What are the implications of the indifference point

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Reference no: EM133441361

Case Study: P. Nutt has a small "batch" peanut roasting machine which is 4'X5' in size with an output of 10 lbs every 15 minutes. Mr. Nutt has a 5,000 square foot building with 1,000 square feet of space upfront where he sells fresh roasted peanuts, caramel corn, (which he also makes fresh daily) and assorted candies. He even sells "scoop" ice-cream in the summer months. The aroma from the roasting peanuts brings in a lot of customers. There was demand from independent stores within a 100 km radius requesting 500-gram bags of fresh roasted peanuts. P. Nutt is now supplying this demand which is using up to 50% of his weekly output capabilities. This coupled with his "in-house" volume places him at 85% of current capacity. P. Nutt figures there is easily 15,000 to 20,000 lbs of weekly wholesale business that could be acquired if he had the production capacity. He also figures that within the next 3 years, he should be able to increase his own retail business by 200% as well. The current selling price for a 500-gram bag of peanuts is $2.00 wholesale and $3.00 retail.

The Peanut Roasting Machine

After doing some research, P. Nutt discovered that there is a new "continuous" peanut roasting machine available for $150,000.00. The machine has an output of up to 2500 lbs per hour. Output and quality are controlled by both temperature controls and belt processing speed. The machine is 80' long X 6' wide and the current building has the room to accommodate this size of machine without problem. P. Nutt can finance the purchase of the machine over a 5-year period for a blended cost (principal and interest) of $2,895.00 per month. The current fixed costs to run the business is $18,500.00 annually. Current annual variable cost is $60,000.00, primarily for labour. Mr. Nutt estimates that if he buys the roaster, his fixed costs (including the bank loan to pay for the machine) will increase by $8,000.00 per month. He also has calculated that his labour costs will increase in relationship to the increased production volume by up to $70,000.00 per year above the current labor expense.

Mr. Nutt, believes that within 6 months of the new machine being operational, he should have the volume to be able to process 4,000 lbs per week, after 36 months 15,000 lbs per week, and after 48 months 20,000 lbs per week. These numbers include the current volume

P. Nutt would be able to buy the peanuts in 2,000 lb size totes and once his volume is large enough, he would be able to bring in up to 48,000 lbs of raw peanuts on a single trailer. The savings per pound by buying direct from the growers instead of through his current distributor would be approximately .40 cents per pound (lb). That would reduce his current cost for raw peanuts to $1.00 per lb from the current $1.40 per lb. In order to justify buying direct, P. Nutt will have to bring in a minimum of 5 totes (10,000 lbs) at a time. Shelf life on the raw peanuts is several months, providing they are stored in a temperature-controlled environment.

Questions:

Calculate P. Nutt's current volume.
What are the capacity options that P. Nutt needs to consider.? What are the fixed and variable costs? What is the indifferent point for the identified options? What are the implications of the indifference point?
Draw the decision tree for purchasing the Peanut Roasting Machine. If Mr. Nutt does not invest in the machine, does he need to worry about the different demand scenarios? Why or why not?
Calculate the expected value for the various capacity options.
What is the worst possible financial outcome for Mr. Nutt? The best possible financial outcome? What other factors, core competency, strategic flexibility, etc., should P. Nutt consider when making his decision?

Reference no: EM133441361

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