What is the indifference point for the two options

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Reference no: EM131482209

CASE STUDY Forster's Market

Introduction

Forster's Market is a retailer of specialty food items, including premium coffees, imported crackers and cheeses, and the like. Last year, Forster's sold 14, 400 pounds of coffee. Forster's pays a local supplier dollar 3 per pound and then sells the coffees for dollar 7 a pound.

The Roaster Decision

While Forster's makes a handsome profit on the coffee business, owner Robbie Forster thinks he can do better. Specifically, Robbie is considering investing in a large industrial-sized coffee roaster that can roast up to 40,000 pounds per year. By roasting the coffee, himself, Robbie will be able to cut his coffee costs to dollar 1.60 a pound. The drawback is that the roaster will be quite expensive; fixed costs (including the lease, power, training, and additional labor) will run about dollar 35,000 a year.

The roaster capacity will also be significantly more than the 14, 400 pounds that Forster's needs. However, Robbie thinks he will be able to sell coffee to area restaurants and coffee shops for dollar 2.90 a pound. Robbie has outlined three possible demand scenarios:

Low demand 18,000 pounds per year

Medium demand 25,000 pounds per year

High demand 35000 pounds per year

These numbers include the 14, 400 pounds sold at Forster's Market. In addition, Robbie thinks all three scenarios are equally likely.

1. What are the two capacity options that Robbie needs to consider? What are their fixed and variable costs? What is the indifference point for the two options? What are the implications of the indifference point?

2. Draw the decision tree for the roaster decision. If Forster's does not invest in the roaster, does Robbie need to worry about the different demand scenarios outlined earlier? Why or why not?

3. Calculate the expected value for the two capacity options. Keep in mind that, for the roaster option, any demand above 14, 400 pounds will generate revenues of only $2.90 a pound. Update the decision tree to show your results.

4. What is the worst possible financial outcome for Forster's? The best possible financial outcome? What other factors- core competency, strategic flexibility, etc.-should Robbie consider when making this decision?

Reference no: EM131482209

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