2-7 Capacity Planning Break Even Decision Tree For Sharing

Capacity Planning
Module 2: Strategic Decisions
• Planning and designing product / services
• QFD
• Facility location: factor rating, load-distance, center of gravity / median
• Facility layout: Assembly Line Balancing, block diagramming
• Capacity planning & management: break-even, decision tree
• Project management: PERT / CPM
2
Dr. Tapas Bhattacharya, Amity Business School
MBA (M&S), 2 Semester, Batch 2024
Capacity Planning
Capacity is the upper limit or ceiling on the load that an operating

unit can handle.
• Capacity also includes

– Equipment
– Space
– Employee skills
• The basic questions in capacity handling are:

– What kind of capacity is needed?
– How much is needed?
– When is it needed?
3
Basic questions in Capacity Planning
What kind of capacity • Depends on products / services that management

is needed? intend to provide
How much is needed? • The volume and certainty of anticipated demand

• Strategic objectives in terms of growth, customer
service and competitions
• The cost of expansion and operation
• The dimension of capacity – Long range, Intermediate
range or short range
When is it needed? • Capacity lead strategy

• Capacity lag strategy
• Average capacity strategy
4
Capacity Planning Process
Develop Quantitative
Forecast
Alternative Factors
Demand
Plans (e.g., Cost)
Compute Evaluate Qualitative

Rated Capacity Factors
Capacity Plans (e.g., Skills)
Compute Select Best

Implement
Needed Capacity
Best Plan
Capacity Plan
5
Types of planning over a time horizon
Long Range Planning

Strategic or long Add Facilities
range planning Add long lead time equipment *
Intermediate Range or
Tactical Planning Sub-Contract Add Personnel
Intermediate Add Equipment Build or Use Inventory
Add Shifts
range planning
Short Range Planning

Operational or Schedule Jobs
short range
planning
* Schedule Personnel
Allocate Machinery
Modify Capacity Use Capacity

*Limited options exist
6
Importance of capacity decisions
• Impact ability to meet future demands
• Affects operating costs
• Major determinant of initial costs
• Involves long-term commitment
• Affects competitiveness
• Affects ease of management
• Globalization adds complexity
• Impacts long range planning
7
Definition and measures of capacity
Capacity • The “throughput,” or number of units a facility can hold,

receive, store, or produce in a period of time.
Effective • Capacity a firm can expect to receive given its product

capacity mix, methods of scheduling, maintenance, and
standards of quality.
Utilization
• Actual output as a percent of design capacity
Efficiency • Actual output as a percent of effective capacity
8
Some formulae and calculations: Utilization
Measure of planned or actual capacity usage of

a facility, work center, or machine
Actual Output
Utilization =
Design Capacity
Planned hours to be used
=
Total hours available
9
Some formulae and calculations: Efficiency
Measure of how well a facility or machine is

performing when used
Actual output
Efficiency =
Effective Capacity
Actual output in units
=
Standard output in units
Average actual time
=
Standard time
10
Example calculations
11
Steps for Capacity Planning
Can be long-term (e.g., facility size,
trends etc.) or short-term (variations
from seasonality or random
• Forecasting capacity requirements fluctuations in demand
• Evaluate existing capacity, and calculate processing requirements

Concepts of “economies of scale” and
• Identify alternatives “experience curve” come into play
• Evaluate alternatives Several methods used for analysis:

• Cost volume analysis (break-even point)
• Assess key qualitative issues • Financial analysis (cash flow, present value)
• Decision theory
• Select one alternative • Waiting line analysis
• Implement alternative chosen
• Monitor results
12
Two key concepts in Capacity Planning..
..before we dig into Break even analysis
Economies and
Experience Curve
diseconomies of scale
• Example: How many rooms should a • Example: What cost per unit to expect in
hotel have? a manufacturing plant?
– Too few hotel rooms, and the fixed costs of – First few units of production incur higher costs –
construction, reception, staff is spread over too more defects, slower workers, higher work time
few rooms – With experience over course of time, learning in
– Too many rooms, and there are extra rooms that the process leads to higher efficiency and lower
are not occupied, or needs additional staff costs
13
Break Even Analysis
• Technique for evaluating process & equipment alternatives.

• Objective: to find the point ( price or units) at which the total costs
equals total revenue.
• Assumptions :
– Revenue and costs are related linearly to volume
– All information is known with certainty
– No time value of money
• Two Costs are considered :
– Fixed Costs : costs that are incurred even if no unit is produced e.g.
depreciation, taxes, debt, mortgage payments, capital cost etc.
– Variable costs : costs that vary with the volume of units produced e.g.
labor cost, materials, portion of utilities etc
14
Break Even chart
Total revenue line

Breakeven point Profit
Total cost = Total revenue
Cost in Dollars
Total cost line
Variable cost
Loss Fixed cost
Volume (units/period)
15
Break Even Analysis: Formulae
BEP (Units) = TFC . BEP (Price) = TFC .

P - VC 1 – VC/P
TFC = Total Fixed Cost TFC = Total Fixed Cost
VC = Unit Variable Cost VC = Unit Variable Cost
P = Unit Selling Price P = Unit Selling Price
16
Break even analysis is Cost-Volume analysis
Key assumptions of cost-volume analysis
• One product is involved
• Everything produced can be sold
• Variable cost per unit is the same regardless of volume
• Fixed costs do not change with volume
• Revenue per unit constant with volume
• Revenue per unit exceeds variable cost per unit
17
Cost Volume Relationships (1 / 3)
18
19
20
Break Even Analysis: Example
A new process costs $10,000 to set up. The revenue earned is $25,000 per
1000 units sold. The variable cost is $22.50 per unit.
Calculate BEP(x) and BEP($).
BEP (x) = TFC . BEP ($) = TFC .

P - VC 1 - VC/P
TFC = 10000 Variable Cost per unit = $22.50

No. of units sold = 1000 Price per unit = 25000 / 1000 = $25
Therefore,
BEP(x) = 10000 / 25 – 22.50 BEP($) =10000 / 1 – 22.5/25

= 10000 / 2.50 = 10000 / 1 – 0.9
= 4000 Nos. = $100,000
21
Decision Tree
• Graphical depiction of all the possibilities or outcomes to solve a specific

issue or avail a potential opportunity.
• It is a widely used technique

for taking crucial decisions :
– project selection,
– cost management,
– operations management,
– production method, and
– to deal with various other
strategic issues in an
organization.
22
Steps in Decision Tree Analysis
1 2 3 4 5
Figure out
Determine
Draft a Put in Expected
and allocate
Define the decision relevant Monetary
payoffs for
decision making tree with all data with Value
each
problem possible probable (EMV) for
possible
outcomes values every
outcome
possibility
23
Decision Tree Analysis: Example 1
A glass factory specializing in crystal is experiencing substantial backlog, and the firm’s
management is considering three courses of action :
i. Arrange for sub-contracting
ii. Construct new facilities
iii. Do nothing (no change)
The correct choice depends largely on demand, which may be low, medium or high. By
consensus , management estimates the respective demand probabilities as 0.1, 0.5 and
0.4 respectively.
The management also estimates the profits when choosing from the three alternatives
(A, B & C) under the different probable levels of demand. These profits are in
thousands of Rupees as presented in the table below :
PROBABILITIES
ALTERNATIVES
0.1 0.5 0.4
A 10 50 90
B -120 25 200
C 20 40 60
24
Step 1 : Start by drawing the three decisions

ALTERN
PROBABILITIES
ATIVES
0.1 0.5 0.4
A 10 50 90
B -120 25 200
C 20 40 60
25
Step 2: Add the possible states of nature, probabilities and payoffs.

ALTERN
PROBABILITIES
ATIVES
0.1 0.5 0.4
A 10 50 90
B -120 25 200 HIGH DEMAND (0.4) 90

C 20 40 60
MEDIUM DEMAND (0.5) 50
LOW DEMAND (0.1) 10
A
HIGH DEMAND (0.4) 200

B LOW DEMAND (0.1) -120

C
LOW DEMAND (0.1)
20
26

LOW DEMAND (0.1) 10
A
Calculations
HIGH DEMANDfor A
(0.4)
High
MEDIUM :DEMAND
0.4 x 90(0.5)
= 36 25
B LOW DEMAND (0.1) 120
Medium : 0.5 x 50 = 25
C Low : 0.1 x 10 = 01
------------
LOW DEMAND (0.1)∑ 62 20
------------
27
Calculations for B
HIGH 90
High : 0.4 DEMAND
x 200 = (0.4)
80
Medium LOW
: 0.5 DEMAND
x 25 = (0.1)
12.5 10
A
Low HIGH
: 0.1 DEMAND
x -120 =(0.4)
-12 200
------------
B LOW DEMAND∑ (0.1)
80.5
120
------------
C
LOW DEMAND (0.1)
20
28
Calculations for C
High : 0.4 x 60 = 24
Medium LOW
: 0.5 DEMAND
x 40 = (0.1)
20 10
A
Low : 0.1 x 20 = 02
------------
B ∑ (0.1)
LOW DEMAND 46 120
------------
C
LOW DEMAND (0.1)
20
29
Step 3: Calculate for all three alternatives
MEDIUM DEMAND (0.5) 62 50

LOW DEMAND (0.1) 10
A

B LOW DEMAND (0.1)
80.5
-120

C
46
LOW DEMAND (0.1)
20
30
Step 4 : Make decision for the best alternative
MEDIUM DEMAND (0.5) 62 50

LOW DEMAND (0.1) 10
A

B B LOW DEMAND (0.1)
80.5
120

C
46
Alternative B generates the LOW DEMAND (0.1)
20
greatest expected profit,
So the choice will be B ie. To
construct a new facility
31
Decision Tree Analysis:
Advantages & Disadvantages
Advantages Disadvantages
+• Depicts Most Suitable Project/Solution: It is an •- Inappropriate for Excessive Data: Not suitable for
effective means of picking out the most appropriate the situations where the data for classification is
project or solution after examining all the vast.
possibilities.
•- Difficult to Handle Numerous Outcomes: If there
+• Easy Data Interpretation and Classification: Not are multiple possible results of every decision, it
being rocket science, decision tree eases out the becomes tedious to compile all these on a decision
process of segregation of the acquired data into tree.
different classes.
•- Impact of Variance: Making changes becomes
+• Assist Multiple Decision-Making Tools: It also problematic since it results in a completely different
benefits the decision-maker by providing input for decision tree.
other analytical methods like nature’s tree.
•- Unsuitable for Continuous Variables:
+• Considers Both, Categorial and Numerical Data: Incorporating many open-ended numerical
This technique takes into consideration the variables increases the possibility of errors.
quantitative as well as the qualitative variables for
better results. •- Sensitive towards Biasness: decision tree maker
may lay more emphasis on preferable variables
+• Initiates Variable Analysis: Its structured
phenomena also facilitates the investigation and •- Expensive Process: resource-intensive process.
filtration of the relevant data.
32
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Capacity Planning

Module 2: Strategic Decisions

• Planning and designing product / services

• Facility location: factor rating, load-distance, center of gravity / median

• Facility layout: Assembly Line Balancing, block diagramming

• Capacity planning & management: break-even, decision tree

• Project management: PERT / CPM

Capacity is the upper limit or ceiling on the load that an operating

• Capacity also includes

• The basic questions in capacity handling are:

What kind of capacity • Depends on products / services that management

How much is needed? • The volume and certainty of anticipated demand

When is it needed? • Capacity lead strategy

Compute Evaluate Qualitative

Compute Select Best

Long Range Planning

Short Range Planning

Modify Capacity Use Capacity

• Impact ability to meet future demands

• Affects operating costs

• Major determinant of initial costs

• Involves long-term commitment

• Affects ease of management

• Globalization adds complexity

• Impacts long range planning

Capacity • The “throughput,” or number of units a facility can hold,

Effective • Capacity a firm can expect to receive given its product

Efficiency • Actual output as a percent of effective capacity

Measure of planned or actual capacity usage of

Measure of how well a facility or machine is

• Evaluate existing capacity, and calculate processing requirements

• Evaluate alternatives Several methods used for analysis:

• Implement alternative chosen

• Technique for evaluating process & equipment alternatives.

Total revenue line

Total cost line

Loss Fixed cost

BEP (Units) = TFC . BEP (Price) = TFC .

TFC = Total Fixed Cost TFC = Total Fixed Cost

VC = Unit Variable Cost VC = Unit Variable Cost

P = Unit Selling Price P = Unit Selling Price

• One product is involved

• Everything produced can be sold

• Variable cost per unit is the same regardless of volume

• Fixed costs do not change with volume

• Revenue per unit constant with volume

• Revenue per unit exceeds variable cost per unit

BEP (x) = TFC . BEP ($) = TFC .

TFC = 10000 Variable Cost per unit = $22.50

BEP(x) = 10000 / 25 – 22.50 BEP($) =10000 / 1 – 22.5/25

• Graphical depiction of all the possibilities or outcomes to solve a specific

• It is a widely used technique

Step 1 : Start by drawing the three decisions

Step 2: Add the possible states of nature, probabilities and payoffs.

B -120 25 200 HIGH DEMAND (0.4) 90

MEDIUM DEMAND (0.5) 25

HIGH DEMAND (0.4) 60

Step 2: Add the possible states of nature, probabilities and payoffs.

HIGH DEMAND (0.4) 90

MEDIUM DEMAND (0.5) 50

Step 2: Add the possible states of nature, probabilities and payoffs.

Step 2: Add the possible states of nature, probabilities and payoffs.

Step 3: Calculate for all three alternatives