AMIS 525

Short-term Decisions Exercise

A company processes it products in several sequential steps. The product [P1] sells for a price of $6 after the first step. After the second step the output [P2] sells for $20 per unit. The variable cost per unit of P2 is $4 in step two and the step two process requires three of the P1 product units per one unit of P2. The third processing step requires two units of the second process step output [P2] per process step three unit [P3]. Variable cost per unit of P3 is $25 in step three. Revenue is $100 for a step three unit of output. Required: If demand is sufficient at all three steps and production capacity is not constrained, what is the optimal processing decision?

Solution: step quantity price

[equivalent bundles: 6 units for step #1]: #1 6 6 #2 2 20 #3 1 100

revenue
extra cost per unit

36
0

40
4

100
25

total extra cost contribution margin

0 36

8 32

33 67

note that to create a step three unit requires that both step two and step three extra cost must be incurred. the conclusion is that step two is not, of itself, a good choice compared to step one but step three is economically best.

cost and revenue by product [at P3 = 20]

revenue cost margin

0 0 0

0 2000 0 660 0 1340

2000 660 1340

Extension: Production capacity is adequate for the second and third steps but step one has a maximum of 120 units per period. Market demand numbers for units produced at the three product stages are 21, 10, and 15, respectively. Required: What is the optimal processing decision?

Solution: step max max quantity makeable quantity saleable #1 120 21

P1

#2 40 10
P2

#3 20 15
P3

best sales mix production plan #1 #2 #3

cost and revenue by stage

21 21 9 90 120 126 0 126 126 0 126

15

3 30 33

15 15 1686 507 1179 1686 507 1179

revenue cost margin

cost and revenue by product

60 1500 132 375 -72 1125 60 1500 12 495 48 1005

revenue cost margin

1/9/2014