© 2006 Prentice Hall, Inc.S7 – 1 Capacity Planning © 2006 Prentice Hall, Inc.

S7 – 2 Capacity  The throughput, or the number of units a facility can hold, receive, store, or produce in a period of time  Determines fixed costs  Determines if demand will be satisfied  Three time horizons

© 2006 Prentice Hall, Inc.S7 – 3 Modify capacity Use capacity Planning Over a Time Horizon Intermediate- range planning SubcontractAdd personnel Add equipmentBuild or use inventory Add shifts Short-range planning Schedule jobs Schedule personnel Allocate machinery * Long-range planning Add facilities Add long lead time equipment * Figure S7.1

© 2006 Prentice Hall, Inc.S7 – 4 Design and Effective Capacity  Design capacity is the maximum theoretical output of a system  Normally expressed as a rate  Effective capacity is the capacity a firm expects to achieve given current operating constraints  Often lower than design capacity

© 2006 Prentice Hall, Inc.S7 – 5 Utilization and Efficiency Utilization is the percent of design capacity achieved Efficiency is the percent of effective capacity achieved Utilization = Actual Output/Design Capacity Efficiency = Actual Output/Effective Capacity

© 2006 Prentice Hall, Inc.S7 – 6 Bakery Example Actual production last week = 148,000 rolls Effective capacity = 175,000 rolls Design capacity = 1,200 rolls per hour Bakery operates 7 days/week, 3 – ‘8 hour shifts’ Design capacity = (7 x 3 x 8) x (1,200) = 201,600 rolls

© 2006 Prentice Hall, Inc.S7 – 7 Bakery Example Actual production last week = 148,000 rolls Effective capacity = 175,000 rolls Design capacity = 1,200 rolls per hour Bakery operates 7 days/week, 3 – ‘8 hour shifts’ Design capacity = (7 x 3 x 8) x (1,200) = 201,600 rolls

© 2006 Prentice Hall, Inc.S7 – 8 Bakery Example Actual production last week = 148,000 rolls Effective capacity = 175,000 rolls Design capacity = 1,200 rolls per hour Bakery operates 7 days/week, 3 – ‘8 hour shifts’ Design capacity = (7 x 3 x 8) x (1,200) = 201,600 rolls Utilization = 148,000/201,600 = 73.4%

© 2006 Prentice Hall, Inc.S7 – 9 Bakery Example Actual production last week = 148,000 rolls Effective capacity = 175,000 rolls Design capacity = 1,200 rolls per hour Bakery operates 7 days/week, 3 – ‘8 hour shifts’ Design capacity = (7 x 3 x 8) x (1,200) = 201,600 rolls Utilization = 148,000/201,600 = 73.4%

© 2006 Prentice Hall, Inc.S7 – 10 Bakery Example Actual production last week = 148,000 rolls Effective capacity = 175,000 rolls Design capacity = 1,200 rolls per hour Bakery operates 7 days/week, 3 – ‘8 hour shifts’ Design capacity = (7 x 3 x 8) x (1,200) = 201,600 rolls Utilization = 148,000/201,600 = 73.4% Efficiency = 148,000/175,000 = 84.6%

© 2006 Prentice Hall, Inc.S7 – 11 Bakery Example Actual production last week = 148,000 rolls Effective capacity = 175,000 rolls Design capacity = 1,200 rolls per hour Bakery operates 7 days/week, 3 – ‘8 hour shifts’ Design capacity = (7 x 3 x 8) x (1,200) = 201,600 rolls Utilization = 148,000/201,600 = 73.4% Efficiency = 148,000/175,000 = 84.6%

© 2006 Prentice Hall, Inc.S7 – 12 Bakery Example Actual production last week = 148,000 rolls Effective capacity = 175,000 rolls Design capacity = 1,200 rolls per hour Bakery operates 7 days/week, 3 – ‘8 hour shifts’ Efficiency = 84.6% Efficiency of new line = 75% Expected Output = (Effective Capacity)(Efficiency) = (175,000)(.75) = 131,250 rolls

© 2006 Prentice Hall, Inc.S7 – 13 Bakery Example Actual production last week = 148,000 rolls Effective capacity = 175,000 rolls Design capacity = 1,200 rolls per hour Bakery operates 7 days/week, three- ‘8 hour shifts’ Efficiency = 84.6% Efficiency of new line = 75% Expected Output = (Effective Capacity)(Efficiency) = (175,000)(.75) = 131,250 rolls

© 2006 Prentice Hall, Inc.S7 – 14 Managing Demand  Demand exceeds capacity  limit demand by raising prices, scheduling longer lead time  Long term solution is to increase capacity  Capacity exceeds demand  motivate marketing  Product changes  Adjusting to seasonal demands  Produce products with complimentary demand patterns

© 2006 Prentice Hall, Inc.S7 – 15 Capacity Considerations  Forecast demand accurately  Understanding the technology and capacity increments  Find the optimal operating level (volume)  Build for change

© 2006 Prentice Hall, Inc.S7 – 16 Approaches to Capacity Expansion (a)Leading demand with incremental expansion Demand Expected demand New capacity (b)Leading demand with one-step expansion Demand New capacity Expected demand (d)Attempts to have an average capacity with incremental expansion Demand New capacity Expected demand (c)Capacity lags demand with incremental expansion Demand New capacity Expected demand Figure S7.4

© 2006 Prentice Hall, Inc.S7 – 17 Break-Even Analysis  Technique for evaluating process and equipment alternatives  Objective is to find the point in dollars and units at which cost equals revenue  Requires estimation of fixed costs, variable costs, and revenue

© 2006 Prentice Hall, Inc.S7 – 18 BREAK EVEN ANALYSIS BREAK EVEN ANALYSIS It refers to the ascertainment of level of operations where total revenue equals to total costs.It refers to the ascertainment of level of operations where total revenue equals to total costs. Analytical tool to determine probable level of operation.Analytical tool to determine probable level of operation. Method of studying the relationship among sales, revenue, variable cost, fixed cost to determine the level of operation at which all the costs are equal to the sales revenue and there is no profit and no loss situation.Method of studying the relationship among sales, revenue, variable cost, fixed cost to determine the level of operation at which all the costs are equal to the sales revenue and there is no profit and no loss situation. Important techniques is profit planning and managerial decision making.Important techniques is profit planning and managerial decision making.

© 2006 Prentice Hall, Inc.S7 – 19 Break-Even Analysis  Fixed costs are costs that continue even if no units are produced  Depreciation, taxes, debt, credit payments  Variable costs are costs that vary with the volume of units produced  Labor, materials, portion of utilities  Contribution is the difference between selling price and variable cost

© 2006 Prentice Hall, Inc.S7 – 20 COSTS VARIABLE COSTS FIXED COSTS Raw materialsRaw materials ComponentsComponents Direct labourDirect labour Overheads, i.e. property costsproperty costs salarysalary admin costsadmin costs

© 2006 Prentice Hall, Inc.S7 – 21 Break-Even Analysis  Costs and revenue are linear functions  Generally not the case in the real world  We actually know these costs  Very difficult to accomplish Assumptions

© 2006 Prentice Hall, Inc.S7 – 22 Profit corridor Loss corridor Break-Even Analysis Total revenue line Total cost line Variable cost Fixed cost Break-even point Total cost = Total revenue – – – – – – – – – – – |||||||||||| Cost Volume (units per period) Figure S7.5

© 2006 Prentice Hall, Inc.S7 – 23 Break-Even Analysis BEP x =Break-even point in units BEP $ =Break-even point in dollars P=Price per unit x=Number of units produced TR=Total revenue = Px F=Fixed costs V=Variable costs per unit TC=Total costs = F + Vx TR = TC or Px = F + Vx Break-even point occurs when BEP x = F P - V

© 2006 Prentice Hall, Inc.S7 – 24 Break-even formula Break-even point = Fixed costs Selling price (per unit) – variable cost (per unit)

© 2006 Prentice Hall, Inc.S7 – 25

© 2006 Prentice Hall, Inc.S7 – 26 DEFINATIONS USED IN BREAK EVEN POINT- DEFINATIONS USED IN BREAK EVEN POINT- Fixed Cost: The sum of all costs required to produce the first unit of a product. This amount does not vary as production increases or decreases, until new capital expenditures are needed.Fixed Cost: The sum of all costs required to produce the first unit of a product. This amount does not vary as production increases or decreases, until new capital expenditures are needed. Variable Unit Cost: Costs that vary directly with the production of one additional unit.Variable Unit Cost: Costs that vary directly with the production of one additional unit. Expected Unit Sales: Number of units of the product projected to be sold over a specific period of time.Expected Unit Sales: Number of units of the product projected to be sold over a specific period of time. Unit Price: The amount of money charged to the customer for each unit of a product or service.Unit Price: The amount of money charged to the customer for each unit of a product or service.

© 2006 Prentice Hall, Inc.S7 – 27 DEFINATIONS CONT DEFINATIONS CONT Total Variable Cost: The product of expected unit sales and variable unit cost. (Expected Unit Sales * Variable Unit Cost )Total Variable Cost: The product of expected unit sales and variable unit cost. (Expected Unit Sales * Variable Unit Cost ) Total Cost: The sum of the fixed cost and total variable cost for any given level of production. (Fixed Cost + Total Variable Cost )Total Cost: The sum of the fixed cost and total variable cost for any given level of production. (Fixed Cost + Total Variable Cost ) Total Revenue: The product of expected unit sales and unit price. (Expected Unit Sales * Unit Price )Total Revenue: The product of expected unit sales and unit price. (Expected Unit Sales * Unit Price ) Profit (or Loss): The monetary gain (or loss) resulting from revenues after subtracting all associated costs. (Total Revenue - Total Costs)Profit (or Loss): The monetary gain (or loss) resulting from revenues after subtracting all associated costs. (Total Revenue - Total Costs)

© 2006 Prentice Hall, Inc.S7 – 28 Break-Even Example Fixed costs = $10,000 Material = $.75/unit Direct labor = $1.50/unit Selling price = $4.00 per unit BEP $ = = F 1 - (V/P) $10, [( )/(4.00)] = = $22, $10, BEP x = = = 5,714 F P - V $10, ( )

© 2006 Prentice Hall, Inc.S7 – 29 Break-Even Example Fixed costs = $10,000 Material = $.75/unit Direct labor = $1.50/unit Selling price = $4.00 per unit

© 2006 Prentice Hall, Inc.S7 – 30 Break-Even Example Fixed costs = $10,000 Material = $.75/unit Direct labor = $1.50/unit Selling price = $4.00 per unit BEP x = = = 5,714 F P - V $10, ( )

© 2006 Prentice Hall, Inc.S7 – 31 Break-Even Analysis BEP x =Break-even point in units BEP $ =Break-even point in dollars P=Price per unit x=Number of units produced TR=Total revenue = Px F=Fixed costs V=Variable costs TC=Total costs = F + Vx BEP $ = BEP x P = P ==F (P - V)/P F P - V F 1 - V/P Profit= TR - TC = Px - (F + Vx) = Px - F - Vx = (P - V)x - F

© 2006 Prentice Hall, Inc.S7 – 32 Break-Even Example BEP $ = F ∑ 1 - x (W i ) ViViPiPiViViPiPi Multiproduct Case whereV= variable cost per unit P= price per unit F= fixed costs W= percent each product is of total dollar sales i= each product

© 2006 Prentice Hall, Inc.S7 – 33 DEPENDENCE DEPENDENCE 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 projected sales.]The product's expected unit sales [sometimes called projected sales.] On the surface, break-even analysis is a tool to calculate at which sales volume the variable and fixed costs of producing your product will be recovered. Another way to look at it is that the break-even point is the point at which your product stops costing you money to produce and sell, and starts to generate a profit for your company.On the surface, break-even analysis is a tool to calculate at which sales volume the variable and fixed costs of producing your product will be recovered. Another way to look at it is that the break-even point is the point at which your product stops costing you money to produce and sell, and starts to generate a profit for your company. It can also use break even analysis to solve managerial problems.It can also use break even analysis to solve managerial problems.

© 2006 Prentice Hall, Inc.S7 – 34 ADVANTAGE ADVANTAGE It is cheap to carry out and it can show the profits/losses at varying levels of output.It is cheap to carry out and it can show the profits/losses at varying levels of output. It provides a simple picture of a business - a new business will often have to present a break-even analysis to its bank in order to get a loan.It provides a simple picture of a business - a new business will often have to present a break-even analysis to its bank in order to get a loan.

© 2006 Prentice Hall, Inc.S7 – 35 LIMITATIONS LIMITATIONS Break-even analysis is only a supply side (i.e. costs only) analysis, as it tells you nothing about what sales are actually likely to be for the product at these various prices.Break-even analysis is only a supply side (i.e. costs only) analysis, as it tells you nothing about what sales are actually likely to be for the product at these various prices. It assumes that fixed costs (FC) are constantIt assumes that fixed costs (FC) are constant It assumes average variable costs are constant per unit of output, at least in the range of likely quantities of sales. (i.e. linearity)It assumes average variable costs are constant per unit of output, at least in the range of likely quantities of sales. (i.e. linearity) It assumes that the quantity of goods produced is equal to the quantity of goods sold (i.e., there is no change in the quantity of goods held in inventory at the beginning of the period and the quantity of goods held in inventory at the end of the period).It assumes that the quantity of goods produced is equal to the quantity of goods sold (i.e., there is no change in the quantity of goods held in inventory at the beginning of the period and the quantity of goods held in inventory at the end of the period). In multi-product companies, it assumes that the relative proportions of each product sold and produced are constant (i.e., the sales mix is constant).In multi-product companies, it assumes that the relative proportions of each product sold and produced are constant (i.e., the sales mix is constant).

© 2006 Prentice Hall, Inc.S7 – 36 THANKS !