There are several worksheets within the workbook you will be utilizing:
- Payback, ROI, Etc – Data is calculated for you. In the example in this assignment you will learn how to analyze and interpret this data.
- Customer Scorecards – Actual product bids won and produced in a POM6 simulation run. This data is captured in the Payback, ROI, Etc worksheet and is used to help us determine whether to purchase or upgrade equipment. This is also to be examined in order to write a final analysis regarding capital purchases.
- Product Lead Times – Not used in any calculations or other spreadsheets but should be examined in order to write a final analysis regarding capital purchases.
- Machines – This lists all of the machines and their levels, the costs, the speeds, etc. associated with production equipment
- Machines 2 – This spreadsheet will allow you to alter the level of machine to see the effects, particularly on time/speed
- Product Gross Profit – Contains the projected gross profit of each product
- Product Info – Shows all the pertinent data associated with each product
- Customers and Products – This is forecast data for each product and each customer
ASSIGNMENT DESCRIPTION AND REQUIREMENTS
In the write-up below you will find roughly two sections.
The first section is a “mini lesson” on capital purchases. This “mini lesson” includes several examples as to how to calculate and interpret capital purchase data utilizing information from Practice Operations. This “mini lesson” and related examples, along with the video referenced above, will teach you how to calculate and analyze capital purchases, particularly with respect to Practice Operations. Pay close attention because both the write-up below and the video will guide you as to how you will complete this assignment and will help you maximize both learning and your grade.
The second section are the assignment details which spell out the requirements to complete the assignment.
As you review the “mini lesson” and watch the video you may have to refer to the Important Notes For This Assignment at the very top of this page.
CAPITAL PURCHASES MINI LESSON
What Are Capital Purchases?
Capital purchases are expenses an organization incurs primarily for large purchases that are durable in nature. Durable means that they last for a long period of time and/or are not consumed right away or never, have long-term value, and generally contribute to the ability to compete. Buildings are a capital purchase because they last, they have long-term value, and organizations typically invest in buildings or land when they need to expand (or begin) their ability to compete and provide what their customers want. In Practice Operations, the assumption is that our organization is a new facility for an existing corporation. The company would have invested in the land, building, and all of the items to enable them to produce the clothing products for their customers. Equipment purchases and upgrades are other types of capital purchases. Our Practice Operations organization starts with three (3) production machines: Cutter, Sewer, and Packer, because every product is processed on those machines. Thus, the company would have expended the capital on those three pieces of equipment.
The Capital Purchase Dilemma
Once the organization is ready for customers, we begin to compete for products from customers. We are quickly faced with choices, including whether to bid an a particular product. If our choices are to bid on products that require more than the Cutter, Sewer, and Packer (e.g. Chiffon Dresses), we must decide whether or not the purchase of those machines is worth the investment. In the case of Chiffon Dresses, we would have to invest in Pressing and Dyeing machines at a total cost of $2500.
There are a number of considerations for new equipment purchases including, but not limited to; 1. Will the purchase be paid back in a reasonable time (payback or when revenue is made to pay back the cost of the machine)?, 2. Will there be enough business to reach payback, or, more importantly generate more revenue and profit in the long-term? , 3. Will that capital purchase allow us to compete in other ways or satisfy other customer needs?, 4. Will the avoidance of that capital purchase inhibit our ability to compete?
In Practice Operations, as in real-life operations, we are also faced with whether or not to invest in the ability to add to our capabilities. In a future assignment we will examine the costs and benefits of training people and those investments in people may add to our capabilities. In this assignment we examine whether or not investments in upgrades to equipment will be of benefit. As in purchase of new capital equipment, we have similar considerations including, but not limited to; 1. Will the upgrade be paid back in a reasonable time (payback)?, 2. Will there be enough business to reach payback, or, more importantly generate more revenue and profit in the long-term?, 3. Will that capital purchase allow us to compete in other ways or satisfy other customer needs?, 4. Will the avoidance of that capital purchase inhibit our ability to compete?, and, additionally, 5. Will that upgrade add to our ability to compete?
Many of these questions are, obviously, related or very similar but all are important.
How Do We Justify Capital Investments?
Now we have to look at the various ways we might justify our investments in new and upgraded capital equipment.
In general, capital investments are examined by three broad criteria: 1. Pay back periods and return on investment (ROI), 2. Cost avoidance and avoidance of other problems, and, 3. Increased abilities and capabilities which will allow for improved competitiveness. In general #3 is related to #1 and #2, and particularly #1. However, there are times it is difficult to specifically know whether or not an investment will provide a return but we know that if we do not make the investment we cannot possibly compete. An example, as above, are Chiffon Dresses. While Chiffon Dresses are not in the top ten in profitability (profit margin), are among the most complex products, and have long lead times (total time to process) in the facility, we know that they are profitable, often have large contract with large profit dollar value, and are a three-season product. The Presser and Dyer needed for Chiffon Dresses also process 11 of the 22 potential products. In addition, several of the 10 other products processed on the Presser and Dyer are among the most profitable.
Thus, without calculating payback or ROI we might justify the purchase of the Presser and Dyer. However, no organization would do that If the numbers do not justify the purchase, then the organization would not do it. Often we would start with the analysis of #3 as we just did and then move to #1 and / or #2. If the rationale used in #3 does not lead us to believe the purchase is worthwhile we would not give up, we would simply be more concerned about what the monetary analyses in #1 and #2 tell us.
For example, the Heat Transfer machine only processes three (3) products. Two of those products are in the top ten in terms of profit margin but they are only available for two seasons each, albeit opposite seasons which might indicate steady need over the course of the year. The other product is a lower profit margin product. The two more profitable products are among the most complex, and the Graphic T-Shirts are a very long lead time item. This would indicate an upgrade might be needed to be able to produce enough fast enough. The Heat Transfer machine is one of the more expensive pieces of equipment. The contract volumes and profit dollars of those contracts for these are more volatile than some as are the availability of contracts. At first glance we would avoid the purchase of the Heat Transfer machine. Then again, what if the only products available for weeks at a time are Coaches Jackets or Graphic T-Shirts? Would idling the factory be worth the risk? Would we have to lay off personnel and risk losing them?
Thus, we would need to analyze any potential capital purchase based on whether or not we would achieve a pay back in a reasonable period of time or achieve a reasonable return on investment (ROI). We may also need to analyze cost and other avoidance.
With respect to upgrading equipment, we use the same types of logical and monetary analyses.
How To Calculate Payback, ROI, and Cost Avoidance in Practice Operations
In Practice Operations we have several pieces of information or data upon which we can build our calculations to justify or reject equipment purchases or upgrades: - Investment or machine cost
- Savings per piece (upgrades only)
- Time savings per piece (upgrades only)
- Profitability of each product
- Time to produce each product
- Cost of shipping, including Expedited and Priority shipping
- Projected Human Resource needs and associated costs
- Historical product sales data
NEW EQUIPMENT PURCHASE JUSTIFICATION
In the Customer Scorecards worksheet in the Practice Operations Production Machine Equipment workbook, you will observe data taken from an actual POM6 simulation run. The worksheet shows the product bids won in their exact order of delivery to the customer. With Sweaters, Coaches Jacket, and Designer Jeans being the predominant products won and produced in the first 3 to 4 months (each month in Practice Operations is 4 weeks), we were immediately presented with capital purchase decisions. We look at the Product Info worksheet and we see we need to purchase Presser and Dyer machines for Sweaters, a Heat Transfer machine for Coaches Jackets, and Dyer and Embroidery machines for Designer Jeans.
During that simulation run we had no idea exactly what types of bids we would receive so we would not have known whether we would receive more bids on those products or other products requiring those machines. However, we have two pieces of information that will help us. The first is the current bid, and the second is the data from the Customers and Products worksheet.
Looking first at the Customers and Products worksheet, we see that the average number of bid opportunities for Sweaters, Coaches Jacket, and Designer Jeans are 17, 24, and 25 respectively. This does not mean we will win the bids or that the bids we receive will be acceptable to us (due to our reputation vs theirs, or price, lead time, or quality requirements). The data simply says that the probability we will have these opportunities to bid on these products is good.
Looking next at the Customer Scorecards worksheet, we look at the current bids. For the purpose of this exercise we look at the first opportunity to bid on Sweaters, Coaches Jacket, and Designer Jeans as if they were new bids available to us, and as if we had no idea what would be available later. That is, the Customers and Products spreadsheet is historical data that tells us on average what has happened in the past with customers and products. The Customer Scorecards worksheet is also historical but for our purposes we will behave as if we only know about the first four products and that we are deciding if we would bid on them and therefore if we would buy the necessary machines.
Coaches Jacket Example
Logic-Only Analysis – Based on Available Data
For this example, we will look at Coaches Jacket. The Customers and Products worksheet tells us that, on average, we will have the opportunity to bid on Coaches Jacket 24 times over the course of one year. Again, we may or may not win the bid due to our reputation vs theirs, or due to price, lead time, or quality requirements. In our example, because we are in the beginning weeks of our operation, our reputation will be quite low. If we are able to bid, it is likely because we found a customer whose reputation is the same as ours.
Stepping through our capital purchase thought process, the Heat Transfer machine, which is required for Coaches Jackets, only processes three (3) products; Coaches Jacket, Graphic T-Shirt, and Windbreaker. Coaches Jacket and Graphic T-Shirt are in the top ten in terms of profit margin, but they are only available for two seasons each, albeit opposite seasons which might indicate steady need for the Heat Transfer machine over the course of the year. Windbreaker is a lower profit margin product. Coaches Jacket is relatively complex, and Graphic T-Shirt are among the most complex of products. Coaches Jacket has one of the shorter lead time while Graphic T-Shirts are a longer lead time item. For Graphic T-Shirts this would indicate that if we purchase the Heat Transfer machine, an upgrade might be needed to be able to produce enough fast enough. The Heat Transfer machine is one of the more expensive pieces of equipment.
The average contract volumes and profit dollars for Coaches Jacket look promising at 400 units and ~$6500 respectively. Graphic T-Shirt and Windbreaker average profit dollars are are considerably lower. To determine this we look at the Customers and Products spreadsheet where we see the spread of order and contract values and the average number of bid opportunities.
If we decide not to purchase the Heat Transfer machine we would avoid the cost and perhaps the likelihood the machine will be idle frequently. Then again, what if the only products available for weeks at a time are Coaches Jackets or Graphic T-Shirts? Would idling the factory be worth the risk? Would we have to lay off personnel and risk losing them?
Thus, pure logic is not enough to justify or reject the purchase of a new Heat Transfer machine. Therefore, we must make the decision based on whether the we can achieve a pay back on the purchase, and in a reasonable time if we can pay back the investment, and/or we can achieve a return on the investment.
Payback and ROI Calculations
Explanation of The Payback, ROI, etc. Spreadsheet
The Payback, ROI, etc. spreadsheet has our products from the Customer Scorecards sheet already entered. That is, each entry in the first table represents the very first time we are presented with a contract we can win. The first table analyzes the data for our initial bids with respect to payback and ROI for the machine purchases. Some products require no machine purchases (Boxer Shorts). Some require one, some two, and some three.
The table assumes the machines required for each product have not yet been purchased. In actuality In the cases of Designer Jeans, Lowe Rise Jeans, Polo Shirts, Hunting Pants, and Chiffon Dresses, for example, the Dyeing machine would have already been purchased, assuming we would have purchased the Dyer based on Sweaters. We would not have to justify new machine purchases once we have purchased a machine.
Thus, each line in the table representing a product upon which we would like to bid, is independent of any other product in the table. Again, as in the previous paragraph, this might not be true in a real Practice Operations simulation. That is, if we had bid on and won the first Sweaters order, we would have purchased the Presser and the Dyer and no other product that uses those machines would require a new machine purchase justification. Later we will look at justifying upgrades to existing equipment.
Again, for each product from the Customer Scorecards list, the very first opportunity to bid is entered in the first table. Each product’s data is used to justify or turn down the machine purchase. In addition, we are using actual product sales price data and “normal” or “average” values for product costs. We know the sales price from the Customer Scorecards, but we use what are known as standard costs (normal or average costs). This is because we have the sales price from the bid sheet but we do not yet know exactly what all of our costs will be so we make the assumption those costs will be close to our standard.
The second table represents the situation where we had already made a purchase decision. If the machine would have already been purchased, there would be no need to justify a new purchase. However, for our purposes we will use the first table and assume each product has to justify the purchase of new machines, if needed.
The third table employs the same type of logic as the first table. That is, each of the products listed on the third table represent the second opportunity to bid on that product as shown on the Customer Scorecards spreadsheet. Each product then has to justify the purchase of an upgrade for the required machines. Cutter, Sewer, and Packer are excluded from consideration for simplicity.
To summarize:
Table 1 calculates a payback and ROI, if they exist, for each individual product for the new machines they require. In the table, each product’s data is used to justify or turn down the purchase. The products are listed in the exact order of bid. WE WILL USE THIS TABLE FOR OUR ANALYSIS.
Table 2 represents the same products and assumes the second time a product is offered for bid, or if another product bid was won and uses that machine, the product does not have to justify a new machine purchase. WE WILL NOT USE THIS FOR ANALYSIS BUT WE CAN USE IT FOR OUR OVERALL PROJECT ANALYSIS.
Table 3 calculates payback, ROI, and Lead Time Savings for affected machines, going from Level 1 to Level 2 for those affected machines. As in Table 1, we ignore the fact that a previous product bid may have justified an upgrade.
Payback and ROI From Table 1 for Coaches Jacket
Because we could not decide whether to buy a Heat Transfer machine based purely on logic, we decide to calculate our projected payback and ROI for Coaches Jacket. Table 1 shows us based on the actual sales price and projected costs Coaches Jacket will net $4674 after the Heat Transfer machine is purchased. Based on the profit data, we only need to produce 111 of those Coaches Jackets to get to break even or payback and that will occur 0.4 weeks into production. Because we are a batch process operation, the projected time to receive that payback is at week 4. The reason for this is because we have to produce all 400 of the Coaches Jackets before we can ship them, we assume 2 weeks to ship, and we round up to the next whole week due to customer payment rules.
Our projected Return on Investment (ROI) is a whopping 259.7 %. This means that not only did we pay for the machine with our after-operating cost profits, but we had plenty of profit left over. The ROI is 259.7% based on the profit after costs and machine purchase. In this case after we sell the product at the bid price, subtract our operating costs and machine upgrade costs and divide this by the machine cost we have an ROI of 259.7%. ($6474-$1800=$4674. $4674/$1800=2.597 or 259.7%.)
Heat Transfer Purchase Based on Coaches Jacket Final Decision
Obviously it makes sense to buy the Heat Transfer machine once we factor in both logic and calculations.
EXISTING EQUIPMENT UPGRADE JUSTIFICATION
For this exercise we will be using Table 3 in the Payback, ROI, Etc. spreadsheet. The products in the list are the exact same from the first table and also represent all of the products listed in the Customer Scorecards spreadsheet. If the data next to the product is blank, this means that product only has one entry in the Customer Scorecards spreadsheet. This also means that in the simulation run from which that data came, those products were won and produced only one time each.
Using the same logic as for the new purchase analysis, we will examine Coaches Jacket and decide whether to upgrade the Heat Transfer machine from Level 1 to Level 2.
The payback occurs at 148 pieces at 0.6 weeks. However, because we must produce the entire batch and ship it to the customer and receive payment, the actual payback time is 5 weeks. The ROI is 305.7% based on the profit after costs and machine purchase. In this case after we sell the product at the bid price, subtract our operating costs and machine upgrade costs and divide this by the machine cost we have an ROI of 305.7%. ($9738-$2400=$7338. $7338/$2400=3.057 or 305.7%.)
In addition to the above calculations, we see that for this Coaches Jacket order, we will save 0.197 weeks or almost one entire day. This is a significant time savings and will allow greater flexibility whenever the Heat Transfer machine is used.
Heat Transfer Upgrade From Level 1 to Level 2 Based on Coaches Jacket Final Decision
With great payback and ROI numbers supported by a Lead Time savings of nearly one day in production, it makes sense to purchase the Level 2 upgrade for the Heat Transfer machine.
FINAL ANALYSIS (COACHES JACKET EXAMPLE)
The workbook data allows us to justify both the original purchase and upgrade from Level 1 to Level 2 for the Heat Transfer machine. While no other products in the Customer Scorecards bid list use the Heat Transfer equipment, having the flexibility in future years, combined with the fact we justified the purchase and upgrade, leads us to conclude the purchase and upgrade make sense. Perhaps Sales can now pursue additional contracts for Coaches Jacket and Graphic T-Shirts, provided more more profitable or profit-dollar producing contracts are not available.
ASSIGNMENT DETAILS
You should have already done the following:
A. Downloaded the M03 – Practice Operations Production Machine Equipment.xlsx downloadExcel workbook.
B. Watched theCapital Purchase Analysis video (Links to an external site.) . Speed up to 1.25 or 1.5 if necessary.
Now you need to complete the assignment
C. Complete the assignment
- Follow the process listed above and in the video for justifying or rejecting new equipment purchases and upgrades for the following products.
- Safari Jacket
- Polo Shirts
- Hunting Pants
- Write a Final Analysis that is concise but thorough (2-5 paragraphs) regarding Capital Purchases based on this exercise, your current experience in Practice Operations, and your examination of the worksheets in the M03 – Practice Operations Production Machine Equipment.xlsx . In addition to what you learned about capital purchases, you should think about the following questions and ideas as you write your analysis.
o Based on the data in the Customer Scorecards and Machines worksheets, would you ever purchase or upgrade a machine based on piece price savings(from Machines spreadsheet)? Why or why not?
o Did you turn down or decide machine(s) should not be purchased or upgraded?
o Looking at table 2 in the Payback, ROI, Etc. worksheet, would you change your mind?
o Assuming the data in the Customers and Products Spreadsheet is accurate forecast data, looking at the Customer Scorecards spreadsheet, and knowing that this exercise in this assignment represents 48 weeks of a 96 week simulation:
o How do you think you will be able to perform in the next 48 weeks and why? (specifically refer to the machines and their levels you believe you will use; this means you are basically forecasting what level of machines you will need and what products you hope to produce)
o What products would you like to produce and which machines and levels would you need?
o Most operations require some type of investment. Have you ever had to justify an investment or a purchase?
o What examples can you think of in real-world operations that might be similar to this assignment’s examples?
o In most operation’s environments when large capital purchase are being analyzed, rarely are the paybacks and ROI’s so dramatic. What would you recommend if you were in and environment where you had to justify a purchase and it “passed” the logic test but “failed” the pay back and ROI test? In some companies (e.g. Toyota) they will use the payback and ROI calculations as guides to help them continuously improve cost and other parameters but. They may make a purchase and justify it based on strategic plans and strategies, or other criteria.
o Etc.