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BUAD 306 Chapter 5 - Capacity Planning Chapter 8 – Location Planning (Cost Volume ONLY) Daily Capacity “There’s only so many hours in a day…” “I can’t take it anymore” “If I eat one more piece, I am going to explode” Capacity Planning The upper limit or ceiling on the load that an operating unit can handle. Establishes the overall level of productive resources for a firm. Enables managers to quantify production capabilities for a firm and make plans accordingly. What to Ask? The basic questions in capacity handling are: What kind of capacity is needed? (resources/facility) How much is needed? (add to existing or build new?) When is it needed? WHO / WHAT / WHERE / WHEN / WHY Importance of Capacity Decisions Should meet future demand Affects operating costs Determines initial cost Involves long-term commitment (requires lots of $$$) Affects competitiveness Definitions Design Capacity Effective Capacity Maximum obtainable output Maximum capacity given product mix, scheduling difficulties, and other doses of reality. Actual output Rate of output actually achieved-cannot exceed effective capacity. Determinants of Effective Capacity Facilities Products or services Standard vs. customized Processes Location / layout Design and execution Human considerations Operations External forces Design: Planned Effective: Reality Actual: Realized Developing Capacity Alternatives Design flexibility into systems Take a “big picture” approach to capacity changes Prepare to deal with capacity “chunks” Attempt to smooth out capacity requirements Identify the optimal operating level Service Capacity Considerations Need to be near the customer Can’t inventory services Volatility in demand Cost-Volume Analysis Relationships between cost, revenue, and volume of output. Variable costs vary directly with volume of output. Break-even point - the volume of output at which total cost and total revenue are equal. Assumptions of Cost-Volume Analysis One product is involved Everything produced can be sold The variable cost per unit is the same regardless of the volume Fixed costs do not change with volume changes The revenue per unit is the same regardless of volume Amount ($) Cost-Volume Relationships Fixed cost (FC) 0 Q (volume in units) Figure 5-8a Amount ($) Cost-Volume Relationships 0 Q (volume in units) Figure 5-8b Amount ($) Cost-Volume Relationships 0 BEP units Q (volume in units) Figure 5-8c Breakeven Point QBEP = FC R - VC BEP Calculations To calculate Total Profit: P = Q(R - VC) - FC where Q = Quantity R = Revenue/unit VC = Variable cost/unit FC = Fixed Cost To calculate the required volume, Q, needed to generate a specified profit, P : Q = P + FC R – VC To calculate a break-even point: QBEP = FC R - VC Example A Process Fixed Variable A 250,000 15 B 350,000 10 C 100,000 30 1. What is the breakeven point for each if revenue = 50? 2. Which would you choose? Example A – Part 2 Process A B C Fixed 250,000 350,000 100,000 Variable Capacity 15 12,000 10 10,000 30 4,000 1. Are you still comfortable with your selections from before given the capacities above? 2. What if demand was expected to be 20,000 for ever? Total Cost Analysis Comparisons between 2 or more alternatives: TC = FC + Q (VC) Example B Process Fixed Variable A 250,000 15 B 350,000 10 1. Which process to use at low volumes? 2. Which process to use at very high volumes? 3. Point of indifference between the two processes? Example B – Part 2 Process Fixed Variable A 250,000 15 B 350,000 10 C 100,000 30 Example B – Part 3 Process A B C Fixed 250,000 350,000 100,000 Variable Capacity 15 25,000 10 50,000 30 8,000 HW #7 A firms plans to begin production of a new small appliance. The manager must decide whether to purchase the motors for the item from a vendor for $7 each or produce in house. If produced in house, it would use one of 2 processes: One has an annual FC = $160,000 and VC = $5/unit. The other has an annual FC = $190,000 and a VC = $4/unit. Determine the range of annual volume for which each alternative would be best.