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Capacity Planning

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How much long-range capacity is needed When more capacity is needed Where facilities should be located (location) How facilities should be arranged (layout) Facility planning answers: Facility Planning

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Forecast Demand Compute Needed Capacity Compute Rated Capacity Evaluate Capacity Plans Implement Best Plan Qualitative Factors (e.g., Skills) Select Best Capacity Plan Develop Alternative Plans Quantitative Factors (e.g., Cost) Capacity Planning Process

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Types of Planning & Time Horizons Add Facilities Add long lead time equipment Schedule Jobs Schedule Personnel Allocate Machinery Sub-Contract Add Equipment Add Shifts Add Personnel Build or Use Inventory Long Range Planning Intermediate Range Planning Short Range Planning Modify Capacity Use Capacity * *

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Definition & Measures of Capacity Design Capacity: The theoretical maximum throughput, or number of units a facility can hold, receive, store, or produce in a period of time. Utilization: Actual output as a percent of design capacity. Effective Capacity: Capacity a firm can expect to receive given its product mix, methods of scheduling, maintenance, and standards of quality. Efficiency: Actual output as a percent of effective capacity.

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Measure of planned or actual capacity usage of a facility, work center, or machine Utilization Actual Output Design Capacity Planned hours to be used Total hours available = = Utilization

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Measure of how well a facility or machine is performing when used Efficiency Actual output Effective Capacity Actual output in units Standard output in units Average actual time Standard time = = = Efficiency

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Actual or Expected Output Actual (or Expected) Output = (Effective Capacity) X (Efficiency)

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Capacity Changes Changes in capacity will likely have implications for: Sales Cash flow Quality Supply chain Human resources Maintenance

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Make Good Capacity Decisions: Forecast demand accurately Understand the technology and capacity increments Find the optimal operating level (volume) Build for change

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Matching Capacity to Demand 1. Make staffing changes (increasing or decreasing the number of employees) 2. Adjust equipment and processes – which might include purchasing additional machinery or selling or leasing out existing equipment 3. Improve methods to increase throughput; and/or 4. Redesign the product to facilitate more throughput

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Matching Capacity to Demand Demand management Vary prices Change lead times Encourage or discourage business Offer complementary products Capacity management Adjust staffing Adjust equipment and processes Change methods to facilitate production Redesign the product to facilitate production

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Approaches to Capacity Expansion Expected Demand Time in Years Demand New Capacity Capacity leads demand with an incremental expansion Capacity leads demand with a one-step expansion Capacity lags demand with an incremental expansion Attempts to have an average capacity, with an incremental expansion

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Approaches to Capacity Expansion Expected Demand Time in Years Demand New Capacity Capacity leads demand with an incremental expansion

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Approaches to Capacity Expansion Expected Demand Time in Years Demand New Capacity Capacity leads demand with a one-step expansion

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Approaches to Capacity Expansion Expected Demand Time in Years Demand New Capacity Capacity lags demand with an incremental expansion

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Approaches to Capacity Expansion Expected Demand Time in Years Demand New Capacity Attempts to have an average capacity, with an incremental expansion

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Breakeven Analysis Technique for evaluating process & equipment alternatives Objective: Find the point ($ or units) at which total cost equals total revenue Assumptions Revenue & costs are related linearly to volume All information is known with certainty No time value of money

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Break-Even Analysis Fixed costs: costs that continue even if no units are produced: depreciation, taxes, debt, mortgage payments Variable costs: costs that vary with the volume of units produced: labor, materials, portion of utilities

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Breakeven Chart Fixed cost Variable cost Total cost line Total revenue line Profit Breakeven point Total cost = Total revenue Volume (units/period) Cost in Dollars Loss

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Breakeven in Units (x) TFC= Total Fixed Cost VC= Unit Variable Cost P= Unit Selling Price

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Breakeven in Dollars ($) TFC= Total Fixed Cost VC= Unit Variable Cost P= Unit Selling Price

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Breakeven Example A new process costs $10,000 to set up The revenue earned is $25,000 per 1,000 units sold The variable cost is $22.50 per unit What is the BEP(x)? What is the BEP($)? 4,000 $100,000

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Strategy Driven Investment Select investments as part of a coordinated strategic plan Choose investments yielding competitive advantage Consider product life cycles Include a variety of operating factors in the financial return analysis Test investments in light of several revenue projections

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Net Present Value F = Future value P = Present value i = Interest rate N = Number of years

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Net Present Value Example #1 A new machine costs $5,000 Over the 3 years of useful life of the machine it produces revenues of $2,000 per year, paid at the end of each year At the end of the 3 rd year the machine is sold to a competitor for $1,000 What is the NPV of the investment if the company has a cost of capital of 10%?

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NPV Solution #1 NPV = $725.02

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Net Present Value Example #2 Machine A Price = $15,000 Maintenance costs = $5,000 at the end of each of 3 years Salvage value = $2,000 at the end of year 3 Discount rate = 10% Machine B Price = $20,000 Maintenance costs = $4,000 at the end of each of 3 years Salvage value = $7,000 at the end of year 3 Discount rate = 10%

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NPV Solution #2 Which machine should the production manager buy? NPV A = -25, NPV B = -24, Machine B

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Limitations of Net Present Value Investments with the same present value may have significantly different project lives and different salvage values Investments with the same net present values may have different cash flows We assume that we know future interest rates - which we do not We assume that payments are always made at the end of the period - which is not always the case

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