Page 90 - DMGT501_OPERATIONS_MANAGEMENT

Operations Management

Notes To solve for the warm feel shirts revenues needed for a target profit of 200,000, we first
calculate the contribution margin ratio as follows:
CMR = (800 – 300)/ 800 = 0.625

A contribution margin ratio of 0.625 means that 62.5% of the revenue from each bike sold
contributes first to fixed costs and then to profit after fixed costs are covered.
Revenue = (5,500,000 + 200,000)/0.625 = 9,120,000

We check to see that the two results are identical by multiplying the number of units (11,400)
times price ( 800) to obtain the revenue amount ( 9,120,000).
The contribution margin ratio can also be written in terms of Total Revenues (TR) and Total
Variable Costs (TVC). That is, for a single product, the CMR is the same whether we compute it
using per-unit selling price and variable cost or using total revenues and total variable costs.
Thus, we can create the following mathematically equivalent version of the CVP formula.
Revenue = F + Profit / [(TR – TVC)/ TR]
For warm feel shirt we could use the forecast information about volume (12,000 bikes) to
determine the contribution margin ratio.
Total revenue = 800 × 12,000 shirts = 9,600,000
Total variable cost = 300 × 12,000 bikes = 3,600,000

Total contribution margin = 9,600,000 – 3,600,000 = 6,000,000
Contribution margin ratio = 6,000,000/ 9,600,000 = 0.625

3.9.3 Break-even Point

Managers often want to know the level of activity required to break even. A CVP analysis can be
used to determine the breakeven point or level of operating activity at which revenues cover all
fixed and variable costs, resulting in zero profit. We can calculate the breakeven point from any
of the preceding CVP formulas, setting profit to zero. Depending on which formula we use, we
calculate the breakeven point in either number of units or in total revenues.

For warm feel shirts, breakeven points are:
Breakeven quantity = ( 5,500,000 + 0)/( 800 – 300) = 11,000 shirts
Breakeven revenue = ( 5, 500,000 + 0)/0.625 = 8,800,000

3.10 Summary

Capacity planning should be solely based on the principle of maximizing the value
delivered to the customer.
Theoretical capacity is what can be achieved under ideal conditions for a short period of
time. Under these conditions, there are no equipment breakdowns, maintenance
requirements, set up times, bottlenecks, or worker errors.

Normal Capacity describes the maximum producible output when plants and equipment
are operated for an average period of time to produce a normal mix of output.
Top management often finds it desirable to express addition to new capacity in terms of
money value of sales.

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