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Current time:0:00Total duration:11:37

Video transcript

in the last video we we talked a little bit about or at least potentially starting a cupcake factory but this is a major investment that I'm I'm thinking about making so I'd like at minimum I made a spreadsheet here in Excel and it's available at at khanacademy.org /downloads slash cupcakes XLS and if you just click slash here you'll see everything in the download directory but I'm gonna start putting more stuff there so I encourage you to play with it but this is essentially it'll do all the math for us that we did in the last video so you know the investment in the factory let's say you know in the real world once I actually got bids from contractors and things like that ends up costing 1.1 million dollars the annual capacity is a million cupcakes per year the cost per cupcake let's say I don't know input cost went up for whatever reason I you know now that I have a computer doing the math for me I can deal with a little bit funnier numbers so let's take say it's a dollar five the price charged per cupcake is two dollars or actually it could be anything right and so this is going to be an input field and right now it says two dollars and this is let's say this is what we assume is how many cupcakes we sell and in this scenario this is the income statement at least as far as we get to the operating income line and so you know it calculates that you have two million of revenue and notice what happens when I change it if I sell my cupcakes for a dollar fifty per cupcake then I only have 1.5 million so it actually computes what we need it to compute it computes the cost of goods sold if I change the number of cupcakes let's see if instead of a million if I sell 500,000 it calculates everything accordingly and all of these scenarios it tells me my operating income and if you go a little bit lower it tells me well capacity utilization that's just how many cupcakes I sold divided by how many I could make so that's 50% utilization and then my return on asset is my operating income divided by my initial investment right so this is 275 thousand divided by 1.1 it was a minus 25 so there's actually a bad outcome so in the last one I touched on a little bit that you know the real lever the real lever that I as a as the owner of my cupcake factory can change his price and then obviously if I charge a lower price more people are going to want to buy my cupcakes and if I charge a higher price fewer people although you know there are some things that when you charge a higher price people think it must be better so maybe they want it or they you know they want to show off to their friends and you know look at this expensive cupcake that I eat and it's kind of a status symbol but you know for the most part the lower you the price the more you sell and now we can actually figure out under what combinations am I going to make certain amounts of money so if I charge a dollar fifty per cupcake and I'm only able to sell 500,000 cupcakes I'm going to take a loss per year of two hundred seventy-five thousand if I sell them for a dollar seventy-five and if I sell I don't know seven hundred thousand cupcakes I'm almost at break you and I lose so let's say I have to do a dollar eighty five here in this situation I actually make money I have a five percent return on asset and just so you know this is a major investment that I'm making 1.1 million dollars I actually want to make sure I understand all of the scenarios of price and sales so what I did is actually used Excel to do a sensitivity study so what I did here is I put all of the let me just go to that part of the spreadsheet and I encourage you to play with this because it's interesting and it shows you that even a fairly simple business you can do a lot of analysis and if you're if you're in high school or in middle school this could actually be a fun I don't know if they allow this type of thing for science projects but go to a local business and kind of analyze the business in a hundred different ways and actually if you watch the probability videos I do all those things on plus a plus all processes and things like that and you can analyze a business and do Excel spreadsheets and you'll probably end up winning the the state science fair you get to call it a math project or engineering project but anyway here I wanted to figure out what is my return on asset so essentially you know the the the my operating profit divided by my initial investment depending on the different prices I might charge and the mut at the different quantities and here it's kind of hard to visualize so I graphed it as a three-dimensional surface 3d alright so you see here if I charge two dollars eighty and I only sell 300,000 then this my return on asset right here and I'll and this curve is actually the zero curve right so this is actually my breakeven right here so any point along this break on the along this curve right here I'm breakeven so if I met two dollars eighty per cupcake and I only sell 300,000 I'm breakeven or if I'm let's see what is this right here if I sell a dollar sixty per cupcake but I sell on if I sell like nine hundred thousand then I'm also breakeven so this is this is my breakeven curve this is what I want to avoid everything here is in the negative right this is this according to the legend - 50 percent to zero percent return so here I'm losing money and I would color it in if I wasn't in Excel mode but if I only if I charged a dollar sixty per cupcake and I only sell four hundred thousand cupcakes I'm going to have a negative return and we can actually figure it out in that little worksheet I just did but anyway this is fun to look at and I encourage you to play with it and actually shows you that it's you know it's a fairly you know interesting and sophisticated thing that you have these two variables that change and even though this is kind of a lot as simple as a business can get and then you can only imagine what happens when you start varying the other parameters but these are the two big ones so let's say you know when I come out the gate I I want everyone in town to taste my cupcakes because I think once they once they taste it they'll realize that that they're delicious and by the way I've also learned from from the cigarette companies and I put nicotine in my cupcake so I think people will become addicted to it so what I do is I want to charge a relatively low price for it so let's say I do come out the gate at oh I don't know a dollar seventy five and that's a very cheap price for cupcakes and there's actually no cupcake producers in this town right now so I just sell out one two three I just sell out of cupcakes and so I'm making $200,000 per year and that's an 18 percent return on asset and you know a lot of people would be happy with that but like a you know I'm I'm leaving money on the table because I'm selling out of my cupcakes so what happens if I raise my price a little bit I should just you know I should just I'm fully utilized right I have a hundred percent utilization so it makes sense for me to see if there's any you know maybe there there's some people who want cupcakes who can't get them because I can't produce that many so let me raise my price a little bit let me say I raise it to a dollar eighty five and at a dollar eighty five it still turns out that I'm selling a million cupcakes in a year now I was right I was leaving money on the table now I'm making 300 thousand a year so I you know this seems like a good idea I want to see kind of how much people are willing to pay so let's say I raise the price to two dollars but in that scenario two dollars it starts to get a little pricey for people it just kind of little sticker shock maybe I should have done a dollar ninety-nine and so I don't sell a million I sell 950 thousand so it's only kind of that you know there was maybe 50,000 people on the margin who'd said hey you know I'd buy at a dollar 85 but I'm not willing to buy it at two dollars but this still works out right I'm still making more money even though I'm selling fewer cupcakes because I'm charging so much more per cupcake and I'm making a 30 percent 37 percent return and let's say you know I keep figuring this out and let's say I figure that the optimal point is me charging $3 per cupcake and at $3 per cupcake I'm able to sell 750,000 cupcakes and I make 962 thousand a year and I have a huge return on asset 88% imagine a business you know or some investment we get 88% of your money every year so that's all in good and I'm you know I'm driving a Bentley and you know and I have the biggest house on a hill in town and all of that but other people say hey all Sal's doing is making cupcakes I can make cupcakes too and I have some money too to build a factory and you know this this is a better return on investment than the stock market or anything else that I know of so I'm also going to get into into the into the the cupcake factory business and so here and this is the second worksheet in the spreadsheet the second worksheet right here so let's say what was my I I was at 1/3 I don't if you could see this maybe I should zoom in a little bit let me see if I can there you go so the same thing so I said $3 and what I say 750,000 cupcakes and my cost was a dollar or five so I was making nine hundred sixty two thousand but then Imran and just so you're curious why I wasn't recording videos for the last two weeks actually Imran is the name of my son and and and he came in to the world two weeks ago and so I think it makes sense to name a cupcake store after him but let's say he comes in and he's like well you know I don't tired of getting an allowance from dad I also want to produce cupcakes and and he actually has more money because his grandma gave him I don't know more money because she likes him more than then maybe her son and so he has a million-five to invest because he's like wow this is such a good investment let me put more money into it 1.5 million and he builds a factory that can produce 2 million cupcakes a year and he's like you know what and also it's a more efficient factory so it actually uses a little little a little less electricity and it wastes a less cream and and and and frosting and and I guess nicotine as well so the cost per cupcake the cost per cupcake is less and he decides to undercut his his father and so he charges 2 dollars 90 per cupcake and when he charges two hours and I bury well you know everyone just kind of runs to him because his cupcakes are just as good there really wasn't much of a barrier so let's say he sells he sells 500,000 cupcakes and then I'm only selling 250,000 at $3 there's just some people who who like my cupcakes so I'm I'm pretty much almost breakeven and you know I say well you know these are my my diehard fans and so to benefit them these guys aren't going to go anywhere else I'm going to raise my prices a little bit just because I know that these guys like me and at least in that situation I'm cutting a profit but then I say well you know what this isn't a good state of affairs he took all my business and I actually want you to to notice something right here what happened immediately I was making an 88% return on my money right and just when this Imran comes in and he enters into the space all of a sudden what what is the what is the return earng he's he's only running at 25 percent utilization but his return on asset has gone down to 20 and because he's at that low utilization his return on assets going down to 20 percent and then my return on assets gone down to 1% so there's a general theme here is when you know someone is doing really well and getting a really great return it attracts competition it attracts capacity right and if there's enough demand to satiate that new capacity maybe they will get a better return but in general over time if there's a very favorable return more and more competition will enter the market and actually I've run out of time in this video in the next video I'll talk about more scenarios with competition see you soon