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Copyright © 2010 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter Strategic Capacity Planning 5 Slides prepared by Laurel Donaldson Douglas.

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Presentation on theme: "Copyright © 2010 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter Strategic Capacity Planning 5 Slides prepared by Laurel Donaldson Douglas."— Presentation transcript:

1 Copyright © 2010 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter Strategic Capacity Planning 5 Slides prepared by Laurel Donaldson Douglas College

2 Copyright © 2010 by The McGraw-Hill Companies, Inc. All rights reserved. Learning Objectives 2 Define capacity, explain the importance of long-term capacity, know how to measure capacity and understand two related performance measures, and describe factors influencing effective capacity. Describe the strategic capacity planning process in organizations, know how to forecast demand and calculate capacity requirements, and discuss major considerations for developing capacity alternatives, Describe the break-even analysis approach for evaluating capacity alternatives, and use it to solve problems. Define capacity, explain the importance of long-term capacity, know how to measure capacity and understand two related performance measures, and describe factors influencing effective capacity. Describe the strategic capacity planning process in organizations, know how to forecast demand and calculate capacity requirements, and discuss major considerations for developing capacity alternatives, Describe the break-even analysis approach for evaluating capacity alternatives, and use it to solve problems. LO 1 LO 3 LO 2

3 Copyright © 2010 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter Outline What is capacity? Measuring capacity Factors influencing capacity Developing capacity alternatives Evaluating alternatives 3

4 Copyright © 2010 by The McGraw-Hill Companies, Inc. All rights reserved. LO 1 What is capacity? The basic questions in capacity handling are: What kind of capacity is needed? How much is needed? When is it needed? 4 Capacity is the upper limit on the load that an operating unit can handle.

5 Copyright © 2010 by The McGraw-Hill Companies, Inc. All rights reserved. LO 1 Importance of Long-Term Capacity Impacts ability to meet future demands Affects operating costs Major determinant of initial costs Involves long-term commitment Affects competitiveness 5

6 Copyright © 2010 by The McGraw-Hill Companies, Inc. All rights reserved. LO 1 Measuring capacity Design capacity maximum obtainable output under ideal conditions Effective capacity Maximum capacity given delays, product mix, scheduling difficulties, and other realities. Actual output rate of output actually achievedcannot exceed effective capacity. Design capacity maximum obtainable output under ideal conditions Effective capacity Maximum capacity given delays, product mix, scheduling difficulties, and other realities. Actual output rate of output actually achievedcannot exceed effective capacity. 6

7 Copyright © 2010 by The McGraw-Hill Companies, Inc. All rights reserved. LO 1 Common Measures of Capacity 7

8 Copyright © 2010 by The McGraw-Hill Companies, Inc. All rights reserved. LO 1 Efficiency and Utilization 8

9 Copyright © 2010 by The McGraw-Hill Companies, Inc. All rights reserved. LO 1 Efficiency/Utilization Example Design capacity = 50 trucks/day Effective capacity = 40 trucks/day Actual output = 36 units/day 9

10 Copyright © 2010 by The McGraw-Hill Companies, Inc. All rights reserved. LO 1 Example: Capacity Actual production last week = 32,000 units Effective capacity = 35,000 units Design capacity = 250 units per hour Factory operates 7 days/week, hour shifts 10 What is the design capacity for one week? Calculate the efficiency and utilization rates. Design capacity = (7 x 3 x 8) x (250) = 42,000 units

11 Copyright © 2010 by The McGraw-Hill Companies, Inc. All rights reserved. LO 1 Actual production last week = 32,000 units Effective capacity = 35,000 units Design capacity = 250 units per hour Factory operates 7 days/week, hour shifts Design capacity = (7 x 3 x 8) x (250) = 42,000 units Example: Capacity 11 Utilization = 32,000/42,000 = 76.2%

12 Copyright © 2010 by The McGraw-Hill Companies, Inc. All rights reserved. LO 1 Actual production last week = 32,000 units Effective capacity = 35,000 units Design capacity = 250 units per hour Factory operates 7 days/week, hour shifts Design capacity = (7 x 3 x 8) x (250) = 42,000 units Example: Capacity 12 Utilization = 32,000/42,000 = 76.2% Efficiency = 32,000/35,000 = 91.4%

13 Copyright © 2010 by The McGraw-Hill Companies, Inc. All rights reserved. LO 1 Factors Influencing Capacity Facilities Floor space, layout Products or services Limited menu in a restaurant Human Training, skills and experience Planning and Operational No of shifts per day, inventory, quality control External Pollution standards, paper work Facilities Floor space, layout Products or services Limited menu in a restaurant Human Training, skills and experience Planning and Operational No of shifts per day, inventory, quality control External Pollution standards, paper work 13

14 Copyright © 2010 by The McGraw-Hill Companies, Inc. All rights reserved. LO 1 Factors Influencing Capacity Facilities Products or services Human Planning and Operational External 14

15 Copyright © 2010 by The McGraw-Hill Companies, Inc. All rights reserved. LO 2 Capacity planning process 3. Measure the capacity now and decide how to bridge the gap a) Generate feasible alternatives b) Evaluate alternatives considering economic and non economic aspects c) Choose the best alternative and implement it 2. Determine capacity requirements 1. Forecast demand one to five years ahead 15

16 Copyright © 2010 by The McGraw-Hill Companies, Inc. All rights reserved. LO 2 Some Possible Growth Patterns 16 Volume Time Growth Decline Cyclical Stable

17 Copyright © 2010 by The McGraw-Hill Companies, Inc. All rights reserved. LO 2 ProductAnnual Demand Standard Processing time per unit (hr.) Processing time needed (hr.) # ,000 # ,400 # ,400 A department works one eight hour shift, 250 days a year, and has these figures for products, their demand, and usage of a type of machine that is currently being considered. How many machines would be needed to handle the required volume? Calculating Capacity Requirements 17

18 Copyright © 2010 by The McGraw-Hill Companies, Inc. All rights reserved. LO 2 Developing Capacity Alternatives Design flexibility into systemsDifferentiate between new and mature productsTake a big picture approach to capacity changesPrepare to deal with capacity chunksAttempt to smooth out capacity requirementsUse capacity cushionIdentify the optimal operating level 18

19 Copyright © 2010 by The McGraw-Hill Companies, Inc. All rights reserved. LO 2 Minimum cost & optimal operating rate are functions of size of production unit. Average cost per unit 0 Small plant Medium plant Large plant Output rate Optimal operating level 19

20 Copyright © 2010 by The McGraw-Hill Companies, Inc. All rights reserved. LO 2 Economies and Diseconomies of Scale 20 Economies of scale Diseconomies of scale Small Facility Medium Facility Large Facility Best operating level Output rate Average cost per unit Best operating level What makes the unit cost increase?

21 Copyright © 2010 by The McGraw-Hill Companies, Inc. All rights reserved. LO 2 Economies and Diseconomies of Scale Economies of scale Fixed costs (facilities, equipment, management) spread out over more units Volume purchase discounts Diseconomies of scale Worker fatigue, equipment breakdown, less room for error, difficulties in coordination Economies of scale Fixed costs (facilities, equipment, management) spread out over more units Volume purchase discounts Diseconomies of scale Worker fatigue, equipment breakdown, less room for error, difficulties in coordination 21

22 Copyright © 2010 by The McGraw-Hill Companies, Inc. All rights reserved. LO 2 Evaluating alternatives Economic considerations Cost, useful life, compatibility, revenue Non economic considerations Public opinion, reactions from employees, community pressure Economic considerations Cost, useful life, compatibility, revenue Non economic considerations Public opinion, reactions from employees, community pressure 22 Techniques used for evaluation: a)Break Even Analysis b)Payback Period c)Net Present Value Techniques used for evaluation: a)Break Even Analysis b)Payback Period c)Net Present Value

23 Copyright © 2010 by The McGraw-Hill Companies, Inc. All rights reserved. LO 3 Break Even Analysis 23

24 Copyright © 2010 by The McGraw-Hill Companies, Inc. All rights reserved. LO 3 Profit Loss Break-Even Analysis 24 Total revenue Total cost Variable cost Fixed cost Break-even point Total revenue = Total cost Amount ($) Q (quantity in units)

25 Copyright © 2010 by The McGraw-Hill Companies, Inc. All rights reserved. LO 3 Example: Break-Even 25 Fixed costs = $40,000 Material = $1.50/unit Labour costs = $3/unit Selling price = $10.00 per unit Q BEP = = = 7273 FC R - VC $40, ( )

26 Copyright © 2010 by The McGraw-Hill Companies, Inc. All rights reserved. LO 3 Example: Break-even Analysis The school cafeteria can make pizza for about $.30 per slice. Cost for kitchen and labour is $200 per day The nearby Pizza Den delivers for $9.00 per pizza (8 slices) Cost for labour reduced to $75 per day Make or Buy? The school cafeteria can make pizza for about $.30 per slice. Cost for kitchen and labour is $200 per day The nearby Pizza Den delivers for $9.00 per pizza (8 slices) Cost for labour reduced to $75 per day Make or Buy? 26

27 Copyright © 2010 by The McGraw-Hill Companies, Inc. All rights reserved. LO 3 Break-Even Problem with Step Fixed Costs 27 Quantity FC + VC = TC Step fixed costs and variable costs. 1 machine 2 machines 3 machines $

28 Copyright © 2010 by The McGraw-Hill Companies, Inc. All rights reserved. LO 3 Multiple break-even points Multiple Break-Even Points 28 $ TC TR Quantity 1 2 3

29 Copyright © 2010 by The McGraw-Hill Companies, Inc. All rights reserved. LO 3 Assumptions of Break Even Analysis One product is involvedEverything produced can be sold Variable cost per unit is the same regardless of volume Fixed costs do not change with volumeRevenue per unit constant with volumeRevenue per unit exceeds variable cost per unit 29

30 Copyright © 2010 by The McGraw-Hill Companies, Inc. All rights reserved. LO 3 Further Financial Analysis Cash Flow (cash received from sales and other sources) -- (cash outflow for labour, material, overhead, taxes) Present Value the sum, in current value, of all future cash flows of an investment proposal. Cash Flow (cash received from sales and other sources) -- (cash outflow for labour, material, overhead, taxes) Present Value the sum, in current value, of all future cash flows of an investment proposal. 30 most used methods of financial analysis: Payback period Net present value (NPV) Internal rate of return (IRR)

31 Copyright © 2010 by The McGraw-Hill Companies, Inc. All rights reserved. LO 1 What is Capacity? Capacity usually refers to the upper limit of: A)inventories B)demand C)supplies D)rate of output E)finances Ans: D Page:

32 Copyright © 2010 by The McGraw-Hill Companies, Inc. All rights reserved. LO 1 What is capacity? Capacity decisions are mostly long term decisions. Ans: False Page: 141 Stating capacity in dollar amounts generally results in a consistent measure of capacity. Ans: False Page:

33 Copyright © 2010 by The McGraw-Hill Companies, Inc. All rights reserved. LO 1 Capacity performance The maximum possible output given a product mix, scheduling difficulties, quality factors, and so on, is: A)utilization B)design capacity C)efficiency D)effective capacity E)available capacity Ans: D Page:

34 Copyright © 2010 by The McGraw-Hill Companies, Inc. All rights reserved. LO 1 Capacity Performance Efficiency is defined as the ratio of: A)actual output to effective capacity B)actual output to design capacity C)design capacity to effective capacity D)effective capacity to actual output E)design capacity to actual output Ans: A Page:

35 Copyright © 2010 by The McGraw-Hill Companies, Inc. All rights reserved. LO 1 Capacity Performance Utilization is defined as the ratio of: A)actual output to effective capacity B)actual output to design capacity C)design capacity to effective capacity D)effective capacity to actual output E)design capacity to actual output Ans: B Page:

36 Copyright © 2010 by The McGraw-Hill Companies, Inc. All rights reserved. Learning Checklist Define capacity and identify some common ways it is measured. Distinguish between efficiency and utilization and be able to calculate them. Describe factors that influence effective capacity. Describe the steps of the strategic capacity planning process. Discuss major considerations for developing capacity alternatives. Use break-even analysis to solve problems. 36


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