Page - Stevenson, Chapter 5, Strategic Capacity Planning

Evaluating Capacity Alternatives (Problems 1 & 3, in class; problems 4 & 5 HW)

Fixed Costs (FC): Rent, insurance, utilities,

Variable Costs (VC): costs to produce

Total Costs (TC) = FC + (VC * Quantity)

Total Revenue (TR) = Revenue * Q

Profit (P) = TR - TC

P= (R * Q) – ((FC +(VC * Q))

P= Q (R – VC) – FC

Quantity for Breakeven Point (QBEP)

QBEP is where TR=TC

QBEP = FC
R - VC

In a capacity decision, would you want to purchase a machine with

a capacity less than QBEP? Why or why not?

Quantity Needed for a specified level of profitability

Q = P + FC
R - VC

How does this relate to capacity decisions?

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Example
Page 192, Number 3

FC = $9,200/month
VC = $.70/unit
Price (Revenue) = $.90/unit

a. determine the volume/month required to breakeven

QBEP = FC
R – VC
= $ 9,200
.90 -.70
= $9,200
.20
= 46,000 pieces of pottery per month

What if the property being considered has a maximum capacity of

40,000 pieces of pottery/month. What is your recommendation?

b. What profit would be realized on a monthly volume of 61,000

pieces? Of 87,000 pieces?

P = Q ( R – VC) – FC
P = 61, 000 (.90-.70) – 9,200
P = 61,000(.20) – 9,200
P = 12,200 – 9,200
P= $3,000

Profit for a volume of 87,000 pieces of pottery

P = Q ( R – VC) – FC
P = 87,000 (.90-.70) – 9,200
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P = 87,000 (.20) – 9,200
P = $17,400 - $9,200
P = $8,200

C. what volume is needed to obtain a profit of $16,000/month

Q = P + FC
R - VC
Q = 16, 000 + 9,200
.90 - .70
Q = 25,200
.20
Q= 126, 000 Units

D. what volume is needed to provide revenue of $23,000 per

month?

TR = R * Q
$23,000 = .90 * Q
23,000 = .90Q
.90 .90
Q= 25, 555.5

E. Plot TC and TR. Where do you get your values for TC and TR?
Pick quantities above and below the breakeven point (46, 000
pieces), such as 10,000, 15,000, 20,000, 50,000 and 60,000 and
solve TC and TR for those quantities. Plot both TC and TR with
quantity on the x-axis and $ on the y-axis.

TC = FC + (VC * Q) TR = R * Q
TC 10,000 pieces = 9,200 + (.70 * 10,000) TR10,000pieces = .90 * 10,000
TC 10,000 pieces = $16,200 TR10,000pieces = $9,000

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At a production quantity of 10,000 pieces, are we making money?
How much?
TC 20,000 pieces = 9,200 + (.70 *20,000) TR 20,000 pieces = .90 * 20,000
TC 20,000 pieces = $23,200 TR 20,000 pieces = $18,000

TC 60,000 pieces = 9,200 + (.70 *60,000) TR 60,000 pieces = .90 * 60,000

TC 60,000 pieces = $51,200 TR 60,000 pieces = $54,000
Total Cost and Total Revenue Plot

70,000 |
|
60,000 |
|
50,000 |
|
40,000 |
|
30,000 |
|
20,000 |
|
10,000 |
|
0 |________________________________________________________________
5 10 15 20 25 30 35 40 45 50

Quantity (in thousands)

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Total Cost and Total Revenue
70000
60000
50000
40000
$

30000
20000
10000
0
10,000 30,000 50,000 70,000
Quantity

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Problem 1

1. Determine the utilization and efficiency for each situation:

Utilization = Actual Output

Design capacity

Efficiency = Actual Output

Effective capacity

a. a loan processing operation that processes an average of 7

loans/day. The operation has a design capacity of 10 loans per day
and an effective capacity of 8 loans/day.

Utilization = 7 loans/day = .70 or 70%

10 loans/day

What could cause the utilization to be less than 100%?

Efficiency = 7 loans/day = .875 or 87.5%

8 loans/day

b. a furnace repair team that services an average of four furnaces a

day if the design capacity is six furnaces a day and the effective
capacity is five furnaces per day.

Utilization = 4 furnaces/day = .6666 or 66.67%

6 furnaces/day

Efficiency = 4 furnaces/day = .80 or 80%

6 furnaces/day

c. Would you say that systems that have higher efficiency ratios
than other systems will always have higher utilization ratios than
other systems? Explain.
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Problem 4

A small firm intends to increase the capacity of a bottleneck

operation by adding a new machine. Two alternatives A & B have
been identified and the costs and revenues associated with each
have been estimated. Annual fixed costs for A would be $40,000
and $30,000 for B; Variable costs per unit would be $10 for A and
$11 for B; and revenue per unit would be $15.

Machine A Machine B
FC = $40,000 FC=$30,000
v=$10 v=$11
R=$15 R=$15

(a) Determine each alternative’s Break-even point in units.

QBEP = FC
R – VC

Machine A Machine B
QBEP = FC QBEP = FC
R – VC R – VC

QBEP = 40,000 QBEP = 30,000

15-10 15 – 11
QBEP = 40,000 QBEP = 30,000
5 4
QBEP = 8,000 units QBEP = 7,500 units

If demand was 7800 units what should you do?

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(b) at what volume of output would the two alternatives yield the
same profit?

Profit = Q ( R - v) - FC
Profit A = Profit B
Q ( R - v) - FC = Q ( R - v) - FC
Q(15-10) - 40,000 = Q(15-11) - 30,000
Q(5) - 40,000 = Q(4) - 30,000
Q =10,000 units

(c) If your expected annual demand is 12,000 units, which

alternative yields higher profit?

Profit A
Profit A = Q ( R - v) - FC
Profit A = 12, 000 ( 15 -10) - 40,000
Profit A = 12,000 (5) - 40,000
Profit A = $20,000

Profit B
Profit B = Q ( R - v) - FC
Profit B = 12,000 (15 - 11) - 30,000
Profit B = 12,000 (4) - 30,000
Profit B = $18,000

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Problem 5

D= 30,000 pens
FC = $25,000
v = $.37

(a). Find the breakeven quantity if pens sell for $1.

R=$1

QBEP = FC
R – VC
QBEP = 25,000
1 – .37
QBEP = 25,000
.63
QBEP = 39,682.53 Can you have .53 of a pen? Which direction
should you round?

(b) At what price must pens be sold to obtain a monthly profit of

$15,000 assuming estimated demand materializes? (What variable
are you going to solve for?)
Profit = Q ( R - v) - FC
$15,000 = 30,000 ( R -$.37) - $25,000
$15,000 = 30,000R - 11,100 - 25,000
$15,000 = 30,000R - 36,100
$51,100 = 30,000R
51,100 = 30,000R
30,000 30,000
1.70333=R
How do you handle the decimal places? If you charged $1.70 per pen
would you yield a monthly profit of $15,000? What should the selling
price be?

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