© 2006 prentice hall, inc.s7 – 1 capacity planning © 2006 prentice hall, inc

© 2006 Prentice Hall, Inc. S7 – 1

Capacity PlanningCapacity Planning

© 2006 Prentice Hall, Inc.


CapacityCapacity

The throughput, or the number of The throughput, or the number of units a facility can hold, receive, units a facility can hold, receive, store, or produce in a period of timestore, or produce in a period of time

Determines fixed costsDetermines fixed costs

Determines if demand will be Determines if demand will be satisfiedsatisfied

Three time horizonsThree time horizons


Modify capacityModify capacity Use capacityUse capacity

Planning Over a Time Planning Over a Time HorizonHorizon

Intermediate-Intermediate-range range planningplanning

Subcontract Add personnelAdd equipment Build or use inventory Add shifts

Short-range Short-range planningplanning

Schedule jobsSchedule personnel Allocate machinery*

Long-range Long-range planningplanning

Add facilitiesAdd long lead time equipment *

Figure S7.1Figure S7.1


Design and Effective Design and Effective CapacityCapacity

Design capacity is the maximum Design capacity is the maximum theoretical output of a systemtheoretical output of a system Normally expressed as a rateNormally expressed as a rate

Effective capacity is the capacity a Effective capacity is the capacity a firm expects to achieve given current firm expects to achieve given current operating constraintsoperating constraints Often lower than design capacityOften lower than design capacity


Utilization and EfficiencyUtilization and Efficiency

Utilization is the percent of design capacity Utilization is the percent of design capacity achievedachieved

Efficiency is the percent of effective capacity Efficiency is the percent of effective capacity achievedachieved

Utilization = Actual Output/Design CapacityUtilization = Actual Output/Design Capacity

Efficiency = Actual Output/Effective CapacityEfficiency = Actual Output/Effective Capacity


Bakery ExampleBakery Example

Actual production last week = Actual production last week = 148,000148,000 rolls rollsEffective capacity = Effective capacity = 175,000175,000 rolls rollsDesign capacity = Design capacity = 1,2001,200 rolls per hour rolls per hourBakery operates Bakery operates 77 days/week, days/week, 3 –3 – ‘ ‘88 hour shifts’ hour shifts’

Design capacity Design capacity = (7 x 3 x 8) x (1,200) = 201,600= (7 x 3 x 8) x (1,200) = 201,600 rolls rolls





Utilization Utilization = 148,000/201,600 = 73.4%= 148,000/201,600 = 73.4%






Efficiency Efficiency = 148,000/175,000 = 84.6%= 148,000/175,000 = 84.6%



Actual production last week = Actual production last week = 148,000148,000 rolls rollsEffective capacity = Effective capacity = 175,000175,000 rolls rollsDesign capacity = Design capacity = 1,2001,200 rolls per hour rolls per hourBakery operates Bakery operates 77 days/week, days/week, 3 –3 – ‘ ‘88 hour shifts’ hour shifts’Efficiency Efficiency = 84.6%= 84.6%Efficiency of new line Efficiency of new line = 75%= 75%

Expected Output = Expected Output = ((Effective CapacityEffective Capacity)()(EfficiencyEfficiency))

= (175,000)(.75) = 131,250= (175,000)(.75) = 131,250 rolls rolls



Actual production last week = Actual production last week = 148,000148,000 rolls rollsEffective capacity = Effective capacity = 175,000175,000 rolls rollsDesign capacity = Design capacity = 1,2001,200 rolls per hour rolls per hourBakery operates Bakery operates 77 days/week, days/week, three-three- ‘ ‘88 hour shifts’ hour shifts’Efficiency Efficiency = 84.6%= 84.6%Efficiency of new line Efficiency of new line = 75%= 75%

Expected Output = Expected Output = ((Effective CapacityEffective Capacity)()(EfficiencyEfficiency))

= (175,000)(.75) = 131,250= (175,000)(.75) = 131,250 rolls rolls


Managing DemandManaging Demand

Demand exceeds capacityDemand exceeds capacity limit demand by raising prices, scheduling limit demand by raising prices, scheduling

longer lead timelonger lead time

Long term solution is to increase capacityLong term solution is to increase capacity

Capacity exceeds demandCapacity exceeds demand motivate marketingmotivate marketing

Product changesProduct changes

Adjusting to seasonal demandsAdjusting to seasonal demands Produce products with complimentary Produce products with complimentary

demand patternsdemand patterns


Capacity ConsiderationsCapacity Considerations

Forecast demand accuratelyForecast demand accurately

Understanding the technology Understanding the technology and capacity incrementsand capacity increments

Find the optimal operating level Find the optimal operating level (volume)(volume)

Build for changeBuild for change


Approaches to Capacity Approaches to Capacity ExpansionExpansion

(a)(a) Leading demand with Leading demand with incremental expansionincremental expansion

Dem

and

Dem

and

Expected Expected demanddemand

New New capacitycapacity

(b)(b) Leading demand with Leading demand with one-step expansionone-step expansion

Dem

and

Dem

and



(d)(d) Attempts to have an average Attempts to have an average capacity with incremental capacity with incremental expansionexpansion

Dem

and

Dem

and New New

capacitycapacity Expected Expected demanddemand

(c)(c) Capacity lags demand with Capacity lags demand with incremental expansionincremental expansion

Dem

and

Dem

and



Figure S7.4Figure S7.4


Break-Even AnalysisBreak-Even Analysis

Technique for evaluating process Technique for evaluating process and equipment alternativesand equipment alternatives

Objective is to find the point in Objective is to find the point in dollars and units at which cost dollars and units at which cost equals revenueequals revenue

Requires estimation of fixed costs, Requires estimation of fixed costs, variable costs, and revenuevariable costs, and revenue


BREAK EVEN ANALYSISBREAK EVEN ANALYSIS

• It refers to the ascertainment of level of operations It refers to the ascertainment of level of operations where total revenue equals to total costs.where total revenue equals to total costs.

• Analytical tool to determine probable level of Analytical tool to determine probable level of operation.operation.

• Method of studying the relationship among sales, Method of studying the relationship among sales, revenue, variable cost, fixed cost to determine the revenue, variable cost, fixed cost to determine the level of operation at which all the costs are equal level of operation at which all the costs are equal to the sales revenue and there is no profit and no to the sales revenue and there is no profit and no loss situation.loss situation.

• Important techniques is profit planning and Important techniques is profit planning and managerial decision making.managerial decision making.



Fixed costs are costs that continue Fixed costs are costs that continue even if no units are producedeven if no units are produced Depreciation, taxes, debt, credit Depreciation, taxes, debt, credit

paymentspayments

Variable costs are costs that vary Variable costs are costs that vary with the volume of units producedwith the volume of units produced Labor, materials, portion of utilitiesLabor, materials, portion of utilities

Contribution is the difference between Contribution is the difference between selling price and variable costselling price and variable cost


COSTSCOSTS

VARIABLE VARIABLE COSTSCOSTS

FIXED FIXED COSTSCOSTS

•Raw Raw materialsmaterials•ComponentsComponents •Direct Direct labourlabour

OverheadsOverheads, , i.e.i.e.•property property costscosts •salarysalary •admin costsadmin costs



Costs and revenue are linear Costs and revenue are linear functionsfunctions Generally not the case in the real Generally not the case in the real

worldworld

We actually know these costsWe actually know these costs Very difficult to accomplishVery difficult to accomplish

AssumptionsAssumptions


Profit corri

dor

Loss

corridor

Break-Even AnalysisBreak-Even AnalysisTotal revenue lineTotal revenue line

Total cost lineTotal cost line

Variable costVariable cost

Fixed costFixed cost

Break-even pointBreak-even pointTotal cost = Total revenueTotal cost = Total revenue

–

900 900 –

800 800 –

700 700 –

600 600 –

500 500 –

400 400 –

300 300 –

200 200 –

100 100 –

–| | | | | | | | | | | |

00 100100 200200 300300 400400 500500 600600 700700 800800 900900 1000100011001100

Co

st

Co

st

Volume (units per period)Volume (units per period)Figure S7.5Figure S7.5



BEPBEPxx == Break-even Break-even point in unitspoint in unitsBEPBEP$$ == Break-even Break-even point in dollarspoint in dollarsPP == Price per Price per unit unit

xx == Number of units Number of units producedproducedTRTR== Total revenue = PxTotal revenue = PxFF == Fixed costsFixed costsVV == Variable costs per Variable costs per unitunitTCTC== Total costs = F + VxTotal costs = F + Vx

TR = TCTR = TCoror

Px = F + VxPx = F + Vx

Break-even point Break-even point occurs whenoccurs when

BEPBEPxx = =FF

P - VP - V


Break-even Break-even formulaformula

Break-even Break-even point =point =

Fixed costsFixed costs

Selling price (per unit) – variable cost (per unit)Selling price (per unit) – variable cost (per unit)


DEFINATIONS USED IN BREAK EVEN DEFINATIONS USED IN BREAK EVEN POINT-POINT-

• Fixed Cost:Fixed Cost:The sum of all costs required to produce the first unit The sum of all costs required to produce the first unit of a product. This amount does not vary as production of a product. This amount does not vary as production increases or decreases, until new capital expenditures increases or decreases, until new capital expenditures are needed. are needed.

• Variable Unit Cost:Variable Unit Cost:Costs that vary directly with the production of one Costs that vary directly with the production of one additional unit. additional unit.

• Expected Unit Sales:Expected Unit Sales:Number of units of the product projected to be sold Number of units of the product projected to be sold over a specific period of time. over a specific period of time.

• Unit Price:Unit Price:The amount of money charged to the customer for The amount of money charged to the customer for each unit of a product or service. each unit of a product or service.


DEFINATIONS CONTDEFINATIONS CONT

• Total Variable Cost:Total Variable Cost:The product of expected unit sales and variable unit cost. The product of expected unit sales and variable unit cost. (Expected Unit Sales * Variable Unit Cost ) (Expected Unit Sales * Variable Unit Cost )

• Total Cost:Total Cost:The sum of the fixed cost and total variable cost for any The sum of the fixed cost and total variable cost for any given level of production. given level of production. (Fixed Cost + Total Variable Cost ) (Fixed Cost + Total Variable Cost )

• Total Revenue:Total Revenue:The product of expected unit sales and unit price. The product of expected unit sales and unit price. (Expected Unit Sales * Unit Price ) (Expected Unit Sales * Unit Price )

• Profit (or Loss):Profit (or Loss):The monetary gain (or loss) resulting from revenues after The monetary gain (or loss) resulting from revenues after subtracting all associated costs. (Total Revenue - Total subtracting all associated costs. (Total Revenue - Total Costs) Costs)


Break-Even ExampleBreak-Even Example

Fixed costs Fixed costs = $10,000= $10,000 Material Material = $.75= $.75/unit/unitDirect labor Direct labor = $1.50= $1.50/unit/unit Selling price Selling price = $4.00= $4.00 per unit per unit

BEPBEP$$ = == =FF

1 - (1 - (V/PV/P))$10,000$10,000

1 - [(1.50 + .75)/(4.00)]1 - [(1.50 + .75)/(4.00)]

= = $22,857.14= = $22,857.14$10,000$10,000

.4375.4375

BEPBEPxx = = = 5,714= = = 5,714FF

P - VP - V$10,000$10,000

4.00 - (1.50 + .75)4.00 - (1.50 + .75)




BEPBEPxx = = = 5,714= = = 5,714FF

P - VP - V$10,000$10,000

4.00 - (1.50 + .75)4.00 - (1.50 + .75)



BEPBEPxx == Break-even Break-even point in unitspoint in unitsBEPBEP$$ == Break-even Break-even point in dollarspoint in dollarsPP == Price per Price per unit unit

xx == Number of units Number of units producedproducedTRTR== Total revenue = PxTotal revenue = PxFF == Fixed costsFixed costsVV == Variable costsVariable costsTCTC== Total costs = F + VxTotal costs = F + Vx

BEPBEP$$ = BEP= BEPx x PP

= P= P

==

= =

FF((P - VP - V))/P/P

FFP - VP - V

FF1 -1 - V/P V/P

ProfitProfit = TR - TC= TR - TC

= Px - = Px - ((F + VxF + Vx))

= Px - F - Vx= Px - F - Vx

= = ((P - VP - V))x - Fx - F



BEPBEP$$ ==FF

∑∑ 1 - x (1 - x (WWii))VVii

PPii

Multiproduct CaseMultiproduct Case

wherewhere VV = variable cost per unit= variable cost per unitPP = price per unit= price per unitFF = fixed costs= fixed costs

WW = percent each product is of total dollar sales= percent each product is of total dollar salesii = each product= each product


DEPENDENCEDEPENDENCE

• Break even analysis depends on the following variables:Break even analysis depends on the following variables:

• The fixed production costs for a product. The fixed production costs for a product.

• The variable production costs for a product. The variable production costs for a product.

• The product's unit price. The product's unit price.

• The product's expected unit sales [sometimes called The product's expected unit sales [sometimes called projected sales.]projected sales.]

• On the surface, break-even analysis is a tool to calculate at On the surface, break-even analysis is a tool to calculate at which sales volume the variable and fixed costs of which sales volume the variable and fixed costs of producing your product will be recovered. Another way to producing your product will be recovered. Another way to look at it is that the break-even point is the point at which look at it is that the break-even point is the point at which your product stops costing you money to produce and sell, your product stops costing you money to produce and sell, and starts to generate a profit for your company. and starts to generate a profit for your company.

• It can also use break even analysis to solve managerial It can also use break even analysis to solve managerial problems.problems.


ADVANTAGEADVANTAGE

• It is cheap to carry out and it can It is cheap to carry out and it can show the profits/losses at varying show the profits/losses at varying levels of output. levels of output.

• It provides a simple picture of a It provides a simple picture of a business - a new business will often business - a new business will often have to present a break-even have to present a break-even analysis to its bank in order to get a analysis to its bank in order to get a loan. loan.


LIMITATIONSLIMITATIONS• Break-even analysis is only a supply side (i.e. costs only) Break-even analysis is only a supply side (i.e. costs only)

analysis, as it tells you nothing about what sales are analysis, as it tells you nothing about what sales are actually likely to be for the product at these various prices. actually likely to be for the product at these various prices.

• It assumes that fixed costs (FC) are constant It assumes that fixed costs (FC) are constant

• It assumes average variable costs are constant per unit of It assumes average variable costs are constant per unit of output, at least in the range of likely quantities of sales. (i.e. output, at least in the range of likely quantities of sales. (i.e. linearity) linearity)

• It assumes that the quantity of goods produced is equal to It assumes that the quantity of goods produced is equal to the quantity of goods sold (i.e., there is no change in the the quantity of goods sold (i.e., there is no change in the quantity of goods held in inventory at the beginning of the quantity of goods held in inventory at the beginning of the period and the quantity of goods held in inventory at the period and the quantity of goods held in inventory at the end of the period). end of the period).

• In multi-product companies, it assumes that the relative In multi-product companies, it assumes that the relative proportions of each product sold and produced are proportions of each product sold and produced are constant (i.e., the sales mix is constant). constant (i.e., the sales mix is constant).


THANKS !THANKS !

© 2006 prentice hall, inc.s7 – 1 capacity planning © 2006 prentice hall, inc

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