mb 664 uvg-tamu may 20081 managerial managerial finance mb-664 investment climate
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MB 664 UVG-TAMU May 2008 1
ManagerialManagerial Finance
MB-664MB-664
Investment Climate Investment Climate
MB 664 UVG-TAMU May 2008 2
Today’s Decision ClimateToday’s Decision Climate• Global economy
• Little or no information lags
• Sources of risk in making decisions
• Decisions at the enterprise level
• Decisions related to expansion
• Importance of quality information in making decisions
MB 664 UVG-TAMU May 2008 4
Expected Commodity PriceExpected Commodity Price
D = SD = S
D
S
$4
10
$1
$7
D = f(Po, PYD, Px, W, …)D = f(Po, PYD, Px, W, …)
S = f(Po, MIC, …)S = f(Po, MIC, …)
MB 664 UVG-TAMU May 2008 5
Implications for the FirmImplications for the Firm
Price
Quantity
D S
PE
QE
Price
OMAX
ATC MC
The MarketThe Market The FirmThe Firm
MB 664 UVG-TAMU May 2008 6
Implications for the FirmImplications for the Firm
Price
Quantity
D S
PE
QE
Price
OMAX
ATC MC
The MarketThe Market The FirmThe Firm
Profit
MB 664 UVG-TAMU May 2008 7
Knowing Your ElasticitiesKnowing Your Elasticities
• Market demand related elasticities
• Market supply related elasticities
• Concept of price flexibility
• Application and implications
MB 664 UVG-TAMU May 2008 8
Price Price
Quantity
∆P
∆P
Inelastic Market DemandInelastic Market DemandInelastic Market DemandInelastic Market Demand Elastic Market DemandElastic Market DemandElastic Market DemandElastic Market Demand
∆Q ∆Q
%∆P>%∆Q %∆P<%∆Q
Identical shiftin the supply curve
Identical shiftin the supply curve
MB 664 UVG-TAMU May 2008 9
Concept of Price FlexibilityConcept of Price FlexibilityPrice
Quantity
EP = - .25If the own price elasticity of demand is equal to .25, then
PF = 1/-.25 = -4.0
This means that if the This means that if the supply coming onto the supply coming onto the market is expected to market is expected to increaseincrease by one percent, by one percent, the price you can expect to the price you can expect to receive for your products receive for your products will will fallfall by 4 percent. by 4 percent.
-4%
+1%
MB 664 UVG-TAMU May 2008 11
5
B
C
D
E
FG
HI
J
Input Decision for Variable InputsInput Decision for Variable InputsInput Decision for Variable InputsInput Decision for Variable Inputs
MB 664 UVG-TAMU May 2008 12
Least Cost Decision RuleLeast Cost Decision Rule
The least cost combination of labor and capital in out example also occurs where:
MPPLABOR ÷ wage rate = MPPCAPITAL ÷ rental rate
MPP per dollar spent on labor
MPP per dollar spent on labor
MPP per dollar spent on capitalMPP per dollar spent on capital=
This decision rule holds for a larger number of inputs as well…
MB 664 UVG-TAMU May 2008 13
Least Cost Input Choice for 100 UnitsLeast Cost Input Choice for 100 UnitsLeast Cost Input Choice for 100 UnitsLeast Cost Input Choice for 100 Units
7
60
MB 664 UVG-TAMU May 2008 14
What Happens if Wage Rate Declines?What Happens if Wage Rate Declines?What Happens if Wage Rate Declines?What Happens if Wage Rate Declines?
As a consequence,the firm woulddesire to use morelabor and less capital…
As a consequence,the firm woulddesire to use morelabor and less capital…
MB 664 UVG-TAMU May 2008 16
Combination of ProductsCombination of ProductsThe profit maximizing combination of two products isfound where the slope of the production possibilitiesfrontier (PPF) is equal to the slope of the iso-revenue curve, or where:
Canned fruit Price of vegetables Canned vegetables Price of fruit= –
Slope of an PPF curve
Slope of an PPF curve
Slope of iso- revenue line
Slope of iso- revenue line
MB 664 UVG-TAMU May 2008 17
Output combination X is currently beyond the firm’s existing capacity. The firm would have to expand its manufacturing capacity and labor force to achieve point X.
Output combination X is currently beyond the firm’s existing capacity. The firm would have to expand its manufacturing capacity and labor force to achieve point X.
Profit Maximization Product ChoiceProfit Maximization Product ChoiceProfit Maximization Product ChoiceProfit Maximization Product Choice
X
MB 664 UVG-TAMU May 2008 18
Canned fruit Price of vegetables
Canned vegetables Price of fruit
Canned fruit Price of vegetables
Canned vegetables Price of fruit= –
Shifting line AB out in a parallel fashion holds both prices constant at their current level
Shifting line AB out in a parallel fashion holds both prices constant at their current level
Profit Maximization Product ChoiceProfit Maximization Product ChoiceProfit Maximization Product ChoiceProfit Maximization Product Choice
MB 664 UVG-TAMU May 2008 19
The firm would shift from point M on the PPF to point N as a result of the decline in the price of fruit. That is, to maximize profit, the firm would cut back its production of canned fruit and produce more canned vegetables.
The firm would shift from point M on the PPF to point N as a result of the decline in the price of fruit. That is, to maximize profit, the firm would cut back its production of canned fruit and produce more canned vegetables.
Profit Maximization Product ChoiceProfit Maximization Product ChoiceProfit Maximization Product ChoiceProfit Maximization Product Choice
MB 664 UVG-TAMU May 2008 21
Growth of the firm…How much should we expand?Growth of the firm…How much should we expand?Growth of the firm…How much should we expand?Growth of the firm…How much should we expand?
Is this firm size earning a profit?Is this firm size earning a profit?
Page 17 in booklet
Page 17 in booklet
MB 664 UVG-TAMU May 2008 22
Growth of the firm…How much should we expand?Growth of the firm…How much should we expand?Growth of the firm…How much should we expand?Growth of the firm…How much should we expand?
No. Its average cost exceeds its average revenue at price P. The firm therefore must either expand or cease operation. How much should it expand?
No. Its average cost exceeds its average revenue at price P. The firm therefore must either expand or cease operation. How much should it expand?
MB 664 UVG-TAMU May 2008 23
Q3
Firm size 2, 3 and 4would earn a profitat price P….
Firm size 2, 3 and 4would earn a profitat price P….
Growth of the firm…How much should we expand?Growth of the firm…How much should we expand?Growth of the firm…How much should we expand?Growth of the firm…How much should we expand?
MB 664 UVG-TAMU May 2008 24
Q3
At size #2, the firm’s profit would be the green area shown above…
At size #2, the firm’s profit would be the green area shown above…
Growth of the firm…How much should we expand?Growth of the firm…How much should we expand?Growth of the firm…How much should we expand?Growth of the firm…How much should we expand?
MB 664 UVG-TAMU May 2008 25
Q3 At size #3, the firm’s profit would be the area shown above…
At size #3, the firm’s profit would be the area shown above…
Growth of the firm…How much should we expand?Growth of the firm…How much should we expand?Growth of the firm…How much should we expand?Growth of the firm…How much should we expand?
MB 664 UVG-TAMU May 2008 26
Q3
At size #4, the firm’s profit would be the area shown above…
At size #4, the firm’s profit would be the area shown above…
Growth of the firm…How much should we expand?Growth of the firm…How much should we expand?Growth of the firm…How much should we expand?Growth of the firm…How much should we expand?
MB 664 UVG-TAMU May 2008 27
If price were to fall to PLR, only size 3 wouldnot lose money; it would break-even.
If price were to fall to PLR, only size 3 wouldnot lose money; it would break-even.
Growth of the firm…How much should we expand?Growth of the firm…How much should we expand?Growth of the firm…How much should we expand?Growth of the firm…How much should we expand?
MB 664 UVG-TAMU May 2008 28
Expansion to size #4 runs the risk of having to downsize or idle part of its existing capacity if the industry settled at price PLR
Expansion to size #4 runs the risk of having to downsize or idle part of its existing capacity if the industry settled at price PLR
Growth of the firm…How much should we expand?Growth of the firm…How much should we expand?Growth of the firm…How much should we expand?Growth of the firm…How much should we expand?
MB 664 UVG-TAMU May 2008 29
Optimal inputcombinationfor output=10
Optimal inputcombinationfor output=10
Expanding the Firm’s CapacityExpanding the Firm’s CapacityExpanding the Firm’s CapacityExpanding the Firm’s Capacity
Page 19 in booklet
Page 19 in booklet
MB 664 UVG-TAMU May 2008 30
Two options if doubling output: 1. Point B ?
Two options if doubling output: 1. Point B ?
Expanding the Firm’s CapacityExpanding the Firm’s CapacityExpanding the Firm’s CapacityExpanding the Firm’s Capacity
MB 664 UVG-TAMU May 2008 31
Two options if doubling output: 1. Point B ?2. Point C?
Two options if doubling output: 1. Point B ?2. Point C?
Expanding the Firm’s CapacityExpanding the Firm’s CapacityExpanding the Firm’s CapacityExpanding the Firm’s Capacity
MB 664 UVG-TAMU May 2008 32
Optimal inputcombinationfor output=10with budget DE
Optimal inputcombinationfor output=10with budget DE
Optimal inputcombination for output=20with budget FG
Optimal inputcombination for output=20with budget FG
Expanding the Firm’s CapacityExpanding the Firm’s CapacityExpanding the Firm’s CapacityExpanding the Firm’s Capacity
MB 664 UVG-TAMU May 2008 33
This combinationcosts more toproduce 20 units of output sincebudget HI exceedsbudget FG
This combinationcosts more toproduce 20 units of output sincebudget HI exceedsbudget FG
Expanding the Firm’s CapacityExpanding the Firm’s CapacityExpanding the Firm’s CapacityExpanding the Firm’s Capacity
MB 664 UVG-TAMU May 2008 35
DefinitionsDefinitions Engineering capacityEngineering capacity – maximum output for which
enterprise was designed Economic capacityEconomic capacity – output given economic objectives
and normal operating policy Capacity utilization rateCapacity utilization rate – ratio of actual output to
engineering capacity Capacity efficiency rateCapacity efficiency rate – ratio of actual output to
economic capacity Desired utilization rateDesired utilization rate – ratio of economic to
engineering capacity BottleneckBottleneck – constraint on economic capacity
MB 664 UVG-TAMU May 2008 36
S1
Engineeringcapacity
Price
Concept of Capacity Utilization at Market LevelConcept of Capacity Utilization at Market LevelConcept of Capacity Utilization at Market LevelConcept of Capacity Utilization at Market Level
MB 664 UVG-TAMU May 2008 37
S1
Economiccapacity
Engineeringcapacity
D1
Price
P1
Concept of Capacity Utilization at Market LevelConcept of Capacity Utilization at Market LevelConcept of Capacity Utilization at Market LevelConcept of Capacity Utilization at Market Level
MB 664 UVG-TAMU May 2008 38
S1
Economiccapacity
Actualoutput
Engineeringcapacity
D1
Price
P1
S2
Concept of Capacity Utilization at Market LevelConcept of Capacity Utilization at Market LevelConcept of Capacity Utilization at Market LevelConcept of Capacity Utilization at Market Level
MB 664 UVG-TAMU May 2008 39
S1
Economiccapacity
Actualoutput
Engineeringcapacity
D1
Price
P1
P2
S2
Concept of Capacity Utilization at Market LevelConcept of Capacity Utilization at Market LevelConcept of Capacity Utilization at Market LevelConcept of Capacity Utilization at Market Level
MB 664 UVG-TAMU May 2008 40
S1
Economiccapacity
Actualoutput
Engineeringcapacity
BottleneckBottleneck
D1
Price
P1
P2
S2
Concept of Capacity Utilization at Market LevelConcept of Capacity Utilization at Market LevelConcept of Capacity Utilization at Market LevelConcept of Capacity Utilization at Market Level
MB 664 UVG-TAMU May 2008 42
Stochastic Relationship Between Output and PriceStochastic Relationship Between Output and Price
An example of potential market outcomes
An example of potential market outcomes
MB 664 UVG-TAMU May 2008 43
An interpretation of potential price variability
An interpretation of potential price variability
MB 664 UVG-TAMU May 2008 44
Pro Forma Analysis of Future TrendsPro Forma Analysis of Future Trends
A necessary element to evaluating potential
investment alternatives.
A necessary element to evaluating potential
investment alternatives.
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