Financial Analysis - Review Notes

Operations managers has to do engineering economic analysis and financial analysis of their project and expenditure proposals.

Chapter Outline of

Richard B. Chase, F. Robert Jacobs, Nicholas J. Aquilano, Operations Management for Competitive Advantage, 10/e, McGraw-Hill Higher Education, 2004


Concepts and Definitions
Fixed Costs
Variable Costs
Sunk Costs
Opportunity Costs
Avoidable Costs
Expected Value
Economic Life and Obsolescence
Depreciation
Straight-Line Method
Sum-of-the-Years' Digits (SYD) Method
Declining-Balance Method
Double-Declining Balance-Method
Depreciation-By-Use Method
Activity-Based Costing
The Effects of Taxes
Choosing Among Investment Proposals
Determining the Cost of Capital
Interest Rate Effects
Compound Value of a Single Account
Compound Value of An Annuity
Present Value of A Future Single Payment
Present Value of An Annuity
Discounted Cash Flow
Methods of Ranking Investments
Net Present Value
Payback
Internal Rate of Return
Ranking Investments with Uneven Live

Summary for Revision

Financial analysis tools and concepts are important for OM.

These tools include the types of costs, activity-based costing, risk, and expected value, and depreciation for more periodic operating decisions. When the focus of OM decisions is capital investment, issues of cost-of-capital calculations and methods of ranking investment proposals are important.


Fixed costs are any expenses that remain constant regardless of the level of output of production.
Variable costs, conversely, vary directly with changes in output levels.
Sunk costs are past expenses or investments that have no salvage value and therefore should not be taken into account when considering investment alternatives.
Opportunity costs are the benefits lost that result from choosing one action over another action.
Avoidable costs are expenses not incurred if an investment is made but that must be incurred if the investment is not made.

Expected value is the sum of expected outcomes multiplied by the probability of their occurrence. Expected values result because there is risk inherent in any investment decision.


The life of a machine or other income-producing assets is estimated and for accounting purposes, the asset is depreciated over this period. Depreciation is a method for allocating costs of capital equipment. Methods of depreciation include the straight-line method, the sum-of-the-years' digits method, the declining-balance method, the double-declining -balance method, and the depreciation-by-use method.

Activity based costing is an important accounting concept for OM and it is the practice of allocating overhead to better reflect actual proportions of overhead consumed by the production activity. Causal factors or cost drivers are identified and are used as the basis for overhead allocation as direct labor is not the best basis for allocating all overheads.

When choosing among investment proposals, investments are generally ranked according to the return they yield in excess of their cost of capital. Investment decisions can include the purchase of new equipment or facilities, replacement of existing equipment or facilities, make-or-buy decisions, lease-or-buy decisions, temporary shutdowns or plant abandonment decisions, or the addition or elimination of a product or product line.
Other financial decisions include determine the cost of capital, tax issues, and interest rate effects on OM decisions. Ways to rank investments include the net present value method, payback period, and the internal rate of return.




Richard B. Chase, F. Robert Jacobs, Nicholas J. Aquilano, Operations Management for Competitive Advantage, 10/e, McGraw-Hill Higher Education, 2004

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