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 CapacityMaximum obtainable output

Effective CapacityMaximum capacity given product mix,

scheduling difficulties, and other doses of reality.

Actual outputRate of output actually achieved--

cannot exceed effective capacity.

Determinants of Effective Capacity Facilities

Location / layout Products or services

Standard vs. customized Processes

Design and execution Human considerations Operations External forces

Design: PlannedEffective: RealityActual: 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

Cost-Volume Relationships

Am

ou

nt

($)

0Q (volume in units)

Total cost = VC + FC

Total variable cost (V

C)

Fixed cost (FC)

Figure 5-8a

Cost-Volume Relationships

Am

ou

nt

($)

Q (volume in units)0

Total r

evenue

Figure 5-8b

Cost-Volume Relationships

Am

ou

nt

($)

Q (volume in units)0 BEP units

Profit

Total r

even

ue

Total cost

Figure 5-8c

Loss

Breakeven Point

QBEP = FC R - VC

BEP Calculations

To calculate Total Profit: P = Q(R - VC) - FC where Q = Quantity

R = Revenue/unitVC = 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 Fixed Variable Capacity

A 250,000 15 12,000

B 350,000 10 10,000

C 100,000 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 Fixed Variable Capacity

A 250,000 15 25,000

B 350,000 10 50,000

C 100,000 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.