LEARNING OBJECTIVES
• EXPLAIN THE IMPORTANCE OF CAPACITY DECISIONS
• DESCRIBE THE DETERMINANTS OF EFFECTIVE CAPACITY
• DESCRIBE THE FACTORS THAT MAY CONSIDER ON THE
DEVELOPMENT OF CAPACITY ALTERNATIVES
• DESCRIBE THE APPROCAHES THAT ARE USEFUL FOR THE
EVALUATION OF CAPACITY ALTERNATIVES
•WHAT IS CAPACITY PLANNING?
CAPACITY PLANNING
•
Capacity is the throughput, or the number of units a facility can hold,
receive, store or produce in a period of time.
•
It is a requirement to determine the facility size of an objective of
achieving high levels of utilization and a high return on investment.
•
It includes:
• equipment
• space
• employee skills
•
Basic questions in capacity handling are:
• what kind of capacity is needed?
• how much is needed?
• when is needed?
CAPACITY PLANNING
The process of determining the production capacity needed by
an organization to meet changing demands for its product.
strategic capacity planning
• balancing of long term supply capabilities and predicted level of
long term demand
• forecasts are key input.
CAPACITY PLANNING CONSIDERATIONS
• Cost, availability of funds, expected returns
• Potential benefits and risk
• degree of uncertainty in forecast
• Sustainability issues
• Rate of capacity addition?
• all at once? or incremental?
• Timing of capacity addition?
• Leading, following or tracking?
• Supply chain support
IMPORTANCE OF CAPACITY DECISIONS
• Impacts ability to meet future demands
• Affects operating costs
• Major determinant of initial cost
• Involves long-term commitment
• Affects competitiveness
• Affects ease of management
DESIGN AND EFFECTIVE CAPACITY
Design capacity is the maximum theoretical output of a system
it is normally expressed as a rate
Effective capacity is the capacity a firm expects to achieve given current
operating constraints
it is often lower than design capacity
Actual output is the rate of output actually achieved (cannot exceed the
effective capacity)
MEASURING CAPACITY EXAMPLES
Types of Business
Input Measures of
Capacity
Output Measures of
Capacity
Car manufacturer
Labor Hours
Cars per shift
Hospitals
Available beds
Patients per month
Pizza Parlor
Labor Hours
Pizzas per day
Retail Store
Floor space in square
feet
Revenue per foot
TWO MEASURES OF SYSTEM PERFORMANCE
Utilization is simply the percent of design capacity achieved
utilization = actual output / design capacity
Efficiency is the percent of the effective capacity achieved
efficiency = actual output / effective capacity
Expected output = (effective capacity)( new efficiency)
EFFECTIVE/UTILIZATION EXAMPLE
DESIGN CAPACITY = 50 TRUCKS/DAY
EFFECTIVE CAPACITY= 40 TRUCKS/DAY
ACTUAL OUTPUT= 36 UNITS/DAY
Efficiency  ???
Utilization ???
EFFECTIVE/UTILIZATION EXAMPLE
DESIGN CAPACITY = 50 TRUCKS/DAY
EFFECTIVE CAPACITY= 40 TRUCKS/DAY
ACTUAL OUTPUT= 36 UNITS/DAY
EXAMPLE
Sara James bakery has a plant processing de luxe breakfast rolls
and wants to determine its capability. last week the facility
produced 148,000 rolls. the effective capacity is 175,000 rolls.
the production line operates 7 days per week, with three-8
hours shift per day. the line was designed to process the nutfilled, cinnamon flavored de luxe roll at rate of 1,200 per hour.
determine the design capacity, utilization and efficiency for this
plant when producing this de luxe roll.what is the expected output
assumed that new line efficiency is 75%?
EXAMPLE
actual production last week = 148,000 rolls
effective capacity = 175,000 rolls
design capacity = 1,200 rolls per hour
bakery operates 7 days/week, 3-8 hours shifts
design capacity =
EXAMPLE
ACTUAL PRODUCTION LAST WEEK = 148,000 ROLLS
EFFECTIVE CAPACITY = 175,000 ROLLS
DESIGN CAPACITY = 1,200 ROLLS PER HOUR
BAKERY OPERATES 7 DAYS/WEEK, 3-8 HOURS SHIFTS
DESIGN CAPACITY = (7 X 3 X 8) X (1,200) = 201,600 ROLLS
UTILIZATION =
EXAMPLE
ACTUAL PRODUCTION LAST WEEK = 148,000 ROLLS
EFFECTIVE CAPACITY = 175,000 ROLLS
DESIGN CAPACITY = 1,200 ROLLS PER HOUR
BAKERY OPERATES 7 DAYS/WEEK, 3-8 HOURS SHIFTS
DESIGN CAPACITY = (7 X 3 X 8) X (1,200) = 201,600 ROLLS
UTILIZATION = 148,000/201,600 = 73.4%
EFFICIENCY =
EXAMPLE
ACTUAL PRODUCTION LAST WEEK = 148,000 ROLLS
EFFECTIVE CAPACITY = 175,000 ROLLS
DESIGN CAPACITY = 1,200 ROLLS PER HOUR
BAKERY OPERATES 7 DAYS/WEEK, 3-8 HOURS SHIFTS
DESIGN CAPACITY = (7 X 3 X 8) X (1,200) = 201,600 ROLLS
UTILIZATION = 148,000/201,600 = 73.4%
EFFICIENCY = 148,000/175,000 = 84.6%
EXAMPLE
ACTUAL PRODUCTION LAST WEEK = 148,000 ROLLS
EFFECTIVE CAPACITY = 175,000 ROLLS
DESIGN CAPACITY = 1,200 ROLLS PER HOUR
BAKERY OPERATES 7 DAYS/WEEK, 3-8 HOURS SHIFTS
UTILIZATION = 73.4%
NEW LINE EFFICIENCY = 75%
EXPECTED OUTPUT =
EXAMPLE
ACTUAL PRODUCTION LAST WEEK = 148,000 ROLLS
EFFECTIVE CAPACITY = 175,000 ROLLS
DESIGN CAPACITY = 1,200 ROLLS PER HOUR
BAKERY OPERATES 7 DAYS/WEEK, 3-8 HOURS SHIFTS
UTILIZATION = 73.4%
NEW LINE EFFICIENCY = 75%
EXPECTED OUTPUT = (EFFECTIVE CAPACITY)(EFFICIENCY)
= (175,000)(.75) = 131,250 ROLLS
EXERCISE
The effective capacity and efficiency for the next quarter at MMU mfg. in
WACO, TEXAS for each three departments are shown:
Department
Effective Capacity
Recent
Efficiency
Design
93,600
0.95
Fabrication
156,000
1.03
Finishing
62,400
1.05
Compute the expected production for next quarter for each department.
STEPS FOR CAPACITY PLANNING
1. Estimate future capacity requirements
2. Evaluate existing capacity
3. Identify alternatives
4. Conduct financial analysis
5. Assess key qualitative issues
6. Select one alternative
7. Implement alternative chosen
8. Monitor results
CAPACITY PLANNING CAN BE VIEWED IN
THREE HORIZONS
Long range capacity (greater than 1 year) - is a junction of
adding facilities and equipment that have a long lead time.
Intermediate range (3 to 18 months) - adding equipment,
personnel, and shifts, subcontracting, building or using
inventory. the aggregate planning task
Short run (usually up to 3 months) - concerned with
scheduling jobs, people and allocating machinery.
CALCULATING PROCESSING REQUIREMENTS
CAPACITY UTILIZATION STRATEGY
KEY TO IMPROVING CAPACITY UTILIZATION IS TO INCREASE
EFFECTIVE CAPACITY BY CORRECTING QUALITY PROBLEMS,
MAINTAINING EQUIPMENT IN GOOD OPERATING CONDITION, FULLY
TRAINING EMPLOYEES, AND FULLY UTILIZING BOTTLENECK
EQUIPMENT.
PLANNING SERVICE CAPACITY
• Need to be near customers
• capacity and location are closely tied
• Inability of store services
• capacity must be matched with timing of demand
• Degree of volatility of demand
• peak demand periods
CONSTRAINT MANAGEMENT
Constraint- limits the performance of a process or system in achieving its
goals.
How to solve it?
1. Identify the most pressing constraint
2. Change the operation to achieve the maximum benefit, given the constraint
3. Make sure other portions of the process are supportive of the constraint
4. Explore and evaluate to overcome constraints
5. Repeat the process until the level of constraints is acceptable
EVALUATING ALTERNATIVES
COST VOLUME ANALYSIS
BREAK-EVEN POINT
FINANCIAL ANALYSIS
CASH FLOW
PRESENT VALUE
DECISION THEORY
WAITING LINE ANALYSIS
EVALUATING ALTERNATIVES
 ASSUMPTIONS OF COST-VOLUME ANALYSIS
1.
2.
ONE PRODUCT IS INVOLVED
3.
VARIABLE COST PER UNIT IS THE
SAME REGARDLESS OF VOLUME
4.
FIXED COSTS DO NOT CHANGE
WITH VOLUME
5.
REVENUE PER
WITH VOLUME
6.
REVENUE PER UNIT EXCEEDS
VARIABLE COST PER UNIT
EVERYTHING PRODUCED CAN BE
SOLD
UNIT
CONSTANT
Cost-Volume Symbols
FC = Fixed cost
VC = Variable cost
v = variable cist per unit
TC = Total cost
TR = Total revenue
R = Revenue per unit
Q = Quantity or volume of output
QBEP = Break-even quantity
P = Profit
EVALUATING
ALTERNATIVES
EVALUATING ALTERNATIVES


BEP- Break-even Point
 Volume of output needed for the
total revenue equaling total cost
 Production below BEP quantity
results in loss
 Production above BEP quantity
results in profit
 Production at BEP quantity: no
profits, no loss
Point of Indifference
 the quantity at which a decision
maker would be indifferent
between
two
competing
alternatives
Break-even point- is the quantity of production
at which the income is equal to total cost.
BREAK-EVEN FORMULA
BEPX = BREAK-EVEN POINT IN UNITS
BEP$ = BREAK-EVEN POINT IN DOLLARS
P
= PRICE PER UNIT (AFTER ALL DISCOUNTS)
X
= NUMBER OF UNITS PRODUCED
TR = TOTAL REVENUE
F
= FIXED COST
V
= VARIABLE COST
TC = TOTAL COST
PROFIT/LOSS = TR -TC
= PX - (F + VX)
= PX - F - VX
= (P - V)X - F
F
BEPx 
pv
BEP$ 
F
v
1
p
BREAK-EVEN SAMPLES
The owner of old-fashioned beery pies, S.Simon, is contemplating adding a
new line of pies, which will require leasing new equipment for a monthly
payment of $6,000. variable costs would be $2.00 per pie, and pies would
retail for $7.00 each.
A. how many pies must be sold in order to break even?
B. what would the profit/loss be if 1,000 pies are made and sold in a month?
C. how many pies must be sold to realize a profit of $4,000?
D. if 2,000 can be sold, and a profit target is $5,000, what price should be
charged per pie?
SOLUTION:
FC = $6,000,VC = $2 PER PIE, R = $7 PER PIE
SOLUTION:
FC = $6,000,VC = $2 PER PIE, R = $7 PER PIE
SOLUTION:
FC = $6,000,VC = $2 PER PIE, R = $7 PER PIE
SOLUTION:
FC = $6,000,VC = $2 PER PIE, R = $7 PER PIE
BREAK-EVEN EXAMPLE
A MANAGER HAS THE OPTION OF PURCHASING ONE, TWO, OR THREE MACHINES. FIXED
COSTS AND POTENTIAL VOLUMES ARE AS FOLLOWS:
NO. OF MACHINES
TOTAL ANNUAL COST
RANGE OF OUTPUT
1
$9,600
0 TO 300
2
15,000
301 TO 600
3
20,000
601 TO 900
VARIABLE COST IS $10 PER UNIT, AND PRICE IS $40 PER UNIT.
A. DETERMINE THE BREAK-EVEN POINT FOR EACH RANGE.
B. IF PROJECTED ANNUAL DEMAND IS BETWEEN 580 AND 660 UNITS, HOW MANY MACHINES
SHOULD THE MANAGER PURCHASE?
BREAK-EVEN EXAMPLE
A FIRM'S MANAGER MUST DECIDE WHETHER TO MAKE OR BUY A CERTAIN ITEM USED
IN THE PRODUCTION OF VENDING MACHINES. COST AND VOLUMES ESTIMATES ARE
AS FOLLOWS:
Make
Buy
Annual Fixed Cost
$150,000
None
Variable Cost/unit
$60
$80
Annual Volume(units)
12,000
12,000
A. GIVEN THESE NUMBERS, SHOULD THE FIRM BUY THIS ITEM?
B. THERE IS A POSSIBILITY THAT VOLUME COULD CHANGE IN THE FUTURE. AT WHAT
VOLUME WOULD THE MANAGER BE INDIFFERENT BETWEEN MAKING AND BUYING?
BREAK-EVEN ANALYSIS
MULTIPRODUCT CASE
F
BEPx 
Wp  Wv
WHERE:
WV = WEIGHTED AVE. VARIABLE COST PER UNIT
WP = WEIGHTED AVE. PRICE PER UNIT
F = TOTAL FIXED COSTS
BREAK-EVEN ANALYSIS
EXAMPLE: BELLE COMPANY MANUFACTURES AND SELLS THREE PRODUCTS:
PRODUCTS A, B, AND C. THE FOLLOWING DATA HAS BEEN PROVIDED THE
COMPANY.
A
B
C
SELLING PRICE
$100
$120
$50
VARIABLE COST PER UNIT
$60
$90
$40
THE COMPANY INCURRED IN $120,000 TOTAL FIXED COSTS. THE COMPANY
EXPECTS THE SALES OF THE THREE PRODUCTS IN THE FOLLOWING RATIO:
35% OF A, 50% OF B AND 15% OF C. COMPUTE THE BREAK-EVEN POINT OF THE
COMPANY IN UNITS AND BREAK EVEN POINT IN DOLLARS?
FINANCIAL ANALYSIS: CERTAINTY
Cash flow refers to the difference between the cash received from sales (of
goods or services) and other sources (e.g., sale of old equipment) and the
cash outflow for labor, materials, overhead, and taxes.
Present value expresses in current value the sum of all future cash flows of
an investment proposal.
3 Most Commonly used Methods of Financial Analysis:
Payback
Present Value
Internal Rate of Return
FINANCIAL ANALYSIS: PAYBACK
Payback is a crude but widely used method that focuses on
the length of time it will take for an investment to return its
original cost.
Example:
A new machine will cost $2,000, but it will result in savings of
$500 per year. What is the payback time in years?
Initial cost = $2,000
Annual savings = $500
The payback time is initial cost divided by annual savings.
Thus, the payback time is:
Paybacktime = Initial Cost/ Annual Savings
= $2,000/ $500per year
= 4 years
FINANCIAL ANALYSIS: PV AND IRR
The present value (PV) method summarizes the initial cost
of an investment, its estimated annual cash flows, and any
expected salvage value in a single value called the
equivalent current value, taking into account the time value
of money (i.e., interest rates).
The internal rate of return (IRR) summarizes the initial cost,
expected annual cash flows, and estimated future salvage
value of an investment proposal in an equivalent interest
rate.
NET PRESENT VALUE
IT IS A MEANS OF DETERMINING THE DISCOUNTED VALUE OF A SERIES CASH
RECEIPTS.
LET NET PRESENT VALUE FORMULA IS:
P = F/(1+I)^N - FOR ONE FUTURE AMOUNT
P = A[(1+I)^N - 1]/ I(1+I)^N - FOR AN ANNUAL SERIES OF UNIFORM AND EQUAL
CASH FLOWS
NET PRESENT VALUE EXAMPLE
River road medical clinic is thinking of investing in sophisticated
new piece of medical equipment. It will generate $7,000 per
year in receipts for 5 years. Determine the present value of this
cash flow assume an interest of 6%.
NET PRESENT VALUE EXAMPLE
P = $7,000[(1+0.06)^5 -1 / 0.06(1+0.06)^5
P = $29,486.55
NET PRESENT VALUE EXAMPLE
WHAT IS THE NET PRESENT VALUE OF AN INVESTMENT
THAT COSTS $75,000 AND HAS A SALVAGE VALUE OF
$45,000? THE ANNUAL PROFIT FROM THE INVESTMENT IS
$15,000 EACH YEAR FOR 5 YEARS. THE COST OF CAPITAL
AT THE RISK IS 12%
NET PRESENT VALUE EXAMPLE
CASH INFLOWS = ANNUAL REVENUE [(1+I)^N -1 / I(1+I)^N] +SALVAGE VALUE(1+I)^-N
CASH INFLOWS = $15,000 [(1+0.12)^5 -1 / 0.12(1+0.12)^5] + $45,000(1+0.12)^-5
CASH INFLOWS = $79,605.85
CASH OUTFLOWS = INVESTMENT COST
CASH OUTFLOWS = $75,000
NPV = INFLOWS – OUTFLOWS
NPV = $79,605.85 - $75,000 = $4,605.85
FINANCIAL ANALYSIS UNCERTAINTY
DECISION THEORY REPRESENTS A GENERAL APPROACH TO DECISION MAKING. IT IS
SUITABLE FOR A WIDE RANGE OF OPERATIONS MANAGEMENT DECISIONS.
Decision Trees Techniques
1. Alternatives
2. States of nature with probability values
 In capacity planning the state of nature usually is future demand or market
favorability
 The objective is to make a decision that maximizes the expected value of the
alternatives.