PRODUCTIONSOPERATIONS MANAGEMENT

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PRODUCTION/OPERATIONS MANAGEMENT
Capacity Planning
Chapter 5
Shanling Li Summer, 2006
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Capacity Planning

• Capacity is the upper limit or ceiling on the
  load that an operating unit can handle ? how much
  we can produce
• Planning for capacity
• Long term deals with overall capacity level.
  Also called strategic capacity planning. Ex
  facility size, major expansions
• Short term deals with variations in capacity
  requirements (created by demand fluctuations) Ex
  Workforce-production plans

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Capacity Planning

• The basic questions of strategic capacity
  planning are
• What kind of capacity is needed?
• How much is needed?
• When is it needed?
• Importance of these decisions
• Determine ability to meet future demand and
  therefore remain/be competitive
• Affects cost (operating, investment costs)
• These decisions involve major investments and
  hence are irreversible in the short run.

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Steps in Strategic Capacity Planning

• Calculate current capacity
• Estimate long-term changes in demand and estimate
  future capacity needs
• Identify sources of capacity to meet these needs
• Select among these alternatives

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Definitions of Capacity

• Design capacity
• maximum obtainable output
• Effective capacity
• maximum capacity given product mix, scheduling
  difficulties, and other doses of reality. (NORMAL
  operating conditions)
• Actual output
• rate of output actually achieved--cannot exceed
  effective capacity.

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Measuring Capacity
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Capacity Utilization

• Measures how much of the available capacity is
  _______ being used

actually
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Efficiency/Utilization Example
Design capacity 50 trucks/day Effective
capacity 40 trucks/day Actual output 36
units/day Actual output
36 units/day Efficiency
90 Effective capacity
40 units/ day
Utilization Actual output
36 units/day
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Design capacity 50 units/day
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Special Requirements for Making Good Capacity
Decisions

• Forecast _______ accurately
• Understanding the technology and capacity
  _________
• Finding the optimal ____________ (volume)
• Build for ______

demand
increments
operating level
change
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Developing Capacity Alternatives

• Design flexibility into systems (for future
  expansion possibilities)
• Understand the product-life-cycle
• Prepare to deal with capacity chunks
• Consider outside sources of capacity -
  subcontracting, capacity acquisition
• Identify the optimal operating level

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Best Operating Level
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Choose Capacity by MatchingForecast Best
Operating Level
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Economies/Diseconomies of Scale
Minimum cost optimal operating rate are
functions of size of production unit.

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Strategy for Matching Capacity to Demand
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Strategy for Matching Capacity to Demand
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Strategy for Matching Capacity to Demand
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Strategy for Matching Capacity to Demand
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Selecting among Alternatives

• Decision Approaches
• Break-Even Analysis (BEA)
• Present Value Analysis (NPV)
• Decision Tree Analysis
• Simulation Waiting Line Analysis (primarily for
  service systems)
• Linear Programming
• Internal Rate of Return (IRR)
• Return on Investment (ROI)

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Breakeven Chart
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Break Even Analysis
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Break Even Analysis- Example 1
We want to add a new line of product. The annual
lease for the equipment is 9,000. We estimate
the production cost to be 3/unit. We plan to
sell it at 6/unit. How many units should we
produce and sell to break even?
If our forecast annual demand is 2,500 units,
should we invest in the new line?
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Break Even Analysis- Example 2

• Capacity investments may require step costs, i.e.
  fixed costs which increase as the desired output
  increases

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Break Even Analysis- Example 2
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Break Even Analysis- Example 2

• Calculate the BEP for each interval

• If estimated annual demand is between 550-650,
  how many machines?

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Example Continued
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Assumptions of Break-Even Analysis

• One product is produced
• The variable cost per unit is constant,
  regardless of the volume
• Revenue per unit is constant, regardless of
  volume
• Fixed cost is either constant or step function

Note that BEA can also be used for Make-or-Buy
analysis
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Present Value Analysis (NPV)

• Cash Flow - the difference between cash _______
  from sales and other sources, and cash ______ for
  labor, material, overhead, and taxes.
• Present Value - the sum, in _______ value, of all
  _____ cash flows of an investment proposal.
• The current value is calculated for a given
  interest rate (__________)

received
outflow
current
future
discount rate
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Present Value Analysis

• The basic formula

• Fn Cash Flow received n periods later in the
  future
• i interest rate per period
• P Net Present Value (Worth) of the cash flow

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PV Analysis for A Single Investment

• Determine the ________ of invest. (N)
• Estimate the _________ for each year F0, F1, F2,
  F3 , , FN-1, FN
• Calculate the _______________

useful life
cash flows
Present Value (PV)
If PV gt 0, the investment is a viable
alternative. Otherwise, reject.
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PV Analysis for Multiple Investments

• Calculate the _______________ for each
  alternative
• Choose the one with _______ PV (if its above 0)

Present Value (PV)
highest
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Example Continued
PVA 4868.5 PVB 7302.8
? CHOOSE _
B
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Assumption of the Present Value Method

• Future cash flows associated with the investments
  can be estimated with high degree of certainty
• The interest rate does not change over time
• When there is high uncertainty (e.g. with the
  future demand) other methods should be used -
  such as decision trees.

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Take Away

• Define explain capacity planning
• Learn tools of Capacity Planning
• Break-Even Analysis
• Single-Product Case
• Multi-product Case