Case Scenario Mr. Smith, the owner of ABCD restaurant has been in business for 7 years. His restaurant serves breakfast, lunch, and dinner. In addition to serving food, he sells specialty food items such as premium coffee. In 2019, Mr. Smith sold 14,400 pounds of coffee in his restaurant. He bought coffee at $3 per pound and sold it for $7 a pound. Due to the good profit from premium coffee sale in 2019, Mr. Smith is considering investing in a large coffee roaster that can roast up to 40,000 pounds per year. By roasting coffee himself, Mr. Smith will be able to reduce his coffee costs to $1.6 a pound. The challenge is that roaster itself is quite expensive; the fixed cost, which includes labor, training, power, and lease is $35,000 per year. Note the capacity of the roaster is much higher than the 14,400 pounds that Mr. Smith needs for internal sale in ABCD restaurant himself. Therefore, he will be able to sell to other restaurants at $2.9 a pound. He has identified three scenarios for demand as shown in Table 1.

DEMAND POUNDS PER YEAR PROBABILITY

low demand 18,000 33.33%

medium demand 25,000 33.33%

high demand 35,000 33.33%

It is important to note that the numbers in table 1 include the 14,400 pounds that Mr. Smith sells in his own restaurant.

Case Scenario Questions 1. Determine the two capacity options that Mr. Smith is considering (clearly describe each capacity option and identify the fixed cost and the variable cost for each scenario). 2. Calculate the indifference point for the two capacity options. 3. Calculate the break-even point 4. Draw the decision tree for the capacity decision 5. If Mr. Smith does not invest in the roaster, do you think he needs to be concerned about the various demand scenarios? Why? 6. What are the expected values for the two capacity options? (do the calculations for each option). After you completed the calculations, update the decision tree to present your results. a. Note that for the second option (investing on a roaster), any demand beyond 14,400 pounds will only generates $2.9 revenue per pound. 7. Describe the best and worst financial result for Mr. Smith. 8. Describe other considerations for Mr. Smith's decision making including strategic flexibility and core competency