BM1710

CAPACITY PLANNING
Capacity
Capacity is the “throughput”, or the number of units a facility can hold, receive, store, or produce in a given
time. Capacity decisions often determine capital requirements and therefore a large portion of fixed cost.
Capacity also determines whether demand will be satisfied or whether facilities will be idle. If a facility is too
large, portions of it will sit unused and add cost to existing production. If a facility is too small, customers—
and perhaps the entire market—will be lost. Determining facility size, with an objective of achieving high
levels of utilization and a high return on investment, is critical (Heizer, Render, & Munson, 2017).
Design and Effective Capacity
Design capacity is the maximum theoretical output of a system in a given period under ideal conditions.
It is normally expressed as a rate, such as the number of tons of steel that can be produced per week,
per month, or per year. For many companies, measuring capacity can be straightforward: it is the
maximum number of units the company is capable of producing in a specific time. However, for some
organizations, determining capacity can be more difficult. Capacity can be measured in terms of beds (a
hospital), active members (a church), or billable hours (a CPA firm). Other organizations use total work
time available as a measure of overall capacity.
EXAMPLE: Ian’s Bistro has tables set with two (2) or four (4) chairs seating a total of 270 guests, but
the tables are never filled that way. Some tables will have one (1) or three (3) guests; tables can be
pulled together for parties of six (6) or eight (8). There are always unused chairs.
Effective capacity is the capacity a firm expects to achieve given the current operating constraints.
Effective capacity is often lower than design capacity because the facility may have been designed for
an earlier version of the product or a different product mix that is currently being produced.
Utilization and efficiency are the two (2) useful measures of system performance. Utilization is simply the
percent of the achieved design capacity. Efficiency, on the other hand, is the percent of the achieved
effective capacity. Depending on how facilities are used and managed, it may be difficult or impossible to
reach 100% efficiency. Operations managers tend to be evaluated on efficiency. The key to improve
efficiency is often found in correcting quality problems and in effective scheduling, training, and
maintenance. The formulas for utilization and efficiency are as follows (Heizer, Render, & Munson, 2017):
𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴 𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂
𝑼𝑼𝑼𝑼𝑼𝑼𝑼𝑼𝑼𝑼𝑼𝑼𝑼𝑼𝑼𝑼𝑼𝑼𝑼𝑼𝑼𝑼 = × 100
𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷 𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶
𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴 𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂
𝑬𝑬𝑬𝑬𝑬𝑬𝑬𝑬𝑬𝑬𝑬𝑬𝑬𝑬𝑬𝑬𝑬𝑬𝑬𝑬 = × 100
𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸 𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶

Case:
Sara James Bakery has a plant for processing Deluxe breakfast rolls and wants to better understand its
capability. Last week, the facility produced 148,000 rolls. The effective capacity is 175,000 rolls. The
production line operates seven (7) days per week, with three (3) eight-hour shifts per day. The line was
designed to process the nut-filled, cinnamon-flavored Deluxe roll at a rate of 1,200 per hour. Determine
the design capacity, utilization, and efficiency for this plant when producing this Deluxe roll.

Solution:
𝑫𝑫𝑫𝑫𝑫𝑫𝑫𝑫𝑫𝑫𝑫𝑫 𝑪𝑪𝑪𝑪𝑪𝑪𝑪𝑪𝑪𝑪𝑪𝑪𝑪𝑪𝑪𝑪 = (7 days × 3 shifts × 8 hours) × (1,200 rolls per hour) = 201, 600 rolls
𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴 𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂 148,000
𝑼𝑼𝑼𝑼𝑼𝑼𝑼𝑼𝑼𝑼𝑼𝑼𝑼𝑼𝑼𝑼𝑼𝑼𝑼𝑼𝑼𝑼 = × 100 = × 100 = 73.41%
𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷 𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶 201,600

06 Handout 1 *Property of STI

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 BM1710

𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴 𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂 148,000

𝑬𝑬𝑬𝑬𝑬𝑬𝑬𝑬𝑬𝑬𝑬𝑬𝑬𝑬𝑬𝑬𝑬𝑬𝑬𝑬 = × 100 = × 100 = 84.57%
𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸 𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶 175,000

Break-even Analysis
Break-even analysis is the critical tool for determining the capacity a facility must have in order to achieve
profitability. The objective of break-even analysis is to find the point, in pesos and units, at which costs
equal revenue. This point is the break-even point. Firms must operate above this level to achieve
profitability.
Fixed costs are costs that continue even if no units are produced. Examples include depreciation, taxes,
debt, and mortgage payments. Variable costs are those that vary with the volume of units produced. The
major components of variable costs are labor and materials. However, other costs such as the portion of
the utilities that varies with volume are also variable costs. The difference between selling price and variable
cost is in the contribution. Only when total contribution exceeds total fixed cost will there be profit (Heizer,
Render, & Munson, 2017).
The break-even point occurs where total revenue equals total costs. Therefore,
𝑇𝑇𝑇𝑇 = 𝑇𝑇𝑇𝑇 or 𝑃𝑃𝑃𝑃 = 𝐹𝐹 + 𝑉𝑉𝑉𝑉.
Two (2) break-even and one (1) profit formula:

𝐹𝐹 𝐹𝐹
𝑩𝑩𝑩𝑩𝑷𝑷𝒙𝒙 = 𝑩𝑩𝑩𝑩𝑷𝑷₱ =
𝑉𝑉
𝑃𝑃 − 𝑉𝑉 1 − 𝑃𝑃
𝑷𝑷𝑷𝑷𝑷𝑷𝑷𝑷𝑷𝑷𝑷𝑷 = 𝑇𝑇𝑇𝑇 − 𝑇𝑇𝑇𝑇
= 𝑃𝑃𝑃𝑃 − (𝐹𝐹 + 𝑉𝑉𝑉𝑉)
= 𝑃𝑃𝑃𝑃 − 𝐹𝐹 − 𝑉𝑉𝑉𝑉
= (𝑃𝑃 − 𝑉𝑉)𝑥𝑥 − 𝐹𝐹
Let:
𝐵𝐵𝐵𝐵𝑃𝑃𝑥𝑥 be the break-even point in units 𝑇𝑇𝑇𝑇 be the total revenue (also 𝑃𝑃𝑃𝑃)
𝐵𝐵𝐵𝐵𝑃𝑃₱ be the break-even point in peso 𝐹𝐹 be the fixed costs
𝑃𝑃 be the price per unit (after all discounts) 𝑉𝑉 be the variable costs per unit
𝑥𝑥 be the number of units produced 𝑇𝑇𝑇𝑇 be the total costs

Single-Product Case:
Stephens, Inc. has determined that their new facility has fixed costs of ₱50,000 this period. The direct
labor is ₱7.50 per unit, the material is ₱3.75 per unit, and the selling price is ₱20.00 per unit. Determine
the minimum peso volume and unit volume needed at the new facility to break even.

Solution:
𝐹𝐹 50,000 50,000 50,000
𝑩𝑩𝑩𝑩𝑷𝑷𝑷𝑷𝑷𝑷𝑷𝑷 = = = = = ₱114,285.71
𝑉𝑉 7.50 + 3.75 1 − 0.5625 0.4375
1 − 𝑃𝑃 1 − � 20.00 �

For multiproduct cases such as manufacturers and restaurants who offer various products/services, each
offer may have a different selling price and variable cost. Thus, the equation is modified to reflect the
proportion of sales for each product by weighting each product’s contribution by its proportion of sales.

06 Handout 1 *Property of STI

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 BM1710

𝐹𝐹
𝑩𝑩𝑩𝑩𝑷𝑷𝑷𝑷𝑷𝑷𝑷𝑷 =
𝑉𝑉
Σ ��1 − 𝑖𝑖 � × 𝑊𝑊𝑖𝑖 �
𝑃𝑃𝑖𝑖
Let:
𝑉𝑉 be the variable costs per unit 𝑊𝑊 be the percent each product is of total
𝑃𝑃 be the price per unit (after all discounts) peso sales
𝐹𝐹 be the fixed costs 𝑖𝑖 be each product

Multiproduct Case:
Le Bistro, like most other restaurants, makes more than one (1) product and would like to know its break-even point in
peso. Fixed costs are ₱45,000 per month.
Annual 𝑽𝑽𝒊𝒊 𝑽𝑽𝒊𝒊 Annual 𝑽𝑽𝒊𝒊
Variable % of
Item Forecasted Price 𝟏𝟏 − Forecasted �𝟏𝟏 − � × 𝑾𝑾𝒊𝒊
Sales Units
Cost 𝑷𝑷𝒊𝒊 𝑷𝑷𝒊𝒊 Sales
Sales(𝑾𝑾𝒊𝒊 ) 𝑷𝑷𝒊𝒊
Sandwich 9,000 ₱100.00 ₱60.00 0.60 0.40 ₱900,000 0.508 0.203
Drinks 9,000 50.00 15.00 0.30 0.60 450,000 0.254 0.178
Baked Potato 7,000 60.00 30.00 0.50 0.50 420,000 0.237 0.119
₱1,770,000 1.000 0.500

Solution:
𝐹𝐹 45,000 × 12 months
𝑩𝑩𝑩𝑩𝑷𝑷𝑷𝑷𝑷𝑷𝑷𝑷 = = = ₱1,080,000.00
𝑉𝑉𝑖𝑖 0.5
Σ ��1 − � × 𝑊𝑊𝑖𝑖 �
𝑃𝑃𝑖𝑖
₱1,080,000
𝑻𝑻𝑻𝑻𝑻𝑻𝑻𝑻𝑻𝑻 𝒅𝒅𝒅𝒅𝒅𝒅𝒅𝒅𝒅𝒅 𝒔𝒔𝒔𝒔𝒔𝒔𝒔𝒔𝒔𝒔 = = ₱3,461.54
312 days
Note: This means that Le Bistro must average sales of ₱3,461.54 per day to break even. Thus, if forecasted
sales of ₱1,770,000 is correct, Le Bistro will earn money, as break-even is at ₱1,080,000.

Expected Monetary Value

𝑬𝑬𝑬𝑬𝑽𝑽𝒂𝒂𝒂𝒂𝒂𝒂𝒂𝒂𝒂𝒂𝒂𝒂𝒂𝒂𝒂𝒂𝒂𝒂𝒂𝒂𝒂𝒂 𝒊𝒊 = (𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃 𝑜𝑜𝑜𝑜 1𝑠𝑠𝑠𝑠 𝑠𝑠𝑠𝑠𝑠𝑠𝑠𝑠𝑠𝑠 𝑜𝑜𝑜𝑜 𝑛𝑛𝑛𝑛𝑛𝑛𝑛𝑛𝑛𝑛𝑛𝑛) × (𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃 𝑜𝑜𝑜𝑜 1𝑠𝑠𝑠𝑠 𝑠𝑠𝑠𝑠𝑠𝑠𝑠𝑠𝑠𝑠 𝑜𝑜𝑜𝑜 𝑛𝑛𝑛𝑛𝑛𝑛𝑛𝑛𝑛𝑛𝑛𝑛)
+. . . +(𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃 𝑜𝑜𝑜𝑜 2𝑛𝑛𝑛𝑛 𝑠𝑠𝑠𝑠𝑠𝑠𝑠𝑠𝑠𝑠 𝑜𝑜𝑜𝑜 𝑛𝑛𝑛𝑛𝑛𝑛𝑛𝑛𝑛𝑛𝑛𝑛) × (𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃 𝑜𝑜𝑜𝑜 2𝑛𝑛𝑛𝑛 𝑠𝑠𝑠𝑠𝑠𝑠𝑠𝑠𝑠𝑠 𝑜𝑜𝑜𝑜 𝑛𝑛𝑛𝑛𝑛𝑛𝑛𝑛𝑛𝑛𝑛𝑛)
+. . . +(𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃 𝑜𝑜𝑜𝑜 𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙 𝑜𝑜𝑜𝑜 𝑛𝑛𝑛𝑛𝑛𝑛𝑛𝑛𝑛𝑛𝑛𝑛) × (𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃 𝑜𝑜𝑜𝑜 𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙 𝑠𝑠𝑠𝑠𝑠𝑠𝑠𝑠𝑠𝑠 𝑜𝑜𝑜𝑜 𝑛𝑛𝑛𝑛𝑛𝑛𝑛𝑛𝑛𝑛𝑛𝑛)
Case: EMV applied to Southern Hospital Supplies

Southern Hospital Supplies, a company that makes hospital gowns, is considering capacity expansion.

The hospital’s major alternatives are to do nothing, build a small plant, build a medium plant, or build a
large plant. The new facility would produce a new type of gown, and currently the potential or
marketability for this product is unknown. If a large plant is built and a favorable market exists, a profit of
₱100,000 could be realized. An unfavorable market would yield a ₱90,000 loss. However, a medium
plant would earn a ₱60,000 profit with a favorable market. A ₱10,000 loss would result from an
unfavorable market. A small plant, on the other hand, would return ₱40,000 with favorable market
conditions and lose only ₱5,000 in an unfavorable market. Of course, there is always the option of doing
nothing.

Recent market research indicates that there is a .4 probability of a favorable market, which means that
there is also a .6 probability of an unfavorable market. With this information, the alternative that will result
in the highest expected monetary value (EMV) can be selected.

06 Handout 1 *Property of STI

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 BM1710

Solution:
Find the expected monetary value of each alternative by multiplying the probability of occurrence for
each state of nature by the payoff for that state of nature and summing them.
𝑬𝑬𝑬𝑬𝑽𝑽𝒍𝒍𝒍𝒍𝒍𝒍𝒍𝒍𝒍𝒍 𝒑𝒑𝒑𝒑𝒑𝒑𝒑𝒑𝒑𝒑 = 0.4(100,000) + 0.6(−90,000) = −14,000
𝑬𝑬𝑬𝑬𝑽𝑽𝒎𝒎𝒎𝒎𝒎𝒎𝒎𝒎𝒎𝒎𝒎𝒎 𝒑𝒑𝒑𝒑𝒑𝒑𝒑𝒑𝒑𝒑 = 0.4(60,000) + 0.6(−10,000) = 18,000
𝑬𝑬𝑬𝑬𝑽𝑽𝒔𝒔𝒔𝒔𝒔𝒔𝒔𝒔𝒔𝒔 𝒑𝒑𝒑𝒑𝒑𝒑𝒑𝒑𝒑𝒑 = 0.4(40,000) + 0.6(−5,000) = 13,000
𝑬𝑬𝑬𝑬𝑽𝑽𝒅𝒅𝒅𝒅 𝒏𝒏𝒏𝒏𝒏𝒏𝒏𝒏𝒏𝒏𝒏𝒏𝒏𝒏 = 0

Note: Based on EMV criteria, Southern should build a medium plant.

Net Present Value

𝑭𝑭𝒗𝒗 = 𝑃𝑃𝑣𝑣 (1 + 𝑖𝑖)𝑛𝑛

Let:

𝐹𝐹𝑣𝑣 be the future value

𝑃𝑃𝑣𝑣 be the present value
𝑖𝑖 be the interest rate
𝑛𝑛 be the number of years

In most investment decisions, however, most companies are interested in calculating the present value of
a series of future cash receipts. Solving for 𝑃𝑃𝑣𝑣 ,
𝐹𝐹
𝑣𝑣
𝑷𝑷𝒗𝒗 = (1+𝑖𝑖) 𝑛𝑛 .

REFERENCES:
Heizer, J., Render, B., & Munson, C. (2017). Operations management: Sustainability and supply chain
management (12th ed.). Boston: Pearson Education Inc.
Krajewski, L. J., Malhotra, M. K., & Ritzman, L. P. (2016). Operations management: Processes and supply
chains (11th ed.). Essex: Pearson Education Limited.
Stevenson, W. J. (2015). Operations management (12th ed.). New York: McGraw Hill Education.

06 Handout 1 *Property of STI

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