1. MB 664 UVG-TAMU May 20081 Managerial Managerial Finance MB-664 Investment Climate

2. MB 664 UVG-TAMU May 20082 Today’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

3. MB 664 UVG-TAMU May 20083 Market Forces

4. MB 664 UVG-TAMU May 20084 Expected Commodity Price D = S D S $4 10 $1 $7 D = f(P o, PYD, P x, W, …) S = f(P o, MIC, …)

5. MB 664 UVG-TAMU May 20085 Implications for the Firm Price Quantity D S PEPE QEQE Price O MAX ATCMC The Market The Firm

6. MB 664 UVG-TAMU May 20086 Implications for the Firm Price Quantity D S PEPE QEQE Price O MAX ATCMC The Market The Firm Profit

7. MB 664 UVG-TAMU May 20087 Knowing Your Elasticities Market demand related elasticities Market supply related elasticities Concept of price flexibility Application and implications

8. MB 664 UVG-TAMU May 20088 Price Quantity ∆P Inelastic Market Demand Elastic Market Demand ∆Q %∆P>%∆Q %∆P<%∆Q Identical shift in the supply curve Identical shift in the supply curve

9. MB 664 UVG-TAMU May 20089 Concept of Price Flexibility Price Quantity E P = -.25 If the own price elasticity of demand is equal to.25, then PF = 1/-.25 = -4.0 This means that if the supply coming onto the market is expected to increase by one percent, the price you can expect to receive for your products will fall by 4 percent. -4% +1%

10. MB 664 UVG-TAMU May 200810 Short Run Input Decisions

11. MB 664 UVG-TAMU May 200811 5 B C D E F G H I J Input Decision for Variable Inputs

12. MB 664 UVG-TAMU May 200812 Least Cost Decision Rule The least cost combination of labor and capital in out example also occurs where: MPP LABOR ÷ wage rate = MPP CAPITAL ÷ rental rate MPP per dollar spent on labor MPP per dollar spent on labor MPP per dollar spent on capital MPP per dollar spent on capital = This decision rule holds for a larger number of inputs as well…

13. MB 664 UVG-TAMU May 200813 Least Cost Input Choice for 100 Units 7 60

14. MB 664 UVG-TAMU May 200814 What Happens if Wage Rate Declines? As a consequence, the firm would desire to use more labor and less capital… As a consequence, the firm would desire to use more labor and less capital…

15. MB 664 UVG-TAMU May 200815 Short Run Enterprise Decisions

16. MB 664 UVG-TAMU May 200816 Combination of Products The profit maximizing combination of two products is found where the slope of the production possibilities frontier (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

17. MB 664 UVG-TAMU May 200817 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 Choice X

18. MB 664 UVG-TAMU May 200818  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 Profit Maximization Product Choice

19. MB 664 UVG-TAMU May 200819 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 Choice

20. MB 664 UVG-TAMU May 200820 Long Run Capacity Decisions

21. MB 664 UVG-TAMU May 200821 Growth of the firm…How much should we expand? Is this firm size earning a profit? Page 17 in booklet Page 17 in booklet

22. MB 664 UVG-TAMU May 200822 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?

23. MB 664 UVG-TAMU May 200823 Q3Q3 Firm size 2, 3 and 4 would earn a profit at price P…. Firm size 2, 3 and 4 would earn a profit at price P…. Growth of the firm…How much should we expand?

24. MB 664 UVG-TAMU May 200824 Q3Q3 At size #2, the firm’s profit would be the green area shown above… Growth of the firm…How much should we expand?

25. MB 664 UVG-TAMU May 200825 Q3Q3 At size #3, the firm’s profit would be the area shown above… Growth of the firm…How much should we expand?

26. MB 664 UVG-TAMU May 200826 Q3Q3 At size #4, the firm’s profit would be the area shown above… Growth of the firm…How much should we expand?

27. MB 664 UVG-TAMU May 200827 If price were to fall to P LR, only size 3 would not lose money; it would break-even. If price were to fall to P LR, only size 3 would not lose money; it would break-even. Growth of the firm…How much should we expand?

28. MB 664 UVG-TAMU May 200828 Expansion to size #4 runs the risk of having to downsize or idle part of its existing capacity if the industry settled at price P LR Growth of the firm…How much should we expand?

29. MB 664 UVG-TAMU May 200829 Optimal input combination for output=10 Optimal input combination for output=10 Expanding the Firm’s Capacity Page 19 in booklet Page 19 in booklet

30. MB 664 UVG-TAMU May 200830 Two options if doubling output: 1. Point B ? Two options if doubling output: 1. Point B ? Expanding the Firm’s Capacity

31. MB 664 UVG-TAMU May 200831 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 Capacity

32. MB 664 UVG-TAMU May 200832 Optimal input combination for output=10 with budget DE Optimal input combination for output=10 with budget DE Optimal input combination for output=20 with budget FG Optimal input combination for output=20 with budget FG Expanding the Firm’s Capacity

33. MB 664 UVG-TAMU May 200833 This combination costs more to produce 20 units of output since budget HI exceeds budget FG This combination costs more to produce 20 units of output since budget HI exceeds budget FG Expanding the Firm’s Capacity

34. MB 664 UVG-TAMU May 200834 Capacity Concepts

35. MB 664 UVG-TAMU May 200835 Definitions Engineering capacity Engineering capacity – maximum output for which enterprise was designed Economic capacity Economic capacity – output given economic objectives and normal operating policy Capacity utilization rate Capacity utilization rate – ratio of actual output to engineering capacity Capacity efficiency rate Capacity efficiency rate – ratio of actual output to economic capacity Desired utilization rate Desired utilization rate – ratio of economic to engineering capacity Bottleneck Bottleneck – constraint on economic capacity

36. MB 664 UVG-TAMU May 200836 S1S1 Engineering capacity Price Concept of Capacity Utilization at Market Level

37. MB 664 UVG-TAMU May 200837 S1S1 Economic capacity Engineering capacity D1D1 Price P1P1 Concept of Capacity Utilization at Market Level

38. MB 664 UVG-TAMU May 200838 S1S1 Economic capacity Actual output Engineering capacity D1D1 Price P1P1 S2S2 Concept of Capacity Utilization at Market Level

39. MB 664 UVG-TAMU May 200839 S1S1 Economic capacity Actual output Engineering capacity D1D1 Price P1P1 P2P2 S2S2 Concept of Capacity Utilization at Market Level

40. MB 664 UVG-TAMU May 200840 S1S1 Economic capacity Actual output Engineering capacity Bottleneck D1D1 Price P1P1 P2P2 S2S2 Concept of Capacity Utilization at Market Level

41. MB 664 UVG-TAMU May 200841 Market Price/Quantity Relationships

42. MB 664 UVG-TAMU May 200842 Stochastic Relationship Between Output and Price An example of potential market outcomes

43. MB 664 UVG-TAMU May 200843 An interpretation of potential price variability

44. MB 664 UVG-TAMU May 200844 Pro Forma Analysis of Future Trends A necessary element to evaluating potential investment alternatives.

45. MB 664 UVG-TAMU May 200845 Evaluation Methods Stochastic analysis of commodity prices and unit input costs Risk and required rates of return Risk adjusted capital budgeting Pro forma financial statement analysis