Revenue and Production: Analysis and Choice of Alternative

The purpose of this report is to analyze the opportunity to produce plastic components for cartridge production and choose the best alternative. It is predicted that the annual demand growth is a triangular distribution with a minimum of 5%, most likely of 17% and a maximum of 25%. Due to the continuous growth in the demand, the alternatives cannot be compared using just the data for 2010. An analysis is carried out for the time period 2011 to 2015 and the present worth of the net income is considered as the criteria to select the alternative.

The analysis basically can be divided into 5 steps:

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1. Forecasting demand for next five years,
2. Estimating capacity required,
3. Developing production strategy,
4. Calculate the operating expenses for the alternatives,
5. Select the alternative based on the present worth of net income.

From the estimated installed base of 7500 OmniVue instruments at the end of year 2010, the demand for the OmniVue instruments and cartridges are forecasted. There is a new product OmniVue mobile, ready to be launched in year 2013.

It is assumed that the OmniVue mobile can be accounted for 30% of the demand for Instruments in year 2013, 50% in year 2014 and 60% in year 2015. The growth in demand for the OmniVue instrument is assumed to decrease after the release of OmniVue mobile. It is estimated that the production capacity of Bergerac to produce OmniVue instruments is approximately 2000 units per year with a production of 5 days per week. It is inferred that using level strategy, the probability that the demand is not met in the next five years is 5. 74%.

There is no need to increase the capacity of the production line apart from changes required when the OmniVue mobile is released. There are various strategies which are compared in build option. For each production strategy, the optimum solution for the capacities in each year is found out. After finding the optimum solutions, the production strategies are compared with each other to find out the best solution for the build option. The production strategies that are analyzed are:

• Level production strategy
• Chase production strategy
• Overtime is allowed / not allowed.

The revenues and other expenses from operations other than OmniVue is estimated and added to the income statement. The net income is calculated. The cash flows for years 2011 to 2015 is also calculated. The net present worth is calculated for the net income and the cash flows. The objective used to optimize the solution is to maximize the mean of net present worth of the net income and cash flows. The four production strategies for the build option are optimized and the maximum net present worth for the options is forecasted. The best solution from the four strategies is chosen and compared to the net present worth of the buy option.

Based on the analysis, build is a better option than buy option. The present worth of the net income is highest for level production, overtime allowed. But level production, overtime not allowed is very close to it and it does not affect the employee relationship. It is recommended to use level production strategy, no overtime (net present worth for net income is $59. 8 million). The current objective is to produce the plastic components for Bergerac with the lowest expenses, which can be achieved by building a unit for plastic component production in the plant itself.

It is also recommended to buy 5 machines instead of 4 machines in year 2010 based on the analysis. Dilemma for Ian Wyckoff Since 2008, Bergerac had been exploring the opportunity to begin its own production of cartridge components. Plastic suppliers like GenieTech and Elsinore faced difficulties in responding to demand spikes, leading to production delays. Such supplier unreliability made it challenging for Bergerac to optimize its cartridge production. Thus, the company had to carry more inventory of parts and finished goods than Wyckoff could have liked.

The obvious appeal to fully control the supply of plastic lead to a strategy, the company has to decide whether to buy or build this capability. GenieTech owner was interested in retirement and was willing to sell the company for a purchase price of $5. 75 million. GenieTech has 8 molding presses each could produce 5 cartridges per cycle with a total capacity of 10,782,720 cartridges per year with 5 days production in a week. The other alternative is to build a unit with 4 molding presses which are more efficient than the presses at GenieTech.

The total capacity of the unit will be 6,097,371cartridges per year with 5 days production in a week. It is required to predict the best long term decision among the buy and build options. Mr. McCarthy’s Analysis of Buy vs Build The analysis by Mr. McCarthy is a good basic analysis for comparing the alternatives, Buy vs Build. The main factor which Mr. McCarthy has not considered is the growing demand of the cartridges. The demand for cartridges is growing steadily and the Mr. McCarthy’s build option with 4 molding presses will not be able to satisfy the demand in the upcoming years .

Additionally, Mr. McCarthy has not considered the possible revenue from the existing operations of GenieTech with other customers. The possible merger could also serve as a possibility for development in a new product line which would favor the growth of the company. So, Mr. McCarthy has not considered all the factors when comparing the two alternatives which means it is not ideal to accept this analysis. Financial analysis to choose between alternatives - Buy Vs Build using a 2011 to 2015 study period The analysis can be basically divided into 5 steps: First, the demand for the years 2011 to 2015 has to be forecasted.

Second step is to estimate the capacity required to meet the demand in both buy and build options. The next step is to plan the production accordingly to meet the demand forecasted previously. The employee strike which is predicted to happen in the start of year 2013 should be accounted for when planning the production. The costs of operation and the revenues are then calculated which is used in the income statement. Final step is to compare the cash flows to determine the optimal solution that can be executed in the years 2011 to 2015.

Estimated demand for OmniVue cartridges and the testing instruments for years 2011 – 2015 The expected annual growth rate of demand is a triangular distribution with a minimum of 5%, a most likely of 17% and a maximum of 25%. From the estimated installed base of 7500 OmniVue instruments at the end of year 2010, the demand for the OmniVue instruments and cartridges are forecasted. There is a new product OmniVue mobile, ready to be launched in year 2013. It is assumed that the OmniVue mobile can be accounted for 30% of the demand for Instruments in year 2013, 50% in year 2014 and 60% in year 2015.

The growth in demand for the OmniVue instrument is assumed to decrease after the release of OmniVue mobile. It is predicted that the installed base at the end of year 2010 is 7500. Bergerac has manufactured 7500 units in the period mid-2006 to 2010. Hence, it is estimated that the production capacity of Bergerac to produce OmniVue instruments is approximately 2000 units per year with a production of 5 days per week.

Using the assumption for increase in demand for the instruments, the number of units to be produced using level production for years 2011 to 2015 is forecasted and it is seen that the probability that the demand is not met is 5. 74%. The maximum number of units to be produced is 2,588. It can be met if the production is increased to 7 days per week whenever required. Hence, it is assumed that there is no need to increase the capacity of the production line apart from changes required when the OmniVue mobile is released.

The minimum and maximum growth rates are 5% and 25% respectively. The demand for the assumed growth rates is plotted. The 4 molding presses proposed by Mr. McCarthy will be sufficient to meet the demand if the growth rate is 5% every year, but will not be able to meet requirements if the demand grows by 25%.

The capacity of the proposed 4 machines with 5 days/week and 7 days/week are plotted. The number of units to be produced with level production is plotted; the proposed 4 machines will be able to meet the demand with overtime (excess of 5 days/week). It is assumed that the OmniVue mobile is given preference in case of shortage of capacity. Optquest is used to estimate the right number of machines to be purchased and the expansion strategy in the future years so that the company profit is maximum.

The cartridge components are the only difference between the buy and build options. There is no increase in the capacity required because the current capacity of 8 machines will be able to satisfy the demand for the next 5 years. It is assumed that the new product OmniVue mobile can be manufactured in the same production line with some modifications in the equipment.

It is assumed that overtime can be used for manufacturing when the 5 days/week is not enough to meet the demands. The overtime wages for the labor are twice the normal. The overtime wages are calculated from the utilization factor of the machines which is 5 days/week normal production (100% utilization). The overtime cannot exceed 40% because there are only 2 more days left in a week. It should be noted that there is only 3% change in the operational expenses for overtime.

Employee strike in 2013: It is predicted to be 50% probability that the employees will do strike for a period of 0. 5 to 3 months. So, it is assumed that the annual capacity is reduced to 75% if the strike duration is 3 months.

Strategies can be formulated to tackle the strike situation by producing more units in the previous year so that the demand can be met in the first 3 months of 2013. The maximum demand during the strike period is estimated to be a maximum of 1. 6 million cartridges and 277 instruments. It is assumed that the OmniVue mobile will be released after the strike is over.

The same number of units is produced every year which will be equal to the production capacity. The plastic components requirement for Bergerac is first satisfied and the remaining capacity is used for the other contracts of GenieTech. After the launch of OmniVue mobile, the production for OmniVue mobile is given preference. Overtime is used for production if the demand exceeds capacity which is unlikely to happen in the next 5 years. Since the production capacity of GenieTech has been always above the demand, the other strategies are not analyzed.

There are various strategies which are compared in build option. For each production strategy, the optimum solution for the capacities in each year is found out. After finding the optimum solutions, the production strategies are compared with each other to find out the best solution for the build option. There criteria used to find the optimum solution is the present worth. The instruments are produced using level production strategy. The production is scheduled based on the demand forecast for the years 2011 to 2015. OmniVue mobile is given more preference like the production strategy for cartridges.

It is assumed that 2 foremen and 6 other labors are required for the production line. It is also assumed that OmniVue mobile instrument also can be manufactured in the same production line with some modification in the equipment. The production of instruments does not impact the analysis because the same cost is incurred in both options.

The operations for other products are directly included in the income statement and it is not analyzed. In level production strategy, the expenses are incurred during a period different from the period in which the product is sold. But, it is expended only when the product is sold.

For that purpose, the cost per unit is calculated and is used to calculate the cost of goods sold. For example, if in a year, 3000 goods are sold and 1000 are from previous year inventory, then the cost is calculated using previous year cost per unit for 1000 units and current year cost per unit for the remaining units. The income tax rate for the company is estimated to be 39% from the income statements for years 2007 to 2009. The revenues and other expenses from operations other than OmniVue is estimated and added to the income statement.

The net income is calculated. Cash flows  Similar to the Income statement, the revenues, expenses and capital investment for each year is calculated from the data and the cash flows for the alternatives are calculated. In cash flow statement, the expenses are expended in the same year when it was spent. The income statement which was prepared previously has used accrual accounting. Depreciation is included in income statement. In cash flow, the capital investments are included instead of depreciation.

The net present worth is calculated for the net income and the cash flows. The objective used to optimize the solution is to maximize the mean of net present worth of the net income and cash flows. The four production strategies for the build option are optimized and the maximum net present worth for the options is forecasted. The best solution from the four strategies is chosen and compared to the net present worth of the buy option. The overtime not allowed scenario is performed in Optquest by adding a constraint that the utilization in all years is less than or equal to 100%.

Present worth of Net income: For chase production strategy, overtime allowed, maximum of mean of net present worth is $58. 770 million. For chase production strategy, overtime not allowed, maximum of mean of net present worth is $58. 486 million.  For level production strategy, overtime allowed, maximum of mean of net present worth is $60. 786 million. For level production strategy, overtime not allowed, maximum of mean of net present worth is $59. 789 million. Based on the analysis, build is a better option than buy option. The present worth of the net income is highest for level production, overtime allowed. But level production, overtime not allowed is very close to the highest and it does not affect the employee relationship.

It is recommended to use level production strategy, no overtime. There is an issue with inventory building in level production strategy. Also, by not choosing the buy option, Bergerac loses a chance to enter a new product line. But, the current objective is to produce the plastic components for Bergerac with the lowest expenses, which can be achieved by building a unit for plastic component production in the plant itself. It is also recommended to buy 5 machines instead of 4 machines in year 2010 based on the analysis.

List of assumptions:

• The growth of demand is a triangular distribution with 5%, 17% and 25%.
• The OmniVue mobile demand accounts for 30%, 50% and 60% in 2013, 2014 and 2015 respectively.
• It is predicted that there is a 50% chance of strike in 2013 for a time period of 0. to 3 months.
• The OmniVue instruments and cartridges can be manufactured in the same production line with some changes in equipment. A $200,000 cost is added in year 2013 for these changes.
• The labor cost for instruments is assumed to be the same as that of cartridges. There will be no impact for assumptions related to instruments because the same cost is assumed in both options.
• The labor growth of GenieTech is 2 to 5%. The material cost increases by 3 to 8%.
• For overtime, the salary is 2 times the salary in normal production hours. The overtime salary is calculated from the utilization.
• OmniVue mobile cartridge will be sold at $8 per unit.
• Transportation cost of plastic components from GenieTech is $0. 1/unit.
• The inventory holding cost for cartridges is $0. 2 for OmniVue and $0. 1 for OmniVue mobile.
• The plastic components are sold to other customers from GenieTech at $1. 66/unit.
• The labor and overhead for instrument production are assumed values. The revenue from other products is assumed to be $35 million. Gross margin for other products is 60%.
• The R & D costs increase 7% every year. The R & D cost for GenieTech is 5% of Bergerac’s.
• Sales and marketing cost is 25% of revenue. Profit sharing is 0. 1% of gross profit.
• The General and administrative cost for HemaVue is $6 million and it increase 10% every year.
• Interests are 5% of Income from operations.
• In capital investments, installation and building cost has a $125,000 fixed cost and $75,000 variable cost per machine.

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