) total revenue equals total cost.
Answer: E
Diff: 2
Key Term: Break-even analysis
Objective: LO S7.4 Compute break-even
Learning Outcome: Explain options for managing bottlenecks and managing capacity in service and manufacturing processes
5) Which of the following statements regarding fixed costs is TRUE?
- A) Fixed costs rise by a constant amount for every added unit of volume.
- B) While fixed costs are ordinarily constant with respect to volume, they can "step" upward if volume increases result in additional fixed costs.
- C) Fixed costs are those costs associated with direct labor and materials.
- D) Fixed costs equal variable costs at the break-even point.
- E) Fixed cost is the difference between selling price and variable cost.
Answer: B
Diff: 2
AACSB: Reflective thinking
Objective: LO S7.4 Compute break-even
Learning Outcome: Explain options for managing bottlenecks and managing capacity in service and manufacturing processes
6) Which of the following costs would be incurred even if no units were produced?
- A) raw material costs
- B) direct labor costs
- C) transportation costs
- D) building rental costs
- E) purchasing costs
Answer: D
Diff: 2
AACSB: Reflective thinking
Objective: LO S7.4 Compute break-even
Learning Outcome: Explain options for managing bottlenecks and managing capacity in service and manufacturing processes
7) Basic break-even analysis typically assumes that:
- A) revenues increase in direct proportion to the volume of production, while costs increase at a decreasing rate as production volume increases.
- B) variable costs and revenues increase in direct proportion to the volume of production.
- C) both costs and revenues are made up of fixed and variable portions.
- D) costs increase in direct proportion to the volume of production, while revenues increase at a decreasing rate as production volume increases because of the need to give quantity discounts.
- E) All of the above are assumptions in the basic break-even model.
Answer: B
Diff: 3
Key Term: Break-even analysis
Objective: LO S7.4 Compute break-even
Learning Outcome: Explain options for managing bottlenecks and managing capacity in service and manufacturing processes
8) Fabricators, Inc. wants to increase capacity by adding a new machine. The fixed costs for machine A are $90,000, and its variable cost is $15 per unit. The revenue is $21 per unit. What is the break-even point for machine A?
- A) $90,000 dollars
- B) 90,000 units
- C) $15,000 dollars
- D) 15,000 units
- E) 4,286 units
Answer: D
Diff: 2
Key Term: Break-even analysis
AACSB: Analytical thinking
Objective: LO S7.4 Compute break-even
Learning Outcome: Explain options for managing bottlenecks and managing capacity in service and manufacturing processes
9) Break-even analysis can be used by a firm that produces more than one product, but:
- A) the results are estimates, not exact values.
- B) the firm must allocate some fixed cost to each of the products.
- C) each product has its own break-even point.
- D) the break-even point depends upon the proportion of sales generated by each of the products.
- E) None of these statements is true.
Answer: D
Diff: 2
Key Term: Break-even analysis
10) The basic break-even model can be modified to handle more than one product. This extension of the basic model requires:
- A) price and sales volume for each product.
- B) price and variable cost for each product, and the percent of sales that each product represents.
- C) that the firm have very low fixed costs.
- D) that the ratio of variable cost to price be the same for all products.
- E) sales volume for each product.
Answer: B
Diff: 2
Key Term: Break-even analysis
Objective: LO S7.4 Compute break-even
Learning Outcome: Explain options for managing bottlenecks and managing capacity in service and manufacturing processes
11) A product sells for $5, and has unit variable costs of $3. This product accounts for $20,000 in annual sales, out of the firm's total of $60,000. When performing multiproduct break-even analysis, what is the weighted contribution of this product?
- A) 0.133
- B) 0.200
- C) 0.40
- D) 0.667
- E) $1.667
Answer: A
Diff: 2
AACSB: Analytical thinking
Objective: LO S7.4 Compute break-even
Learning Outcome: Explain options for managing bottlenecks and managing capacity in service and manufacturing processes
12) ________ analysis finds the point at which costs equal revenues.
Answer: Break-even
Diff: 1
Key Term: Break-even analysis
Objective: LO S7.4 Compute break-even
Learning Outcome: Explain options for managing bottlenecks and managing capacity in service and manufacturing processes
13) ________ cost is the cost that continues even if no units are produced.
Answer: Fixed
Diff: 2
Objective: LO S7.4 Compute break-even
Learning Outcome: Explain options for managing bottlenecks and managing capacity in service and manufacturing processes
14) Multiproduct break-even analysis calculates the ________ of each product, ________ it in proportion to each product's share of total sales.
Answer: contribution; weighting
Diff: 3
Key Term: Break-even analysis
Objective: LO S7.4 Compute break-even
Learning Outcome: Explain options for managing bottlenecks and managing capacity in service and manufacturing processes
15) Define
fixed costs.
Answer: Fixed costs are those that continue even if no units are produced.
Diff: 2
Objective: LO S7.4 Compute break-even
Learning Outcome: Explain options for managing bottlenecks and managing capacity in service and manufacturing processes
16) Define
variable costs. What special assumption is made about variable costs in the textbook?
Answer: Variable costs are those that vary with the number of units produced. Linearity (or proportionality) is assumed.
Diff: 2
AACSB: Reflective thinking
Objective: LO S7.4 Compute break-even
Learning Outcome: Explain options for managing bottlenecks and managing capacity in service and manufacturing processes
17) How is break-even analysis useful in the study of the capacity decision? What limitations does this analytical tool have in this application?
Answer: Breakeven is defined as the volume for which costs equal revenue. It is useful to know the break-even point for each capacity alternative under consideration. In reality, costs may not be as linear as they are assumed to be in this model.
Diff: 2
Key Term: Break-even analysis
AACSB: Reflective thinking
Objective: LO S7.4 Compute break-even
Learning Outcome: Explain options for managing bottlenecks and managing capacity in service and manufacturing processes
18) 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?
Answer: BEP = 60 units; TR = $40,000, TC = $19,000, therefore Profit = $21,000.
Diff: 2
Key Term: Break-even analysis
AACSB: Analytical thinking
Objective: LO S7.4 Compute break-even
Learning Outcome: Explain options for managing bottlenecks and managing capacity in service and manufacturing processes
19) A product is currently made in a process-focused shop, where fixed costs are $8,000 per year and variable cost is $40 per unit. The firm currently sells 200 units of the product at $200 per unit. A manager is considering a repetitive focus to lower costs (and lower prices, thus raising demand). The costs of this proposed shop are fixed costs = $24,000 per year and variable costs = $10 per unit. If a price of $80 will allow 400 units to be sold, what profit (or loss) can this proposed new process expect? Do you anticipate that the manager will want to change the process? Explain.
Answer: Old: TR = $40,000, TC = $16,000, therefore Profit = $24,000.
New: TR = $80 × 400 = $32,000, TC = $24,000 + $10 × 400 = $28,000, for a profit of $4,000.
Most will say NO; the larger repetitive process is less profitable than the smaller process-focused shop.
Diff: 2
AACSB: Analytical thinking
Objective: LO S7.4 Compute break-even
Learning Outcome: Explain options for managing bottlenecks and managing capacity in service and manufacturing processes
20) A firm sells two products. Product R sells for $20; its variable cost is $6. Product S sells for $50; its variable cost is $30. Product R accounts for 60 percent of the firm's sales, while S accounts for 40 percent. The firm's fixed costs are $4 million annually. Calculate the firm's break-even point in dollars.
Answer: The contribution for product R is 70 percent of selling price, or 0.70; the contribution for product S is 0.40. The weighted contribution for R is .70 × .60 = .42; the weighted contribution for S is .40 × .40 = .16. The sum of the weighted contributions is 0.58. The break-even point is $4,000,000 / 0.58 = $6,896,552.
Diff: 3
Key Term: Break-even analysis
AACSB: Analytical thinking
Objective: LO S7.4 Compute break-even
Learning Outcome: Explain options for managing bottlenecks and managing capacity in service and manufacturing processes
21) A graphic design studio is considering three new computers. The first model, A, costs $5000. Model B and C cost $3000 and $1000 respectively. If each customer provides $50 of revenue and variable costs are $20/customer, find the number of customers required for each model to break even.
Answer: A: BEP = 5000/(50-20) = 166.7 customers
B: BEP = 3000/(50-20) = 100 customers
C: BEP = 1000/(50-20) = 33.3 customers
Diff: 2
Key Term: Break-even analysis
AACSB: Analytical thinking
Objective: LO S7.4 Compute break-even
Learning Outcome: Explain options for managing bottlenecks and managing capacity in service and manufacturing processes
22) A firm is considering adding a second secretary to answer phone calls and make appointments. The cost of the secretary will be $10/hour and she will work 200 hours each month. If each new client adds $400 of profit to the firm, how many clients must the secretary arrange for the firm to break even?
Answer: BEP= 10(200)/(400) = 5 clients per month
Diff: 2
Key Term: Break-even analysis
AACSB: Analytical thinking
Objective: LO S7.4 Compute break-even
Learning Outcome: Explain options for managing bottlenecks and managing capacity in service and manufacturing processes
23) A local business owner is considering adding another employee to his staff in an effort to increase the number of hours that the store is open per day. If the employee will cost the owner $4,000 per month and the store takes in $50/hour in revenue with variable costs of $15/hour, how many hours must the new employee work for the owner to break even?
Answer: BEP = 4000/(50 - 15) = 114.3 hours
Diff: 2
Key Term: Break-even analysis
AACSB: Analytical thinking
Objective: LO S7.4 Compute break-even
Learning Outcome: Explain options for managing bottlenecks and managing capacity in service and manufacturing processes
24) A firm produces three products in a repetitive process facility. Product A sells for $60; its variable costs are $20. Product B sells for $200; its variable costs are $80. Product C sells for $25; its variable costs are $15. The firm has annual fixed costs of $320,000. Last year, the firm sold 1000 units of A, 2000 units of B, and 10,000 units of C. Calculate the break-even point of the firm. The firm has some idle capacity at these volumes, and chooses to cut the selling price of A from $60 to $45, believing that its sales volume will rise from 1000 units to 2500 units. What is the revised break-even point?
Answer: Calculations for the original version of this problem are:
| Product | Selling price P | Variable cost V | V/P | 1-V/P | Sales | Percent of sales | Weighted contrib. |
| A | $60 | $20 | .333 | .667 | $60,000 | .0845 | .0564 |
| B | $200 | $80 | .400 | .600 | $400,000 | .5634 | .3380 |
| C | $25 | $15 | .600 | .400 | $250,000 | .3521 | .1408 |
| | | | | $710,000 | 1.0000 | 0.5352 |
The original break-even for this firm was $320,000/.5352 = $597,907. This is a calculator-based result; Excel reports $597,895
When the price of A is reduced, the revised calculations are:
| Product | Selling price P | Variable cost V | V/P | 1-V/P | Sales | Percent of sales | Weighted contrib. |
| A | $45 | $20 | .444 | .556 | $112,500 | .1475 | .0820 |
| B | $200 | $80 | .400 | .600 | $400,000 | .5246 | .3148 |
| C | $25 | $15 | .600 | .400 | $250,000 | .3279 | .1312 |
| | | | | $762,500 | 1.0000 | 0.5280 |
The firm's breakeven point has increased to $320,000 /.5280 = $606,061. (Calculator-based; Excel reports $606,211).
Diff: 3
Key Term: Break-even analysis
AACSB: Analytical thinking
Objective: LO S7.4 Compute break-even
Learning Outcome: Explain options for managing bottlenecks and managing capacity in service and manufacturing processes
25) A firm produces three products. Product A sells for $60; its variable costs are $20. Product B sells for $200; its variable costs are $120. Product C sells for $25; its variable costs are $10. Last year, the firm sold 1000 units of A, 2000 units of B, and 10,000 units of C. The firm has fixed costs of $320,000 per year. Calculate the break-even point of the firm.
Answer: Calculations for this problem are:
| Product | Selling price P | Variable cost V | V/P | 1-V/P | Sales | Percent of sales | Weighted contrib. |
| A | $60 | $20 | .333 | .667 | $60,000 | .0845 | .0564 |
| B | $200 | $120 | .600 | .400 | $400,000 | .5634 | .2254 |
| C | $25 | $10 | .400 | .600 | $250,000 | .3521 | .2113 |
| | | | | $710,000 | 1.0000 | .4931 |
Break-even for this firm is $320,000/.4931 = $648,956. Note: this result reflects calculator rounding, as students might experience at exam time. Excel reports $649,143.
Diff: 3
Key Term: Break-even analysis
AACSB: Analytical thinking
Objective: LO S7.4 Compute break-even
Learning Outcome: Explain options for managing bottlenecks and managing capacity in service and manufacturing processes
Section 4 Reducing Risk with Incremental Changes
1) Changes in capacity may lead, lag, or straddle the demand.
Answer: TRUE
Diff: 2
Objective: LO S7.1 Define capacity
Learning Outcome: Explain options for managing bottlenecks and managing capacity in service and manufacturing processes
2) Of the four approaches to capacity expansion, the approach that "straddles" demand:
- A) uses incremental expansion.
- B) uses one-step expansion.
- C) at some times leads demand, and at other times lags.
- D) works best when demand is not growing but is stable.
- E) Choices A and C are both correct.
Answer: E
Diff: 2
Objective: LO S7.1 Define capacity
Learning Outcome: Explain options for managing bottlenecks and managing capacity in service and manufacturing processes
3) Which of the following is FALSE regarding capacity expansion?
- A) "Average" capacity sometimes leads demand, sometimes lags it.
- B) If "lagging" capacity is chosen, excess demand can be met with overtime or subcontracting.
- C) Total cost comparisons are a rather direct method of comparing capacity alternatives.
- D) Capacity may only be added in large chunks.
- E) In manufacturing, excess capacity can be used to do more setups, shorten production runs, and drive down inventory costs.
Answer: D
Diff: 2
Key Term: Capacity
4) Lag and straddle strategies for increasing capacity have what main advantage over a leading strategy?
- A) They are cheaper.
- B) They are more accurate.
- C) They delay capital expenditure.
- D) They increase demand.
- E) All of the above are advantages.
Answer: C
Diff: 2
Objective: LO S7.1 Define capacity
Learning Outcome: Explain options for managing bottlenecks and managing capacity in service and manufacturing processes
5) What is a common method used to increase capacity with a lag strategy?
- A) overtime
- B) subcontracting
- C) new facilities
- D) new machinery
- E) A and B
Answer: E
Diff: 2
Objective: LO S7.1 Define capacity
Learning Outcome: Explain options for managing bottlenecks and managing capacity in service and manufacturing processes
6) The capacity planning strategy that delays adding capacity until capacity is below demand, then adds a capacity increment so that capacity is above demand, is said to ________ demand.
Answer: straddle
Diff: 2
Objective: LO S7.1 Define capacity
Learning Outcome: Explain options for managing bottlenecks and managing capacity in service and manufacturing processes
Section 5 Applying Expected Monetary Value (EMV) to Capacity Decisions
1) Possible decision alternatives found in capacity EMV problems are future demands or market favorability.
Answer: FALSE
Diff: 2
Objective: LO S7.5 Determine expected monetary value of a capacity decision
Learning Outcome: Explain options for managing bottlenecks and managing capacity in service and manufacturing processes
2) A retailer is considering building a large store. If the local economy experiences expansion, the firm expects the store to earn a $2,000,000 profit next year. If the local economy experiences a contraction, the firm expects the store to lose $400,000 next year. Analysts estimate a 20% chance for the local economy to experience an expansion next year (hence an 80% chance for contraction). What is the expected monetary value (EMV) of building the large store?
- A) $1,600,000
- B) $720,000
- C) $2,000,000
- D) $80,000
- E) $1,520,000
Answer: D
Diff: 2
AACSB: Analytical thinking
Objective: LO S7.5 Determine expected monetary value of a capacity decision
Learning Outcome: Explain options for managing bottlenecks and managing capacity in service and manufacturing processes
3) Describe how EMV might be used to analyze a capacity decision.
Answer: The EMV for each capacity decision (perhaps large, medium, and small plants) can be evaluated for unknown costs/revenue/other conditions. Each possible scenario (perhaps low, medium, and high demand) is given a payoff value and a probability. The weighted results of these various states of nature sum to the EMV for each capacity decision. An operations manager can then choose the highest EMV to maximize profit or the lowest EMV to minimize costs.
Diff: 3
AACSB: Reflective thinking
Objective: LO S7.5 Determine expected monetary value of a capacity decision
Learning Outcome: Explain options for managing bottlenecks and managing capacity in service and manufacturing processes
4) A firm is weighing three capacity alternatives: small, medium, and large job shop. Whatever capacity choice is made, the market for the firm's product can be "moderate" or "strong." The probability of moderate acceptance is estimated to be 40 percent; strong acceptance has a probability of 60 percent. The payoffs are as follows. Small job shop, moderate market = $24,000; Small job shop, strong market = $54,000. Medium job shop, moderate market = $20,000; medium job shop, strong market = $64,000. Large job shop, moderate market = -$2,000; large job shop, strong market = $96,000. Which capacity choice should the firm make?
Answer: The expected values for the three decision alternatives (capacities) are: small job shop = $42,000; medium job shop = $46,400; and large job shop = $56,800. The firm should choose the large job shop.
Diff: 2
AACSB: Analytical thinking
Objective: LO S7.5 Determine expected monetary value of a capacity decision
Learning Outcome: Explain options for managing bottlenecks and managing capacity in service and manufacturing processes
5) A firm is about to undertake the manufacture of a product, and it is weighing three capacity alternatives: small job shop, large job shop, and repetitive manufacturing. The small job shop has fixed costs of $3,000 per month, and variable costs of $10 per unit. The larger job shop has fixed costs of $12,000 per month and variable costs of $3 per unit. The repetitive manufacturing plant has fixed costs of $30,000 and variable costs of $1 per unit. Demand for the product is expected to be 1,000 units per month with "moderate" market acceptance, but 2,000 under "strong" market acceptance. The probability of moderate acceptance is estimated to be 60 percent; strong acceptance has a probability of 40 percent. The product will sell for $25 per unit regardless of the capacity decision. Which capacity choice should the firm make?
Answer: The payoffs are as follows: small job shop, moderate acceptance = $12,000; small job shop, strong acceptance = $27,000; large job shop, moderate acceptance = $10,000; large job shop, strong acceptance = $32,000; repetitive manufacturing, moderate acceptance = -$6,000; and repetitive manufacturing, strong acceptance = $18,000. The expected value for the small job shop decision alternative is $18,000. The expected value of the large job shop alternative is $18,800. The expected value for the repetitive manufacturing alternative is $3600. The firm should choose the large job shop capacity alternative.
Diff: 3
AACSB: Analytical thinking
Objective: LO S7.5 Determine expected monetary value of a capacity decision
Learning Outcome: Explain options for managing bottlenecks and managing capacity in service and manufacturing processes
6) Suppose that the market has a 70% chance of being favorable and a 30% chance of being unfavorable. A favorable market will yield a profit of $300,000, while an unfavorable market will yield a profit of $20,000. What is the expected monetary value (EMV) in this situation?
Answer: EMV = (0.7)($300,000) + (0.3)($20,000) = $210,000 + $6,000 = $216,000
Diff: 2
AACSB: Analytical thinking
Objective: LO S7.5 Determine expected monetary value of a capacity decision
Learning Outcome: Explain options for managing bottlenecks and managing capacity in service and manufacturing processes
Section 6 Applying Investment Analysis to Strategy-Driven Investments
1) One limitation of the net present value approach to investments is that investments with identical net present values may have very different cash flows.
Answer: TRUE
Diff: 2
Key Term: Net present value
Objective: LO S7.6 Compute net present value
Learning Outcome: Explain options for managing bottlenecks and managing capacity in service and manufacturing processes
2) The net present value of $10,000 to be received in exactly three years is considerably greater than $10,000.
Answer: FALSE
Diff: 1
Key Term: Net present value
Objective: LO S7.6 Compute net present value
Learning Outcome: Explain options for managing bottlenecks and managing capacity in service and manufacturing processes
3) Net present value:
- A) is gross domestic product less depreciation.
- B) is sales volume less sales and excise taxes.
- C) is profit after taxes.
- D) ignores the time value of money.
- E) is the discounted value of a series of future cash receipts.
Answer: E
Diff: 2
Key Term: Net present value
Objective: LO S7.6 Compute net present value
Learning Outcome: Explain options for managing bottlenecks and managing capacity in service and manufacturing processes
4) Net present value will be greater:
- A) as a fixed set of cash receipts occurs later rather than earlier.
- B) if the future value of a cash flow is smaller.
- C) for one end-of-year receipt of $1200 than for twelve monthly receipts of $100 each.
- D) for a 4% discount rate than for a 6% discount rate.
- E) All of the above are true.
Answer: D
Diff: 2
Key Term: Net present value
AACSB: Analytical thinking
Objective: LO S7.6 Compute net present value
Learning Outcome: Explain options for managing bottlenecks and managing capacity in service and manufacturing processes
5) A capacity alternative has an initial cost of $50,000 and cash flow of $20,000 for each of the next four years. If the cost of capital is 5 percent, the net present value of this investment is:
- A) greater than $80,000 but less than $130,000.
- B) greater than $130,000.
- C) less than $30,000.
- D) impossible to calculate, because no interest rate is given.
- E) impossible to calculate, because variable costs are not known.
Answer: C
Diff: 2
Key Term: Net present value
AACSB: Analytical thinking
Objective: LO S7.6 Compute net present value
Learning Outcome: Explain options for managing bottlenecks and managing capacity in service and manufacturing processes
6) A capacity alternative has an initial cost of $50,000 and cash flow of $20,000 for each of the next four years. If the cost of capital is 5 percent, what is the approximate net present value of this investment?
- A) $20,920
- B) $26,160
- C) $49,840
- D) $70,920
- E) $106,990
Answer: A
Diff: 3
Key Term: Net present value
AACSB: Analytical thinking
Objective: LO S7.6 Compute net present value
Learning Outcome: Explain options for managing bottlenecks and managing capacity in service and manufacturing processes
7) ________ is a means of determining the discounted value of a series of future cash receipts.
Answer: Net present value or NPV
Diff: 2
Key Term: Net present value
Objective: LO S7.6 Compute net present value
Learning Outcome: Explain options for managing bottlenecks and managing capacity in service and manufacturing processes
8) What are the four limitations of the net present value technique?
Answer: (1) Investments with the same net present value may have significantly different projected lives and different salvage values. (2) Investments with the same net present value may have different cash flows. Different cash flows may make substantial differences in the company's ability to pay its bills.
(3) The assumption is that we know future interest rates, which we do not. (4) Payments are always made at the end of the period (week, month, or year), which is not always the case.
Diff: 3
Key Term: Net present value
Objective: LO S7.6 Compute net present value
Learning Outcome: Explain options for managing bottlenecks and managing capacity in service and manufacturing processes
9) Health Care Systems of the South is about to buy an expensive piece of diagnostic equipment. The company estimates that it will generate uniform revenues of $500,000 for each of the next eight years. What is the present value of this stream of earnings, at an interest rate of 6%? What is the net present value if the machine lasts only six years, not eight? If the equipment cost $2,750,000, should the company purchase it?
Answer:
S =
R ×
X = 500,000 × 6.210 = $3,105,000;
S =
R ×
X = 500,000 × 4.917 = $2,458,500
The company should purchase the equipment if it believes it will last eight years, but not if it fears that it will last only six.
Diff: 2
Key Term: Net present value
AACSB: Analytical thinking
Objective: LO S7.6 Compute net present value
Learning Outcome: Explain options for managing bottlenecks and managing capacity in service and manufacturing processes
10) A new machine tool is expected to generate receipts as follows: $5,000 in year one; $3,000 in year two, nothing in the next year, and $2,000 in the fourth year. At an interest rate of 6%, what is the net present value of these receipts? Is this a better net present value than $2,500 each year over four years? Explain.
Answer: 5,000 × .943 + 3,000 × .890 + 2,000 × .792 = $8,969 using Table S7.1 ($8,971.16 using Excel). The steady stream generates an NPV of 2,500 × 3.465 = $8,662.5 ($8,662.76 using Excel). The irregular stream has a higher net present value because the larger receipts come early.
Diff: 2
Key Term: Net present value
AACSB: Analytical thinking
Objective: LO S7.6 Compute net present value
Learning Outcome: Explain options for managing bottlenecks and managing capacity in service and manufacturing processes
11) Advantage Milling Devices is preparing to buy a new machine for precision milling of special metal alloys. This device can earn $300 per hour, and can run 3,000 hours per year. The machine is expected to be this productive for four years. If the interest rate is 6%, what is the net present value of the annual cash flows? What is the net present value if the interest rate is not 6%, but 9%? Why does present value fall when interest rates rise?
Answer:
S =
R ×
X = 300 × 3,000 × 3.465 = $3,118,500;
S =
R ×
X = 300 × 3,000 × 3.240 = $2,916,000
NPV falls because higher interest rates create a greater discount on future receipts.
Diff: 2
Key Term: Applying investment analysis to strategy-driven investments
AACSB: Analytical thinking
----------------------------------
OPERATIONS MANAGEMENT - 2017 - COLLECTION
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Principles of Operations Management: Sustainability and Supply Chain Management, 10th Edition, 2017
Operations Research: An Introduction, 10th Edition, Hamdy A. Taha, 2017
Introduction to Operations and Supply Chain Management, 4th Edition, Cecil B. Bozarth, Robert B. Handfield, 2016
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