In the last video, we talked about creating a cake factory. This is an important investment that I consider So at least, I made an Excel spreadsheet You can download khanacademy.org/downloads/cupcakes.xls here. Just click this slash and you will see everything in the download directory. I will put more things in there I suggest you try it But this is basically-it will do all the calculations for us In the last video we talked about factory investment. In the real world, suppose I have bids from contractors, etc. The final cost is $1.1 million. The annual production capacity is 1 million cakes. The cost of each cake is—for example, the cost of the input goes up, no matter what the reason. Now, I have a computer to do calculations for me, and I can handle some strange numbers.
Assume that the cost of each cake is $1.05. Each cake sells for 2 dollars. Moreover, it can actually be any number, right? So this is an input field, and now it is $2. Suppose this is the number of cakes we sold. under these circumstances This is the income statement, at least until the line of operating income. So it calculates that you have $2 million in income. Note what happens when you change it. If each cake sells for $1.50, then I will only get $1.5 million. So it is actually calculated according to our needs.
It calculates the cost of goods sold. If I change the number of cakes, let's see, If it does not sell 1 million, but sells 500,000, it will recalculate all figures accordingly. And in all these cases, it tells me what my operating income is. And if you go down a bit, it tells me what the capacity utilization is. This is the quantity I sell divided by the quantity I can produce. So the utilization rate is 50%, then My return on assets is my operating income divided by my initial investment, right? So this is 275,000 divided by 1.1, which equals -25 This is actually a bad result In the previous video, I talked about a little bit As the owner of the cake factory, the lever I have is to change the price Obviously, if I charge a lower price, more people will buy my cake And if I charge a higher price, fewer people will buy Although there are some things that people will think it is better when they charge a higher price. Maybe they want this, or they want to show off in front of their friends Look at how expensive the cake I eat, it’s a status symbol But in most cases, the lower the price, the more you sell And now, we can figure out how much money I can make under which combination.
If I charge $1.50 per cake, I can only sell 500,000 cakes I will lose $275,000 a year If I charge $1.75 per cake, if I sell, for example, 700,000 cakes I almost break even. So let’s see, you want to sell each cake for $1.85 In this case, I can indeed make money. I have a 5% return on assets And, just to let you know, this is a major investment of mine, $1.1 million Actually I want to make sure that I understand all possible prices and sales options What I actually did was do sensitivity research with Excel What I'm doing here is to put all of it – let me go directly to that part of the spreadsheet I suggest you play with this, because it is fun It shows that even for a fairly simple business, you can do a lot of analysis And, if you’re in middle or high school, this might actually be interesting I don’t know if they can make this kind of thing a scientific project Go to a local company and analyze one hundred different business scenarios.
In fact, if you watched the probability video This is how I do all things about Poisson processes You can analyze business and make Excel spreadsheets This way you are likely to win the state science competition championship Call it a math project or engineering project But anyway, I have to figure out what my return on assets is? It’s basically my operating profit divided by my initial investment It depends on the different prices I charge, and different quantities. It’s hard to imagine, so I drew it as a three-dimensional surface. 3D. As you can see here, if I charge $2.80 per cake and I only sell 300,000 pieces, then this is my return on assets. This curve is actually a zero curve, right? In fact, my break-even point is here. Any point on this curve is my break-even point So, if I sell each cake for $2.80 and I only sell 300,000 pieces, I will maintain a breakeven Let's see, what is here? If I sell each cake for $1.60, and I sell 900,000 pieces, then I have also maintained a breakeven.
This is my break-even curve. This is what i want to avoid Everything here is at a loss, yes, according to the instructions, a return of -50% to 0%. So I am losing money here, if it is not in Excel mode, I will add color If I charge $1.60 per cake, I only sell 400,000 cakes I will have a negative return We can know it I just made this little worksheet But anyway, it’s fun to watch, I suggest you play with it This actually shows that it is a rather interesting and complicated thing You have two variables that can be changed And this is the simplest business model. You can only imagine what happens when you start to change other parameters But these are two very important parameters. Suppose, when I launch, I want everyone in the town to try my cake Because I think once they taste it, they will realize that the cake is delicious. By the way, I learned a trick from a cigarette company Put nicotine in the cake so people become addicted What I want to do is, I want to set a lower price For example, when I launched it, the price was $1.75 per cake.
This is a very cheap cake price There is no cake maker in this small town now. Suppose I sell all the cakes So my annual income is 200,000 US dollars, and the return on assets is 18%. Many people will be satisfied with this But I thought, hey, because I sold out all the cakes, I still have some money I haven't made. What if I raise the price slightly? I took full advantage of the factory’s capacity, right? I have 100% utilization.
Let me see if there is any possibility-maybe Some people want to buy cakes, but they can’t because I can’t produce that much Let me increase my price slightly Suppose I increase it to $1.85. At $1.85, I can still sell one million cakes a year Now I am right. I used to leave money on the table Now I can make 300,000 U.S. dollars a year.
This looks like a good idea. I want to see what price people are willing to pay For example, I increased the price to $2 However, in this case, $2 is starting to become a bit expensive for people It is a bit like a sky-high price. Maybe I should be priced at $1.99 So I couldn't sell 1 million. I only sold 950,000. There seems to be a difference of fifty thousand people Hey, you know, I will buy it at $1.85, but I don't want to buy it at $2. But this is still good, right? I still made more money Even if I sell fewer cakes Because I increased the price of each cake so much, I got 37% return Suppose i continue to do this And the best point I came up with is to charge $3 per cake At $3, I can sell 750,000 cakes.
My annual income is 962,000 US dollars. I have a huge return on assets: 88% Imagine a business or investment can see your money get 88% return every year So that’s great. I will drive a Bentley and own the biggest house on a mountain in town. But other people said, hey, Thrall is just making cakes I can also make cakes, I also have some money to build a factory This has a better return on investment compared to the stock market or other things. So I also want to do a cake factory business. So, here is the second worksheet in the spreadsheet. Suppose, I invest 1.1 million US dollars. I don't know if you can see it. Maybe I should zoom in a bit. That's it. This is the same thing. So I said that each cake is $3 and 750,000 cakes are sold My cost is $1.05 per cake. So, my income is 962,000 US dollars.
But then, Imran — if you’re curious, why I haven’t recorded a video for two weeks Imran is actually my son's name. He came into this world two weeks ago Therefore, I think it would make sense to name his cake shop after him. For example, if he comes, he said, I am tired of asking for pocket money from my father. I also want to make cakes. He actually has more money because his grandma gave him more money Because she likes him better than her son. So he has 1.5 million US dollars to invest, he is very excited, This is a very good investment, allowing me to invest more money in this business. 1.5 million US dollars. He established a factory that can produce 2 million cakes a year. Is also a more efficient factory, so it actually uses less electricity It consumes less cream, frosting, and nicotine.
So the cost of each cake is less. He decided to compete with his father at a low price, so he only charged $2.90 per cake. When he only charged $2.90—everyone ran to him Because his cake is just as good. There are really not many barriers. Suppose, he sold 500,000 cakes. Then I sold only 250,000 for $3 each Some people only like my cakes. So I almost broke even and said, okay, these are my hardcore fans. And so, it's good for them-these guys won't go anywhere else. I will raise the price a bit. Because I know these guys like me. At least in this case, I have a profit. But then I said, well, you know, this is not a good business situation. He took all my business. Actually, I want you to notice that something is here, what happened immediately. I used to have 88% return, right? When Imran came and he entered this business field, suddenly, what was my return? He only runs at 25% utilization. But his return on assets dropped to 20.
Moreover, because he is at that utilization rate, his return on assets has dropped to 20%. However, my return on assets dropped to 1%. Therefore, there is a common theme here. When someone does a good job and gets a good return, it attracts competition. It will attract power, right? If there is enough demand to meet this new capability, maybe they will get better returns. But in general, over time, if there is a very good return, more competitors will enter the market. Actually I have used up my time in the studio. In the next video, I will talk about more competition. Goodbye.