20/1/2022

Capacity Planning

Dr. M. Azizur Rahman

PhD (NUS, Singapore), MSc (NTU, Singapore), MEng (NUS, Singapore), BSc Eng (BUET),
MIEB(Life), MIMechE, CEng(UK)
Assistant Professor
Dept. of Mechanical and Production Engineering
Ahsanullah University of Science and Technology (AUST)

Capacity Planning
• Capacity is the upper limit or ceiling on the
load that an operating unit can handle.
• Capacity is the maximum rate of output of a process or
a system

• The basic questions in capacity handling are:

– What kind of capacity is needed?
– How much is needed?
– When is it needed?
In any case, management must review product and service choices
periodically to ensure that the company makes capacity changes when
they are needed for cost, competitive effectiveness, or other reasons.

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Importance of Capacity
Decisions
CAPACITY DECISIONS ARE STRATEGIC

1.Impacts ability to meet future demands

2.Affects operating costs
3.Major determinant of initial costs
4.Involves long-term commitment
5.Affects competitiveness
6.Affects ease of management
7.Globalization adds complexity
8.Impacts long range planning

Defining and measuring

Capacity
• Design capacity
– maximum output rate or service capacity an
operation, process, or facility is designed for.
• Effective capacity
– Design capacity minus allowances such as
personal time, maintenance, and scrap.

Effective capacity is usually less than design capacity

owing to realities of changing product mix, the need
for periodic maintenance of equipment, lunch breaks,
problems in scheduling and balancing operations, and
similar circumstances.

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Efficiency and Utilization

- Actual output
rate of output actually achieved—cannot exceed
effective capacity.

Actual output
Efficiency =
Effective capacity

Actual output
Utilization =
Design capacity
Both measures expressed as percentages

Efficiency/Utilization Example
Design capacity = 50 units/day
Effective capacity = 40 units/day
Actual output = 36 units/day

Actual output 36 units/day

Efficiency = = = 90%
Effective capacity 40 units/ day

Utilization = Actual output 36 units/day

= = 72%
Design capacity 50 units/day

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Determinants of Effective
Capacity

• Facilities (size and provision for expansion)

• Product and service factors
• Process factors (quality of output)
• Human factors (training, skill, experience)
• Operational factors (inventory stocking
decisions, late deliveries, quality inspection)
• Supply chain factors (suppliers, ware house,
transportation, distributors)
• External factors (pollution standards,
unnecessary paper works)

Strategy
• Strategies plans for achieving
organizational goals
– Vision
– Mission
– Goal
– Strategy (It provides focus for decision
making)
– Tactics (the methods and actions used to
accomplish strategies)
– Operations
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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 (availability of capital,
lead time, etc. needed to make the
changes, expected demand)
3.Need to maintain balance
4.Extent of flexibility of facilities
(uncertainty of demand will influence it)

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Steps for Capacity Planning

1.Estimate future capacity requirements
2.Evaluate existing capacity and facilities
3.Identify alternatives for meeting
requirements
4.Conduct financial analysis of alternatives
5.Assess key qualitative issues
6.Select one alternative
7.Implement alternative chosen
8.Monitor results

Make or Buy
Make - Produce good or provide service itself
Buy – Outsource from another organizations

Factors:
• Available capacity
• Expertise
• Quality considerations
• Nature of demand
• Cost
• Risk

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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”
(mass/large)
5.Attempt to smooth out capacity
requirements
6.Identify the optimal operating level ( in
terms of cost of unit cost of output)
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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 (instability) of
demand
– Peak demand periods

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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 Optimal
Rate Rate of output
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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

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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

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Cost volume Analysis

Financial Analysis
𝑻𝒐𝒕𝒂𝒍 𝑪𝒐𝒔𝒕, 𝑻𝑪 = 𝑭𝑪 + 𝑽𝑪
• Net present value 𝑉𝑎𝑟𝑖𝑎𝑏𝑙𝑒 𝐶𝑜𝑠𝑡, 𝑉𝐶 = 𝑄 × 𝑣
• Internal rate of return
𝑇𝑜𝑡𝑎𝑙 𝑅𝑒𝑣𝑒𝑛𝑢𝑒, 𝑇𝑅 = 𝑄 × 𝑟
• Pay back period

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Cost-Volume Relationships

A. Fixed, variable and total costs

Amount ($)

Fixed cost (FC)

0
Q (volume in units)
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Cost-Volume Relationships
B. Total revenue increases linearly with output
Amount ($)

0
Q (volume in units)

203

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Cost-Volume Relationships
C. Profit = TR – TC
(At BEP, TR = TC)

Amount ($)

0 BEP units
Q (volume in units) 204

Break-even Analysis

• Total Cost = Fixed Cost +Variable Cost

TC = FC + VC
• Variable Cost = Number of Unit Produced X
Variable Cost Per Unit
VC = Q X v
• Total revenue = Number of Unit Produced X
Revenue Per Unit
TR = Q X r

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Break-even Analysis

• Profit = TR – TC
= (Q X r) - [FC + VC]
= (Q X r) - [FC + (Q X v)]
= Qr - FC – Qv
= Qr - Qv - FC
= (r-v)Q – FC

𝑷𝒓𝒐𝒇𝒊𝒕 𝑭𝑪
Q=
𝒓 𝒗

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Break-even Analysis
• Break-even point (BEP) is the point at which total
cost and total revenue are equal. That means profit
is equal to zero. There no profit, no loss at this
point.
• TR = TC
=> Q X r = FC + VC
Q X r = FC + (Q X v)
Qr – Qv = FC
=> Q( r – v) = FC
=> Q =

BEPx = BEP$ = Xr
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Break-even Analysis

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Figure: Break-even Chart

Break-even for Linear TR and TC

• If the variable cost
per unit is reduced,
then the TC line has
a smaller slope and
the breakeven point
will decrease.
• This is an advantage
because the smaller
the value of Q(BE),
the greater the
profit for a given
amount of revenue

Figure: Effect on the

breakeven point when
the variable cost per unit
is reduced
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Break-even Analysis
Problem-1
Normal production level of a company is 60 per
month, but due to significantly improved economic
conditions, now the production is increased at 72
per month. Fixed cost is $2400 per month,
Variable cost per unit is $35 and Revenue per unit
is $75.
(a) Calculate the breakeven point.
(b) What is the current profit level per month for
the facility?
(c) What will be the revenue if monthly production
level reduced to 45 units and others remain
constant? 210

Break-even Analysis
Here, Fixed cost, FC = $2400
Variable cost per unit, v = $35
Revenue per unit, r = $75
(a)BEPx = = = 60 units
(b) Current profit, p = Q × (r - v) - FC
= 72 × ($75 - $35) - $2400
= $480
(c) We know, p = Q × (r - v) – FC
For Q = 45 units,
$480 = 45 × (r - $35) - $2400
=> $480 + $2400= 45 × (r - $35)
=>$2880/45 = r - $35
⸫ revenue, r = $99 211

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Break-even Analysis

Problem-2
A firm produces radios with a fixed cost of $7000
per month and a variable cost of $5 per radio. If
radio sell for $8 each:
a) What is the break even point?
b) What output is needed to produce a profit of
$2000/month?
c) What is the profit or loss if 500 radios are
produced each week?

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Break-even Analysis

a) BEPx = = = 2333 radios per month

b) Q= = = 3000 radios per

month

c) Monthly Production = 500 X (52/12) = 2167

Profit = TR – TC = (r-v)Q – FC = (8-5) X 2167 –
7000 = - 500 ($500 loss per month)

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Break-even Analysis

Problem-3

A firm produces radios with a fixed cost of $7000

per month and a variable cost of $5 per radio for
the first 3000 radios produced per month. For all
the radios produced each month after the first
3000 the variable cost is $10 per radio (for added
overtime and maintenance costs). If radios sell
for $8 each, what are the break even points?

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Break-even Analysis
For any Q: TR = 8Q
For Q<=3000/month: TC = 7000 + 5Q
For Q>3000/month: TC = 7000 + 5(3000) + 10 (Q-3000)
= -8000 + 10Q
For Q<=3000/month: 7000 + 5Q = 8Q => Q= 2333/month
This is Q<=3000/month. So, it is a valid break-even point.
For Q>3000/month: -8000 + 10Q = 8Q => Q =4000/month
This is Q>3000/month. So, it is a valid break-even point.

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Resource Planning ,
Budgeting &
Cost Estimation

Dr. M. Azizur Rahman

PhD (NUS, Singapore), MSc (NTU, Singapore), MEng (NUS, Singapore), BSc Eng (BUET),
MIEB(Life), MIMechE, CEng(UK)
Assistant Professor
Dept. of Mechanical and Production Engineering
Ahsanullah University of Science and Technology (AUST)

Resource (Capacity) Planning

Capacity Requirement Planning (CRP)
 is a tool to show the workload at each work centre, based
on forecasts and all known demands.
CRP assumes infinite capacity.
It does not automatically solve capacity problems,
Only tells us what are the problems.

To calculate capacity requirements, we need a Routing,

 which is a list of the operations needed to produce an item,
 with the time it takes to set-up and operate the machine

When you do not have enough capacity, basically you have two
alternatives:
 Get more capacity
 Change the MPS
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Capacity Planning
Capacity
Planning

Material
Requirement
Planning

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Material Requirements Planning

• Materials requirements planning (MRP I) is the
logic for determining the number of parts,
components, and materials needed to produce a
product.
• MRP provides time scheduling information
specifying when each of the materials, parts, and
components should be ordered or produced.
• MRP is a software system to manage dependent
demand inventory.

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Independent vs Dependent Demand

▪ Independent demand - the demand for item is independent of the

demand for any other item in inventory

▪ Dependent demand - the demand for item is dependent upon the

demand for some other item in the inventory

Independent Dependent demand

demand

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MRP Evolution

MRP Schedule Materials

Closed Loop Schedule Materials

MRP Incorporate Feedback

Schedule & Purchase

MRP II Materials
Coordinate w/ Mfg
Resources

ERP

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ERP Systems

• Enterprise Resource Planning Systems is a

computer system that integrates application
programs in accounting, sales, manufacturing,
and other functions in the firm
• This integration is accomplished through a
database shared by all the application programs

Typical ERP System

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Enterprise Resource Planning (ERP)

• What an ERP system does
• Integrating the firm’s functional areas
• Used by many different types of organizations

 How ERP systems are designed

 Single comprehensive database
 Managers to monitor all of the company’s products at all locations
and at all times
 Information is automatically updated in the all applications when
transactions occur
 Streamlines the data flows throughout the organization
 Requires a careful analysis of major processes
 Significant changes in ERP systems - interoperability
Copyright © 2010 Pearson Education, Inc.
Publishing as Prentice Hall.

Materials Requirements Planning (MRP I)

• MRP is a computerized information system to manage
dependent demand inventory and schedule orders

• Translates the master production schedule (MPS) into

requirements for all subassemblies, components, and raw
materials through the MRP explosion

 Dependent demand
 Quantity required varies with the production plans of other items
 Component
 Parent

Copyright © 2010 Pearson Education, Inc.

Publishing as Prentice Hall.

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MRP Inputs

Authorized Other
master production sources
schedule of demand

Engineering
Inventory Inventory MRP Bills of
and process
transactions records explosion materials
designs

Material
requirements
plan

Figure – Material Requirements Plan Inputs

Copyright © 2010 Pearson Education, Inc.

Publishing as Prentice Hall.

Bill of Materials
• A record of all components of an item
• Shows the parent-component relationship
• The usage quantities are derived from engineering and
process design

 Some common terms

 End items
 Intermediate items
 Subassemblies
 Purchased items
 Part commonality (sometimes called standardization of
parts or modularity)

Copyright © 2010 Pearson Education, Inc.

Publishing as Prentice Hall.

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Bill of Materials (BOM)

A: End item or Final product D,E,G: Purchased items
B,C,F: Intermediate item/Subassemblies/Parent

LT = 1

B (3) C (1)

LT = 2 LT = 3

D (1) E (2) F (1) D (1)

LT = 3 LT = 6 LT = 1 LT = 3

G (1)

LT = 3
Figure 15.19 – BOM for Product A
Copyright © 2010 Pearson Education, Inc.
Publishing as Prentice Hall.

Master Production Schedule (MPS)

• Details how many end items will be produced within
specified periods of time
It breaks the sales and operations plan into specific product
schedules
Create a prospective MPS and test whether it meets the schedule
with available resources

 Sums of quantities must equal to sales and operational plan

 Production must be allocated efficiently over time
 Capacity limitations and bottlenecks may be determined

Copyright © 2010 Pearson Education, Inc.

Publishing as Prentice Hall.

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Difference between CRP and MRP

CRP MRP
• Deals with Workcenter • Deals with Part Number
• How much capacity need? • What is needed?
• When the capacity needed? • When the material is needed?
• Objective: • Objective:
 Sufficient capacity  Provide ‘right
availability materials/parts
 ‘where’ and ‘when’  ‘right time to right place’
needed  to meet schedules for
 to accomplish planned complete products
production

230

Budget &
Cost Estimation
A plan for allocating resources, especially, allocates
the scarce resources to various endeavors of
organization
After plan, First priority is to obtain resources to do work

Over-funding – produce waste/encourage slack management

Under-funding – inhibits accomplishments/creates frustration

Need to forecast
• resources required
• quantity and time required
• cost including price inflation
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Two types of budget

• Top-Down
• Bottom-Up

Top-Down budget
• Managers estimate overall project cost as well as cost of major subprojects
• Lower levels breakdown the estimates for the specific tasks
• Mainly prepared based on “considerable past experience”
Bottom-Up budget
• Elemental tasks, schedules and individual budgets are constructed following WBS
• People related to work are consulted regarding times and budgets for accuracy
• Start with estimating in terms of resources, e.g., labor hr, material

Two budgets are never going to be same

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Iterative budget

First, senior management needs to increase top-down budget

Next, junior team involved in real work reduces bottom-up budget

If negotiation point is not reached

If low impact at final If high impact at final

stage, accept the stage, accept the
seniors’ one juniors’ one 233

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Estimating cost
• Direct cost
• Overhead cost
• General & Administrative (G&A) cost

Cost estimating method

• Ratio method
• Similar cost of past project – start point
• Factors related to uniqueness
• People factor
• External factors

Most reliable method is to ask related person

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Time-phased budget

Committed
Costs

Scheduled

Actual

Project duration

Two types of error in budget estimation

• Random error – overestimate and underestimate are equally likely
• Biased error – overestimate and underestimate are not equally likely

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Two simple statistical measures are used for a person’s

performance as an estimator:

 MAD/MAR – Mean absolute deviation/ration

 TS – Tracking signal

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