Description
capacity planning, breakeven analysis, applying decision trees to capacity planning, cost volume relationships, approaches to capacity expansion, theory of constraints.
Strategic Capacity Planning and Management
1
Outline
CAPACITY PLANNING Strategic Capacity Management BREAKEVEN ANALYSIS APPLYING DECISION TREES TO CAPACITY DECISIONS STRATEGY DRIVEN INVESTMENTS
– Investment, Variable Cost, and Cash Flow – Net Present Value
2
Capacity Decisions _Strategic Capacity and medium term capacity decisions
Marketplace and Demand Demand Forecasts, orders Product Decisions Process Planning & Capacity Decisions Research and Technology
Work Force Raw Materials Available External Capacity Subcontractors
Aggregate Prod Plan/ Capacity Medium term
Master Production Schedules, MRP systems Capacity Reqmnt Plan Detailed Work Schedules / Fine cut capacity plan
Inventory On Hand
Multiple levels of capacity decisions
3
Types of Planning/ Decisions Over a Time Horizon
Long Range Planning Intermediate Range Planning Short Range Planning
*Limited options exist
Add Facilities Add long lead time equipment Sub-Contract Add Equipment Add Shifts
*
Add Personnel Build or Use Inventory Schedule Jobs Schedule Personnel Allocate Machinery
* Modify Capacity
Use Capacity
4
Capacity Planning
Capacity is the upper limit or ceiling on the load that an operating unit can handle. The basic questions in capacity handling are:
– – –
What kind of capacity is needed? How much is needed? When is it needed?
Importance of Capacity Decisions
1. 2. 3. 4. 5. 6. 7. 8.
Impacts 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
Capacity
Design capacity
–
maximum output rate or service capacity an operation, process, or facility is designed for Design capacity minus allowances such as personal time, maintenance, and scrap rate of output actually achieved--cannot exceed effective capacity.
Effective capacity
–
Actual output
–
Efficiency and Utilization
Actual output
Efficiency =
Effective capacity
Actual output
Utilization = Design capacity
Both measures expressed as percentages
Efficiency/Utilization Example
Design capacity = 50 trucks/day Effective capacity = 40 trucks/day Actual output = 36 units/day
Actual output
=
36 units/day = 40 units/ day
Efficiency =
90% Effective capacity
Utilization =
72%
Actual output Design capacity
=
36 units/day 50 units/day =
Determinants of Effective Capacity
Facilities Product and service factors Process factors Human factors Operational factors Supply chain factors External factors
Strategy Formulation
Capacity strategy for long-term demand Demand patterns Growth rate and variability Facilities
– Cost of building and operating
Technological changes
– Rate and direction of technology changes
Behavior of competitors Availability of capital and other inputs
Key Decisions of Capacity Planning
1. Amount of capacity needed
2. Timing of changes 3. Need to maintain balance
4. Extent of flexibility of facilities
Capacity cushion – extra demand intended to offset uncertainty
Steps for Capacity Planning
1. Estimate future capacity requirements 2. Evaluate existing capacity
3. Identify alternatives
4. Conduct financial analysis 5. Assess key qualitative issues 6. Select one alternative 7. Implement alternative chosen
8. Monitor results
Make or Buy
1. Available capacity
2. Expertise 3. Quality considerations
4. Nature of demand
5. Cost 6. Risk
Developing Capacity Alternatives
1. Design flexibility into systems 2. Take stage of life cycle into account 3. Take a ?big picture? approach to capacity
changes 4. Prepare to deal with capacity ?chunks? 5. Attempt to smooth out capacity requirements 6. Identify the optimal operating level
Economies of Scale
Economies of scale
– If the output rate is less than the optimal level, increasing output rate results in decreasing average unit costs
Diseconomies of scale
– If the output rate is more than the optimal level, increasing the output rate results in increasing average unit costs
Evaluating Alternatives
Production units have an optimal rate of output for minimal cost. Average cost per unit
Minimum average cost per unit
Minimum cost
0
Rate of output
Evaluating Alternatives
Minimum cost & optimal operating rate are functions of size of production unit. Average cost per unit
Small
plant
Medium plant
Large plant
0
Output rate
Planning Service Capacity
Need to be near customers
– Capacity and location are closely tied
Inability to store services
– Capacity must be matched with timing of demand
Degree of volatility of demand
– Peak demand periods
Cost-Volume Relationships
Amount ($)
Fixed cost (FC) 0 Q (volume in units)
Cost-Volume Relationships
Amount ($) 0
Q (volume in units)
Cost-Volume Relationships
Amount ($) 0
BEP units Q (volume in units)
Break-Even Analysis
Fixed costs: costs that continue even if no units are produced: depreciation, taxes, debt, mortgage payments Variable costs: costs that vary with the volume of units produced: labor, materials, portion of utilities BEP ($) = Total Fixed Cost 1 - ( Variable Cost / Selling Price) BEP (units) = Total Fixed Cost Price – Variable Cost
23
Break-Even Problem with Step Fixed Costs
3 machines
2 machines 1 machine Quantity Step fixed costs and variable costs.
Break-Even Problem with Step Fixed Costs
$
BEP2 TC
BEP
3
TC
3 TC 2 1
Quantity Multiple break-even points
Breakeven Analysis
Technique for evaluating process & equipment alternatives Objective: Find the point ($ or units) at which total cost equals total revenue Assumptions – Revenue & costs are related linearly to volume – All information is known with certainty – No time value of money
26
Breakeven Chart
Total revenue line Breakeven point Total cost = Total revenue Cost in Dollars Profit Total cost line Variable cost Loss
Fixed cost
Volume (units/period)
27
Crossover Chart
Process A: low volume, high variety Process B: Repetitive Process C: High volume, low variety
Fixed cost - Process C
Fixed cost - Process B Fixed cost - Process A
Process A Process B
Process C
Lowest cost process
28
Cost of Wrong Process Found Via Breakeven Analysis
$ Fixed cost
Low volume, high variety process
Variable cost
$ Fixed cost
Variable cost
$
Variable cost Fixed cost
High volume, low variety process
Repetitive process
Total cost for low volume high variety
B1 B3 A B B2
Total cost for repetitive process Total cost for high volume, low variety process
Volume
29
Approaches to Capacity Expansion
Expected Demand New Capacity Demand Demand Expected Demand New Capacity
Time in Years Capacity leads demand with an incremental expansion Expected Demand Demand New Capacity
Time in Years Capacity leads demand with a one-step expansion
Expected Demand New Capacity Demand
Time in Years Capacity lags demand with an incremental expansion
Time in Years Attempts to have an average capacity, with an incremental expansion
30
Route Sheet
Lists all operations
Route Sheet for Bracket
Sequence 1 2 3 4 Machine Shear # 3 Shear # 3 Drill press Brake press Operation Shear to length Shear 45° corners Drill both holes Bend 90° Setup Time 5 8 15 10 Operation Time/Unit .030 .050 3.000 .025
For a batch = only one set up is required This causes effective capacity to decrease if multiple set ups are required
Calculating Processing Requirements
Product Annual Demand Standard processing time per unit (hr.) Processing time needed (hr.)
#1 #2 #3
400 300 700
5.0 8.0 2.0
2,000 2,400 1,400 5,800
Total machine hours available= 8 hours per shift* No. of shifts* working days (Generally 300 days per year)
Capacity Bottlenecks and balancing
Inputs
1
200/hr
2
50/hr
3
200/hr
To customers
(a) Operation 2 a bottleneck
33
Capacity Bottlenecks & balanced flow system
Inputs
1 200/hr
2 200/hr
3 200/hr
To customers
(b) All operations bottlenecks
Case ABC Demm
34
Theory of Constraints
1. Identify the system bottleneck(s) 2. Exploit the bottleneck(s) 3. Subordinate all other decisions to step 2 4. Elevate the bottleneck(s) 5. Do not let inertia set in
35
Managing Existing Capacity ( S. T.)
Demand Management
? Vary prices ? Vary promotion Capacity Management
? Change lead times (e.g., backorders)
? Offer complementary products
Vary staffing Change equipment & processes Change methods Redesign the product for faster processing
36
Pure Strategies - The Extremes Capacity management
Level Strategy Production rate is constant
Level production - produce at constant rate & use inventory as needed to meet demand
Chase Strategy Production equals demand
Chase demand - change workforce levels so that production matches demand
37
Level Production
Demand
Production
Units
Time
38
Chase Demand
Demand Production Units
Time
39
Managing capacity (Medium/short term) _matching capacity to demand
Demand Options — change demand:
– influencing demand – pricing, promotion – backordering during high demand periods – counterseasonal product mixing
40
Managing capacity (medium/short term ) _matching capacity to demand
Capacity Options — change capacity:
– changing inventory levels – varying work force size by hiring or layoffs – varying production capacity through overtime or idle time – subcontracting – using part-time workers
41
Financial Analysis
Cash Flow - the difference between cash received from sales and other sources, and cash outflow for labor, material, overhead, and taxes. Present Value - the sum, in current value, of all future cash flows of an investment proposal.
Capacity Decisions
Identify Capacity Gaps
Kitchen capacity = 80,000 meals Dining room capacity = 105,000 meals
43
Capacity Decisions
Identify Capacity Gaps
Kitchen capacity = 80,000 meals Dining room capacity = 105,000 meals Demand Year 1: Year 2: Year 3: Year 4: Year 5: 90,000 meals 100,000 meals 110,000 meals 120,000 meals 130,000 meals
44
Capacity Decisions
Identify Capacity Gaps
Kitchen capacity = 80,000 meals Dining room capacity = 105,000 meals Demand Year 1: Year 2: Year 3: Year 4: Year 5: 90,000 meals 100,000 meals 110,000 meals 120,000 meals 130,000 meals Kitchen Capacity Gaps
45
Capacity Decisions
Identify Capacity Gaps
Kitchen capacity = 80,000 meals Dining room capacity = 105,000 meals Demand Year 1: Year 2: Year 3: Year 4: Year 5: 90,000 meals 100,000 meals 110,000 meals 120,000 meals 130,000 meals Kitchen Capacity Gaps Year 1: 90,000 – 80,000 = 10,000
46
Capacity Decisions
Identify Capacity Gaps
Kitchen capacity = 80,000 meals Dining room capacity = 105,000 meals Demand Year 1: Year 2: Year 3: Year 4: Year 5: 90,000 meals 100,000 meals 110,000 meals 120,000 meals 130,000 meals Kitchen Capacity Gaps Year 1: Year 2: Year 3: Year 4: Year 5: 90,000 – 80,000 = 10,000 100,000 – 80,000 = 20,000 110,000 – 80,000 = 30,000 120,000 – 80,000 = 40,000 130,000 – 80,000 = 50,000
47
Capacity Decisions
Identify Capacity Gaps
Kitchen capacity = 80,000 meals Dining room capacity = 105,000 meals Demand Year 1: Year 2: Year 3: Year 4: Year 5: 90,000 meals 100,000 meals 110,000 meals 120,000 meals 130,000 meals Dining Room Capacity Gaps Year 1: Year 2: Year 3: Year 4: Year 5:
48
Capacity Decisions
Identify Capacity Gaps
Kitchen capacity = 80,000 meals Dining room capacity = 105,000 meals Demand Year 1: Year 2: Year 3: Year 4: Year 5: 90,000 meals 100,000 meals 110,000 meals 120,000 meals 130,000 meals Dining Room Capacity Gaps Year 1: Year 2: Year 3: Year 4: Year 5: no gaps no gaps
49
Capacity Decisions
Identify Capacity Gaps
Kitchen capacity = 80,000 meals Dining room capacity = 105,000 meals Demand Year 1: Year 2: Year 3: Year 4: Year 5: 90,000 meals 100,000 meals 110,000 meals 120,000 meals 130,000 meals Dining Room Capacity Gaps Year 1: Year 2: Year 3: Year 4: Year 5: no gaps no gaps 110,000 – 105,000 = 5,000
50
Capacity Decisions
Identify Capacity Gaps
Kitchen capacity = 80,000 meals Dining room capacity = 105,000 meals Demand Year 1: Year 2: Year 3: Year 4: Year 5: 90,000 meals 100,000 meals 110,000 meals 120,000 meals 130,000 meals Dining Room Capacity Gaps Year 1: Year 2: Year 3: Year 4: Year 5: no gaps no gaps 110,000 – 105,000 = 5,000 120,000 – 105,000 = 15,000 130,000 – 105,000 = 25,000
51
Capacity Decisions
Evaluate Alternatives
52
Capacity Decisions
Evaluate Alternatives
Expand capacity to meet expected demand through Year 5
53
Capacity Decisions
Evaluate Alternatives
Expand capacity to meet expected demand through Year 5
Year Demand Cash Flow
54
Capacity Decisions
Evaluate Alternatives
Expand capacity to meet expected demand through Year 5
Year 1 Demand 90,000 Cash Flow (90,000 – 80,000)2 = $20,000
55
Capacity Decisions
Evaluate Alternatives
Expand capacity to meet expected demand through Year 5
Year 1 2 3 4 5 Demand 90,000 100,000 110,000 120,000 130,000 Cash Flow (90,000 – 80,000)2 = $20,000 (100,000 – 80,000)2 = $40,000 (110,000 – 80,000)2 = $60,000 (120,000 – 80,000)2 = $80,000 (130,000 – 80,000)2 = $100,000
56
Capacity Decisions
Evaluate Alternatives
Figure 8.5
57
Decision making related to capacity management
Break even point Cash flows and NPV. Decision making under uncertaintydecision trees
58
Analyzing Problems with Decision Trees
Define the problem Structure or draw the decision tree Assign probabilities to the states of nature Estimate payoffs for each possible combination of alternatives and states of nature Solve the problem by computing expected monetary values for each state-of-nature node
Decision Tree
State 1
1
Outcome 1 Outcome 2 Outcome 3 Outcome 4
State 2 State 1
2
Decision Node
State 2
State of Nature Node
Getz Products Decision Tree Completed and Solved
EMV for node 1 = $10,000
Payoffs
Favorable market (0.5)
$200,000
1
Unfavorable market (0.5) -$180,000 Favorable market (0.5) $100,000 -20,000
Construct small plant 2
Unfavorable market (0.5)
EMV for node 2 = $40,000
0
EMV = (0.5) *200,000 + (0.5) (-)180,000= 10,000
Capacity Decisions
Decision Trees
Low demand
Don’t expand High demand 1 2 Expand
Low demand
High demand
62
Capacity Decisions
Decision Trees
Low demand [0.40]
Don’t expand High demand [0.60] 1 2 Expand
Low demand [0.40]
High demand [0.60]
63
Capacity Decisions
Small/Low = $70 (0.40)
Expected Payoff = Event * Event Probability
Decision Trees
Low demand [0.40]
$70
Don’t expand
$90
High demand [0.60] 1
2 Expand
$135
Low demand [0.40]
$135
$40
High demand [0.60]
$220
64
Capacity Decisions
Small/Low = $70 (0.40) = $28
Expected Payoff = Event * Event Probability
Decision Trees
Low demand [0.40]
$70
Don’t expand
$90
High demand [0.60] 1
2 Expand
$135
Low demand [0.40]
$135
$40
High demand [0.60]
$220
65
Capacity Decisions
Small/Low = $70 (0.40) = $28 Small/High = $135 (0.60)= $81
Expected Payoff = Event * Event Probability
Decision Trees
Low demand [0.40]
$70
Don’t expand
$90
High demand [0.60] 1
2 Expand
$135
Low demand [0.40]
$135
$40
High demand [0.60]
$220
66
Decision Tree and Capacity Decision
-$14,000
$18,000 $13,000
Market favorable (0.4)
Market unfavorable (0.6) Market favorable (0.4) Market unfavorable (0.6) $100,000 -$90,000 $60,000 -10,000 -5,000 $40,000 $0
67
Market favorable (0.4) Market unfavorable (0.6)
Getz Products Decision Tree with Probabilities and EMVs Shown
$106,400
1st decision point 2nd decision point
$106,000 Fav. Mkt (0.78)
Unfav. Mkt (0.22)
2 3 4 5
$190,000 -$190,000 $90,000 $30,000
$63,600
Fav. Mkt (0.78)
Unfav. Mkt (0.22) Fav. Mkt (0.27) Unfav. Mkt (0.73) Fav. Mkt (0.27) Unfav. Mkt (0.73) Fav. Mkt (0.5) Unfav. Mkt (0.5) Fav. Mkt (0.5)
1 $2,400 $49,200
-$87,400 $2,400
$10,000 $190,000
-$190,000 $90,000 $30,000 $10,000 $200,000 -$180,000 $100,000
$10,000
$40,000
6
$40,000
7
Unfav. Mkt (0.5)
$20,000 $0
Problem 1:
Practice Problems
Bascomb’s Candy is considering the introduction of a new line of products. In order to produce the new line, the bakery is considering either a major or minor renovation of the current plant. The market for the new line of products could be either favorable or unfavorable. Bascomb’s Candy has the option of not developing the new product line at all. Develop the appropriate decision tree.
Problem 2:
Practice Problems
With major renovation, at Bascomb’s Candy (See Problem 1 above) the payoff from a favorable market is $100,000 and from an unfavorable market $–90,000. Minor renovations and favorable market has a payoff of $40,000 and an unfavorable market $–20,000. Assuming that a favorable © likely, Hall, Inc., the decision market andtoan unfavorable market are equally2004 by PrenticesolveUpper Saddle River, N.J. 07458 PowerPoint presentation accompany Heizer/Render – A-30 Principles of Operations Management, 5e, and Operations Management, tree. 7e
Problem 2:
Solution Practice Problems
Practice Problems
With major renovation, at Bascomb’s Candy (See Problem 1 above) the payoff from a favorable market is $100,000 and from an unfavorable market $–90,000. Minor renovations and favorable market has a payoff of $40,000 and an unfavorable market $–20,000. Assuming that a favorable market and an unfavorable market are equally likely, solve the decision tree.
Strategy Driven Investment
Select investments as part of a coordinated strategic plan Choose investments yielding competitive advantage
Consider product life cycles
Include a variety of operating factors in the financial return analysis Test investments in light of several revenue projections
71
Net Present Value
F = future value P = present value r = interest rate N = number of years
P?
F (i ? 1) N
72
NPV in a More Convenient Form
Present value of $1.00
Year 1 2 3 4 5 6 7 8 9 5% 0.952 0.907 0.864 0.823 0.784 0.746 0.711 0.677 0.645 6% 0.943 0.890 0.840 0.792 0.747 0.705 0.665 0.627 0.592 7% 0.935 0.873 0.816 0.763 0.713 0.666 0.623 0.582 0.544 8% 0.925 0.857 0.794 0.735 0.681 0.630 0.583 0.540 0.500
73
F NPv ? ? I ? N (r ? 1) NPv ? ? I ? FX 1 where X ? N (r ? 1 )
NPV example
I invest Rs 10,000/ - today in a security. In second year it gives me Rs 5000. In year 3 it gives me Rs 5000. In year 4 it gives me Rs 4500. What is the net present value of my investment if interest rate is 14%.
Year 0 -10,000
Yr 1 -
Yr 2 5000
Yr 3 5000
Yr 4 4500
Yr 5
-10,000
0
5000/ 5000/ 4500/ (1+.14)2 (1+.14)3 (1+.14)4
-10,000
3847
3374
2664
NPV = -10,000 + 3847+3374+2664 = ( -)15
74
Cash Flow example
A local restaurant is considering adding a salad bar. The investment required to remodel the dining area and add the salad bar will be $16,000. Other information about the project is as follows. 1. The price and variable cost per salad are $3.50 and $2.00, respectively. 2. Annual demand should be about 11,000 salads. 3. Fixed costs, other than depreciation, will be $8,000, which cover the energy to operate the refrigerated unit and wages for another part-time employee to stock the salad bar during peak business hours. 4. The assets go into the MACRS 5-year class for depreciation purposes, with no salvage value. 5. The tax rate is 40 percent. 6. Management wants to earn a return of at least 14 percent on the project. Determine the after-tax cash flows for the life of this project.
75
Cash Flow
Cash Flow = Net operating Income + Depreciation
76
NPV for this problem
Yr 0 -16,000 -16000 Yr 1 6380/1.14 5596 Yr 2 Yr 3 Yr 4 Yr 5 7148/1.142 6329/1.143 5837/1.144 5837/1.145 5500 4272 3456 3031
NPV ( 5 year) = 5855
77
Thank You
78
Complementary Products
Sales (Units) 5,000 4,000 3,000 2,000 1,000 0
Total
Heaters
A/c s
J M M J S N J M M J S N J Time (Months)
79
Approaches to Capacity Expansion
Expected Demand
New Capacity
Demand
Time in Years Capacity leads demand with an incremental expansion
80
Approaches to Capacity Expansion
Expected Demand New Capacity Demand
Time in Years
Capacity leads demand with a one-step expansion
81
Approaches to Capacity Expansion
Expected Demand New Capacity Demand Time in Years Capacity lags demand with an incremental expansion
82
Approaches to Capacity Expansion
New Capacity Expected Demand
Demand
Time in Years Attempts to have an average capacity, with an incremental expansion
83
doc_910889880.pptx
capacity planning, breakeven analysis, applying decision trees to capacity planning, cost volume relationships, approaches to capacity expansion, theory of constraints.
Strategic Capacity Planning and Management
1
Outline
CAPACITY PLANNING Strategic Capacity Management BREAKEVEN ANALYSIS APPLYING DECISION TREES TO CAPACITY DECISIONS STRATEGY DRIVEN INVESTMENTS
– Investment, Variable Cost, and Cash Flow – Net Present Value
2
Capacity Decisions _Strategic Capacity and medium term capacity decisions
Marketplace and Demand Demand Forecasts, orders Product Decisions Process Planning & Capacity Decisions Research and Technology
Work Force Raw Materials Available External Capacity Subcontractors
Aggregate Prod Plan/ Capacity Medium term
Master Production Schedules, MRP systems Capacity Reqmnt Plan Detailed Work Schedules / Fine cut capacity plan
Inventory On Hand
Multiple levels of capacity decisions
3
Types of Planning/ Decisions Over a Time Horizon
Long Range Planning Intermediate Range Planning Short Range Planning
*Limited options exist
Add Facilities Add long lead time equipment Sub-Contract Add Equipment Add Shifts
*
Add Personnel Build or Use Inventory Schedule Jobs Schedule Personnel Allocate Machinery
* Modify Capacity
Use Capacity
4
Capacity Planning
Capacity is the upper limit or ceiling on the load that an operating unit can handle. The basic questions in capacity handling are:
– – –
What kind of capacity is needed? How much is needed? When is it needed?
Importance of Capacity Decisions
1. 2. 3. 4. 5. 6. 7. 8.
Impacts 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
Capacity
Design capacity
–
maximum output rate or service capacity an operation, process, or facility is designed for Design capacity minus allowances such as personal time, maintenance, and scrap rate of output actually achieved--cannot exceed effective capacity.
Effective capacity
–
Actual output
–
Efficiency and Utilization
Actual output
Efficiency =
Effective capacity
Actual output
Utilization = Design capacity
Both measures expressed as percentages
Efficiency/Utilization Example
Design capacity = 50 trucks/day Effective capacity = 40 trucks/day Actual output = 36 units/day
Actual output
=
36 units/day = 40 units/ day
Efficiency =
90% Effective capacity
Utilization =
72%
Actual output Design capacity
=
36 units/day 50 units/day =
Determinants of Effective Capacity
Facilities Product and service factors Process factors Human factors Operational factors Supply chain factors External factors
Strategy Formulation
Capacity strategy for long-term demand Demand patterns Growth rate and variability Facilities
– Cost of building and operating
Technological changes
– Rate and direction of technology changes
Behavior of competitors Availability of capital and other inputs
Key Decisions of Capacity Planning
1. Amount of capacity needed
2. Timing of changes 3. Need to maintain balance
4. Extent of flexibility of facilities
Capacity cushion – extra demand intended to offset uncertainty
Steps for Capacity Planning
1. Estimate future capacity requirements 2. Evaluate existing capacity
3. Identify alternatives
4. Conduct financial analysis 5. Assess key qualitative issues 6. Select one alternative 7. Implement alternative chosen
8. Monitor results
Make or Buy
1. Available capacity
2. Expertise 3. Quality considerations
4. Nature of demand
5. Cost 6. Risk
Developing Capacity Alternatives
1. Design flexibility into systems 2. Take stage of life cycle into account 3. Take a ?big picture? approach to capacity
changes 4. Prepare to deal with capacity ?chunks? 5. Attempt to smooth out capacity requirements 6. Identify the optimal operating level
Economies of Scale
Economies of scale
– If the output rate is less than the optimal level, increasing output rate results in decreasing average unit costs
Diseconomies of scale
– If the output rate is more than the optimal level, increasing the output rate results in increasing average unit costs
Evaluating Alternatives
Production units have an optimal rate of output for minimal cost. Average cost per unit
Minimum average cost per unit
Minimum cost
0
Rate of output
Evaluating Alternatives
Minimum cost & optimal operating rate are functions of size of production unit. Average cost per unit
Small
plant
Medium plant
Large plant
0
Output rate
Planning Service Capacity
Need to be near customers
– Capacity and location are closely tied
Inability to store services
– Capacity must be matched with timing of demand
Degree of volatility of demand
– Peak demand periods
Cost-Volume Relationships
Amount ($)
Fixed cost (FC) 0 Q (volume in units)
Cost-Volume Relationships
Amount ($) 0
Q (volume in units)
Cost-Volume Relationships
Amount ($) 0
BEP units Q (volume in units)
Break-Even Analysis
Fixed costs: costs that continue even if no units are produced: depreciation, taxes, debt, mortgage payments Variable costs: costs that vary with the volume of units produced: labor, materials, portion of utilities BEP ($) = Total Fixed Cost 1 - ( Variable Cost / Selling Price) BEP (units) = Total Fixed Cost Price – Variable Cost
23
Break-Even Problem with Step Fixed Costs
3 machines
2 machines 1 machine Quantity Step fixed costs and variable costs.
Break-Even Problem with Step Fixed Costs
$
BEP2 TC
BEP
3
TC
3 TC 2 1
Quantity Multiple break-even points
Breakeven Analysis
Technique for evaluating process & equipment alternatives Objective: Find the point ($ or units) at which total cost equals total revenue Assumptions – Revenue & costs are related linearly to volume – All information is known with certainty – No time value of money
26
Breakeven Chart
Total revenue line Breakeven point Total cost = Total revenue Cost in Dollars Profit Total cost line Variable cost Loss
Fixed cost
Volume (units/period)
27
Crossover Chart
Process A: low volume, high variety Process B: Repetitive Process C: High volume, low variety
Fixed cost - Process C
Fixed cost - Process B Fixed cost - Process A
Process A Process B
Process C
Lowest cost process
28
Cost of Wrong Process Found Via Breakeven Analysis
$ Fixed cost
Low volume, high variety process
Variable cost
$ Fixed cost
Variable cost
$
Variable cost Fixed cost
High volume, low variety process
Repetitive process
Total cost for low volume high variety
B1 B3 A B B2
Total cost for repetitive process Total cost for high volume, low variety process
Volume
29
Approaches to Capacity Expansion
Expected Demand New Capacity Demand Demand Expected Demand New Capacity
Time in Years Capacity leads demand with an incremental expansion Expected Demand Demand New Capacity
Time in Years Capacity leads demand with a one-step expansion
Expected Demand New Capacity Demand
Time in Years Capacity lags demand with an incremental expansion
Time in Years Attempts to have an average capacity, with an incremental expansion
30
Route Sheet
Lists all operations
Route Sheet for Bracket
Sequence 1 2 3 4 Machine Shear # 3 Shear # 3 Drill press Brake press Operation Shear to length Shear 45° corners Drill both holes Bend 90° Setup Time 5 8 15 10 Operation Time/Unit .030 .050 3.000 .025
For a batch = only one set up is required This causes effective capacity to decrease if multiple set ups are required
Calculating Processing Requirements
Product Annual Demand Standard processing time per unit (hr.) Processing time needed (hr.)
#1 #2 #3
400 300 700
5.0 8.0 2.0
2,000 2,400 1,400 5,800
Total machine hours available= 8 hours per shift* No. of shifts* working days (Generally 300 days per year)
Capacity Bottlenecks and balancing
Inputs
1
200/hr
2
50/hr
3
200/hr
To customers
(a) Operation 2 a bottleneck
33
Capacity Bottlenecks & balanced flow system
Inputs
1 200/hr
2 200/hr
3 200/hr
To customers
(b) All operations bottlenecks
Case ABC Demm
34
Theory of Constraints
1. Identify the system bottleneck(s) 2. Exploit the bottleneck(s) 3. Subordinate all other decisions to step 2 4. Elevate the bottleneck(s) 5. Do not let inertia set in
35
Managing Existing Capacity ( S. T.)
Demand Management
? Vary prices ? Vary promotion Capacity Management
? Change lead times (e.g., backorders)
? Offer complementary products
Vary staffing Change equipment & processes Change methods Redesign the product for faster processing
36
Pure Strategies - The Extremes Capacity management
Level Strategy Production rate is constant
Level production - produce at constant rate & use inventory as needed to meet demand
Chase Strategy Production equals demand
Chase demand - change workforce levels so that production matches demand
37
Level Production
Demand
Production
Units
Time
38
Chase Demand
Demand Production Units
Time
39
Managing capacity (Medium/short term) _matching capacity to demand
Demand Options — change demand:
– influencing demand – pricing, promotion – backordering during high demand periods – counterseasonal product mixing
40
Managing capacity (medium/short term ) _matching capacity to demand
Capacity Options — change capacity:
– changing inventory levels – varying work force size by hiring or layoffs – varying production capacity through overtime or idle time – subcontracting – using part-time workers
41
Financial Analysis
Cash Flow - the difference between cash received from sales and other sources, and cash outflow for labor, material, overhead, and taxes. Present Value - the sum, in current value, of all future cash flows of an investment proposal.
Capacity Decisions
Identify Capacity Gaps
Kitchen capacity = 80,000 meals Dining room capacity = 105,000 meals
43
Capacity Decisions
Identify Capacity Gaps
Kitchen capacity = 80,000 meals Dining room capacity = 105,000 meals Demand Year 1: Year 2: Year 3: Year 4: Year 5: 90,000 meals 100,000 meals 110,000 meals 120,000 meals 130,000 meals
44
Capacity Decisions
Identify Capacity Gaps
Kitchen capacity = 80,000 meals Dining room capacity = 105,000 meals Demand Year 1: Year 2: Year 3: Year 4: Year 5: 90,000 meals 100,000 meals 110,000 meals 120,000 meals 130,000 meals Kitchen Capacity Gaps
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Capacity Decisions
Identify Capacity Gaps
Kitchen capacity = 80,000 meals Dining room capacity = 105,000 meals Demand Year 1: Year 2: Year 3: Year 4: Year 5: 90,000 meals 100,000 meals 110,000 meals 120,000 meals 130,000 meals Kitchen Capacity Gaps Year 1: 90,000 – 80,000 = 10,000
46
Capacity Decisions
Identify Capacity Gaps
Kitchen capacity = 80,000 meals Dining room capacity = 105,000 meals Demand Year 1: Year 2: Year 3: Year 4: Year 5: 90,000 meals 100,000 meals 110,000 meals 120,000 meals 130,000 meals Kitchen Capacity Gaps Year 1: Year 2: Year 3: Year 4: Year 5: 90,000 – 80,000 = 10,000 100,000 – 80,000 = 20,000 110,000 – 80,000 = 30,000 120,000 – 80,000 = 40,000 130,000 – 80,000 = 50,000
47
Capacity Decisions
Identify Capacity Gaps
Kitchen capacity = 80,000 meals Dining room capacity = 105,000 meals Demand Year 1: Year 2: Year 3: Year 4: Year 5: 90,000 meals 100,000 meals 110,000 meals 120,000 meals 130,000 meals Dining Room Capacity Gaps Year 1: Year 2: Year 3: Year 4: Year 5:
48
Capacity Decisions
Identify Capacity Gaps
Kitchen capacity = 80,000 meals Dining room capacity = 105,000 meals Demand Year 1: Year 2: Year 3: Year 4: Year 5: 90,000 meals 100,000 meals 110,000 meals 120,000 meals 130,000 meals Dining Room Capacity Gaps Year 1: Year 2: Year 3: Year 4: Year 5: no gaps no gaps
49
Capacity Decisions
Identify Capacity Gaps
Kitchen capacity = 80,000 meals Dining room capacity = 105,000 meals Demand Year 1: Year 2: Year 3: Year 4: Year 5: 90,000 meals 100,000 meals 110,000 meals 120,000 meals 130,000 meals Dining Room Capacity Gaps Year 1: Year 2: Year 3: Year 4: Year 5: no gaps no gaps 110,000 – 105,000 = 5,000
50
Capacity Decisions
Identify Capacity Gaps
Kitchen capacity = 80,000 meals Dining room capacity = 105,000 meals Demand Year 1: Year 2: Year 3: Year 4: Year 5: 90,000 meals 100,000 meals 110,000 meals 120,000 meals 130,000 meals Dining Room Capacity Gaps Year 1: Year 2: Year 3: Year 4: Year 5: no gaps no gaps 110,000 – 105,000 = 5,000 120,000 – 105,000 = 15,000 130,000 – 105,000 = 25,000
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Capacity Decisions
Evaluate Alternatives
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Capacity Decisions
Evaluate Alternatives
Expand capacity to meet expected demand through Year 5
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Capacity Decisions
Evaluate Alternatives
Expand capacity to meet expected demand through Year 5
Year Demand Cash Flow
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Capacity Decisions
Evaluate Alternatives
Expand capacity to meet expected demand through Year 5
Year 1 Demand 90,000 Cash Flow (90,000 – 80,000)2 = $20,000
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Capacity Decisions
Evaluate Alternatives
Expand capacity to meet expected demand through Year 5
Year 1 2 3 4 5 Demand 90,000 100,000 110,000 120,000 130,000 Cash Flow (90,000 – 80,000)2 = $20,000 (100,000 – 80,000)2 = $40,000 (110,000 – 80,000)2 = $60,000 (120,000 – 80,000)2 = $80,000 (130,000 – 80,000)2 = $100,000
56
Capacity Decisions
Evaluate Alternatives
Figure 8.5
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Decision making related to capacity management
Break even point Cash flows and NPV. Decision making under uncertaintydecision trees
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Analyzing Problems with Decision Trees
Define the problem Structure or draw the decision tree Assign probabilities to the states of nature Estimate payoffs for each possible combination of alternatives and states of nature Solve the problem by computing expected monetary values for each state-of-nature node
Decision Tree
State 1
1
Outcome 1 Outcome 2 Outcome 3 Outcome 4
State 2 State 1
2
Decision Node
State 2
State of Nature Node
Getz Products Decision Tree Completed and Solved
EMV for node 1 = $10,000
Payoffs
Favorable market (0.5)
$200,000
1
Unfavorable market (0.5) -$180,000 Favorable market (0.5) $100,000 -20,000
Construct small plant 2
Unfavorable market (0.5)
EMV for node 2 = $40,000
0
EMV = (0.5) *200,000 + (0.5) (-)180,000= 10,000
Capacity Decisions
Decision Trees
Low demand
Don’t expand High demand 1 2 Expand
Low demand
High demand
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Capacity Decisions
Decision Trees
Low demand [0.40]
Don’t expand High demand [0.60] 1 2 Expand
Low demand [0.40]
High demand [0.60]
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Capacity Decisions
Small/Low = $70 (0.40)
Expected Payoff = Event * Event Probability
Decision Trees
Low demand [0.40]
$70
Don’t expand
$90
High demand [0.60] 1
2 Expand
$135
Low demand [0.40]
$135
$40
High demand [0.60]
$220
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Capacity Decisions
Small/Low = $70 (0.40) = $28
Expected Payoff = Event * Event Probability
Decision Trees
Low demand [0.40]
$70
Don’t expand
$90
High demand [0.60] 1
2 Expand
$135
Low demand [0.40]
$135
$40
High demand [0.60]
$220
65
Capacity Decisions
Small/Low = $70 (0.40) = $28 Small/High = $135 (0.60)= $81
Expected Payoff = Event * Event Probability
Decision Trees
Low demand [0.40]
$70
Don’t expand
$90
High demand [0.60] 1
2 Expand
$135
Low demand [0.40]
$135
$40
High demand [0.60]
$220
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Decision Tree and Capacity Decision
-$14,000
$18,000 $13,000
Market favorable (0.4)
Market unfavorable (0.6) Market favorable (0.4) Market unfavorable (0.6) $100,000 -$90,000 $60,000 -10,000 -5,000 $40,000 $0
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Market favorable (0.4) Market unfavorable (0.6)
Getz Products Decision Tree with Probabilities and EMVs Shown
$106,400
1st decision point 2nd decision point
$106,000 Fav. Mkt (0.78)
Unfav. Mkt (0.22)
2 3 4 5
$190,000 -$190,000 $90,000 $30,000
$63,600
Fav. Mkt (0.78)
Unfav. Mkt (0.22) Fav. Mkt (0.27) Unfav. Mkt (0.73) Fav. Mkt (0.27) Unfav. Mkt (0.73) Fav. Mkt (0.5) Unfav. Mkt (0.5) Fav. Mkt (0.5)
1 $2,400 $49,200
-$87,400 $2,400
$10,000 $190,000
-$190,000 $90,000 $30,000 $10,000 $200,000 -$180,000 $100,000
$10,000
$40,000
6
$40,000
7
Unfav. Mkt (0.5)
$20,000 $0
Problem 1:
Practice Problems
Bascomb’s Candy is considering the introduction of a new line of products. In order to produce the new line, the bakery is considering either a major or minor renovation of the current plant. The market for the new line of products could be either favorable or unfavorable. Bascomb’s Candy has the option of not developing the new product line at all. Develop the appropriate decision tree.
Problem 2:
Practice Problems
With major renovation, at Bascomb’s Candy (See Problem 1 above) the payoff from a favorable market is $100,000 and from an unfavorable market $–90,000. Minor renovations and favorable market has a payoff of $40,000 and an unfavorable market $–20,000. Assuming that a favorable © likely, Hall, Inc., the decision market andtoan unfavorable market are equally2004 by PrenticesolveUpper Saddle River, N.J. 07458 PowerPoint presentation accompany Heizer/Render – A-30 Principles of Operations Management, 5e, and Operations Management, tree. 7e
Problem 2:
Solution Practice Problems
Practice Problems
With major renovation, at Bascomb’s Candy (See Problem 1 above) the payoff from a favorable market is $100,000 and from an unfavorable market $–90,000. Minor renovations and favorable market has a payoff of $40,000 and an unfavorable market $–20,000. Assuming that a favorable market and an unfavorable market are equally likely, solve the decision tree.
Strategy Driven Investment
Select investments as part of a coordinated strategic plan Choose investments yielding competitive advantage
Consider product life cycles
Include a variety of operating factors in the financial return analysis Test investments in light of several revenue projections
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Net Present Value
F = future value P = present value r = interest rate N = number of years
P?
F (i ? 1) N
72
NPV in a More Convenient Form
Present value of $1.00
Year 1 2 3 4 5 6 7 8 9 5% 0.952 0.907 0.864 0.823 0.784 0.746 0.711 0.677 0.645 6% 0.943 0.890 0.840 0.792 0.747 0.705 0.665 0.627 0.592 7% 0.935 0.873 0.816 0.763 0.713 0.666 0.623 0.582 0.544 8% 0.925 0.857 0.794 0.735 0.681 0.630 0.583 0.540 0.500
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F NPv ? ? I ? N (r ? 1) NPv ? ? I ? FX 1 where X ? N (r ? 1 )
NPV example
I invest Rs 10,000/ - today in a security. In second year it gives me Rs 5000. In year 3 it gives me Rs 5000. In year 4 it gives me Rs 4500. What is the net present value of my investment if interest rate is 14%.
Year 0 -10,000
Yr 1 -
Yr 2 5000
Yr 3 5000
Yr 4 4500
Yr 5
-10,000
0
5000/ 5000/ 4500/ (1+.14)2 (1+.14)3 (1+.14)4
-10,000
3847
3374
2664
NPV = -10,000 + 3847+3374+2664 = ( -)15
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Cash Flow example
A local restaurant is considering adding a salad bar. The investment required to remodel the dining area and add the salad bar will be $16,000. Other information about the project is as follows. 1. The price and variable cost per salad are $3.50 and $2.00, respectively. 2. Annual demand should be about 11,000 salads. 3. Fixed costs, other than depreciation, will be $8,000, which cover the energy to operate the refrigerated unit and wages for another part-time employee to stock the salad bar during peak business hours. 4. The assets go into the MACRS 5-year class for depreciation purposes, with no salvage value. 5. The tax rate is 40 percent. 6. Management wants to earn a return of at least 14 percent on the project. Determine the after-tax cash flows for the life of this project.
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Cash Flow
Cash Flow = Net operating Income + Depreciation
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NPV for this problem
Yr 0 -16,000 -16000 Yr 1 6380/1.14 5596 Yr 2 Yr 3 Yr 4 Yr 5 7148/1.142 6329/1.143 5837/1.144 5837/1.145 5500 4272 3456 3031
NPV ( 5 year) = 5855
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Thank You
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Complementary Products
Sales (Units) 5,000 4,000 3,000 2,000 1,000 0
Total
Heaters
A/c s
J M M J S N J M M J S N J Time (Months)
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Approaches to Capacity Expansion
Expected Demand
New Capacity
Demand
Time in Years Capacity leads demand with an incremental expansion
80
Approaches to Capacity Expansion
Expected Demand New Capacity Demand
Time in Years
Capacity leads demand with a one-step expansion
81
Approaches to Capacity Expansion
Expected Demand New Capacity Demand Time in Years Capacity lags demand with an incremental expansion
82
Approaches to Capacity Expansion
New Capacity Expected Demand
Demand
Time in Years Attempts to have an average capacity, with an incremental expansion
83
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