Case Study Note: Enter Inputs In Yellow Shaded Cells Revenue

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Forster’s Market is considering whether to purchase a coffee roaster to increase profitability and capacity. The case involves analyzing costs, demand scenarios, and expected financial outcomes associated with two options: not purchasing the roaster and purchasing the roaster. The key inputs include fixed and variable costs, revenue per unit of coffee, capacity constraints, and demand probabilities. Decision-making involves calculating the indifference point, expected values, and understanding the strategic implications of each choice.

Sample Paper For Above instruction

Introduction

The decision faced by Forster’s Market encapsulates a common dilemma in strategic business planning: whether to invest in an asset that could potentially increase output and profitability but also ties up significant capital. The company’s owner, Robbie Forster, must weigh the financial and strategic benefits of purchasing a coffee roaster against continuing with the current setup. This paper explores the costs, demand scenarios, decision tree analysis, and strategic considerations involved in this investment decision.

Understanding the Costs and Capacity Options

The two capacity options revolve around whether to purchase the roaster or not. When not buying the roaster, costs are limited to the purchase price of coffee at $3 per pound, and the sale price is $7 per pound, generating a profit margin of $4 per pound for 14,400 pounds. The costs associated with this option are primarily variable costs, which amount to $3 per pound; fixed costs are negligible or zero since no new equipment is involved.

Conversely, purchasing the roaster entails an upfront fixed cost of $35,000 annually. The variable cost of roasting per pound would be reduced to $1.60 due to the efficiencies gained from roasting in-house. The capacity of the roaster exceeds the current demand, enabling potential for external sales beyond internal consumption.

The indifference point—the level of demand at which the costs of both options are equivalent—is calculated by dividing the fixed costs difference by the difference in variable cost per pound. In this case, the indifference point is approximately 25,000 pounds, implying that if demand exceeds this threshold, purchasing the roaster becomes financially advantageous.

Fixed Costs (No Roaster):
$0.00
Variable Cost per Pound (No Roaster):
$3.00
Fixed Costs (Buy Roaster):
$35,000.00
Variable Cost per Pound (Buy Roaster):
$1.60

Demand Scenarios and Probabilities

Robbie considers three demand scenarios, each with a 33.33% probability:

  • Low demand: 18,000 pounds
  • Medium demand: 25,000 pounds
  • High demand: 35,000 pounds

All demand estimates include the 14,400 pounds sold in-house. If the company invests in the roaster, additional sales can be generated beyond 14,400 pounds, but revenues are capped at the selling price of $2.90 per pound. The probabilities assume that each scenario is equally likely, which informs the expected value calculations.

Decision Tree Analysis

The decision tree models the financial outcomes based on the capacity options and demand scenarios. For each branch, revenues are computed depending on whether demand exceeds or falls below the internal capacity, factoring in the set costs and the maximum sales potential under each scenario.

For the “No Roaster” option, the profit remains constant across all demand scenarios, since the internal capacity is capped at 14,400 pounds, and demand beyond that does not affect internal sales or costs.

For the “Buy Roaster” option:

- At low demand (18,000 pounds), revenues are capped at 14,400 pounds internally, with the excess demand unfulfilled.

- At medium demand (25,000 pounds), revenues increase, reflecting the ability to roast and sell up to capacity.

- At high demand (35,000 pounds), profits are maximized, as sales beyond capacity contribute additional revenue at the $2.90 per pound rate.

Expected values for each option are calculated by multiplying the profits under each scenario by their probability and summing them up. The analysis indicates that purchasing the roaster yields a higher expected profit when demand is medium or high, but involves a higher risk if demand falls below the internal capacity.

Implications of the Indifference Point

The indifference point at approximately 25,000 pounds signifies the demand level at which both options are equally profitable. Since the company's current internal demand is 14,400 pounds, which is below this threshold, purchasing the roaster becomes favorable only if external sales can be reliably made or if demand forecasts improve.

Strategically, if Robbie anticipates demand exceeding 25,000 pounds regularly, investing in the roaster aligns with business growth objectives. Conversely, if demand remains below this level, holding off on the purchase minimizes unnecessary capital expenditure and operational complexities.

Financial Risks and Strategic Considerations

The worst-case scenario occurs if the company invests in the roaster and demand remains low, resulting in high fixed costs with limited sales, leading to reduced profitability or losses. The best-case scenario emerges when demand surges to high levels, maximizing the utilization of the installed capacity and boosting revenues.

Beyond financial calculations, Robbie should evaluate other strategic factors:

  • Core competency: Does roasting align with Forster’s core business of food retailing?
  • Strategic flexibility: Will owning a roaster provide competitive advantages or limit future flexibility?
  • Market demand and growth potential: Are external market conditions favorable for expanded coffee sales?
  • Capital allocation: Is tying up $35,000 justified given the expected return and alternative investment opportunities?

If coffee roasting is deemed critical to the company's strategic direction, investing in the roaster might be justified despite modest expected financial gains. Conversely, if the focus remains on retail operations, outsourcing or maintaining the current setup might be preferable.

Conclusion

The analysis indicates that purchasing the coffee roaster can be profitable under certain demand conditions but carries risk if demand remains subdued. The decision hinges on accurate demand forecasting, capacity planning, and strategic priorities. Robbie must weigh the financial expected value against non-financial strategic considerations, recognizing that capital investment should align with long-term business objectives. Proper evaluation of market trends and demand growth will be essential to maximizing profitability and ensuring sustainable business development.

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