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Break even analysis and decision tree

1.) A news clipping service is considering modernization. Rather than manually clipping and photocopying articles of interest and mailing them to its clients, employees electronically input stories from most widely circulated publications into a database. Each new issue is searched for key words, such as a client's company name, competitors' names, type of business, and the company's products, services, and officers. When matches occur, affected clients are instantly notified via an on-line network. If the story is of interest, it is electronically transmitted, so the client often has the story and can prepare comments for follow-up interviews before the publication hits the street. The manual process has fixed costs of $400,000 per year and variable costs of $6.20 per clipping mailed. The price charged the client is $8.00 per clipping. The computerized process has fixed costs of $1,300,000 per year and variable costs of $2.25 per story electronically transmitted to the client.

a. If the same price is charged for either process, what is the annual volume beyond which the automated process is more attractive?
b. The present volume of business is 225,000 clippings per year. Many of the clippings sent with the current process are not of interest to the client or are multiple copies of the same story appearing in several publications. The news clipping service believes that by improving service and by lowering the price to $4.00 per story, modernization will increase volume to 900,000 stories transmitted per year. Should the clipping service modernize?
c. If the forecasted increase in business is too optimistic, at what volume will the new process break even?

2.) A manager is trying to decide whether to buy one machine or two. If only one machine is purchased and demand proves to be excessive, the second machine can be purchased later. Some sales would be lost, however, because the lead time for delivery of this type of machine is six months. In addition, the cost per machine will be lower if both machines are purchased at the same time. The probability of low demand is estimated to be 0.30 and that of high demand, 0.70. The after-tax net present value of the benefits (NPV) from purchasing two machines together is $90,000 if demand is low and $170,000 if demand is high. If one machine is purchased and demand is low, the NPV is $120,000. If demand is high, the manager has three options. Doing nothing, which has an NPV of $120,000; subcontracting, with an NPV of $140,000; and buying the second machine, with an NPV of $130,000.

a. Draw a decision tree for this problem.
b. What is the best decision and what is its expected payoff?

Solution Summary

The break even analysis and decision trees are determined.