This chapter examines how important strategic capacity planning is for

products and services. The overall objective of strategic capacity planning is

to reach an optimal level where production capabilities meet demand.
Capacity needs include equipment, space, and employee skills. If production
capabilities are not meeting demand, high costs, strains on resources, and
customer loss may result. It is important to note that capacity planning has
many long term concerns given the long term commitment of resources.
Managers should recognize the broader effects capacity decisions have on
the entire organization. Common strategies include leading capacity, where
capacity is increased to meet expected demand, and following capacity,
where companies wait for demand increases before expanding capabilities. A
third approach is tracking capacity which adds incremental capacity over
time to meet demand.Finally, The two most useful functions of capacity
planning are design capacity and effective capacity. Design capacity refers to
the maximum designed service capacity or output rate and the effective
capacity is the design capacity minus personal and other allowances.
These two functions of capacity can be used to find the efficiency
and utilization. These are calculated by the formulas below:
Efficiency = Actual Output/ Effective Capacity x 100%
Utilization = Actual Output/ Design Capacity x 100%
-Chapter 5 Strategic Capacity Planning for Products and Services

Capacity refers to a system's potential for producing goods or delivering

services over a specified time interval. Capacity planning involves long-term
and short term considerations. Long-term considerations relate to the overall
level of capacity; short-term considerations relate to variations in capacity
requirements due to seasonal, random, and irregular fluctuations in demand.

Excess capacity arises when actual production is less than what is achievable
or optimal for a firm. This often means that the demand in the market for the
product is below what the firm could potentially supply to the market. Excess
capacity is inefficient and will cause manufacturers to incur extra costs or
lose market share. Capacity can be broken down in two categories: Design
Capacity and Effective Capacity: refers to the maximum designed service
capacity or output rate. Effective capacity is design capacity minus personal
and other allowances. Product and service factors effect capacity
tremendously.

Chapter 5 focuses on capacity planning for products and services. Capacity is

the ability of a systems potential for producing goods or delivering services
over a specific time interval. The capacity decisions within a company are
very important because they help determine the limit of output and provide a
major insight to determining operating costs. Basic decisions about capacity
often have long term consequences and this chapter explains the
ramifications of those choices. When considering capacity planning within a
company, three key inputs should be considered. The three inputs are the
kind of capacity to be determined, how much of the products will be needed,
and when will the product be needed.

The most important concept of capacity planning is to find a medium

between long term supply and capabilities of an organization and the
predicted level of long term demand. Organizations also have to plan for
actual changes in capacity, changes in consumer wants and demand,
technology and even the environment. When evaluating alternatives in
capacity planning, managers have to consider qualitative and quantitative
aspects of the business. These aspects involve economic factors, public
opinions, personal preferences of managers.

This chapter describes capacity planning as a key factor in designing

systems. The capacity decision is strategic and long-term in nature. Capacity
planning is described as matching the capabilities of an organization with the
predicted level of future demand. Many organizations become involved with
capacity planning due to changes in demand, technology, the environment,
etc. Organizations have capacities or limits that their system can handle.

Three key inputs to capacity planning:

1. The kind of capacity that will be needed
2. How much capacity will be needed
3. When will it be needed
*Accurate forecasts are critical to the planning process

Defining And Measuring Capacity

When selecting a measure of capacity, it is best to choose one that doesn't

need updating. When dealing with more than one product, it is best to
measure capacity in terms of each product. For example, the capacity of a
firm is to either produce 100 microwaves or 75 refrigerators. This is less
confusing than just saying the capacity is 100 or 75. Another method of
measuring capacity is by referring to the availability of inputs. Note that one
specific measure of capacity can't be used in all situations; it needs to
tailored to the specific situation at hand.

Determinants of Effective Capacity

Facilities: The size and provision for expansion are key in the design of
facilities. Other facility factors include locational factors (transportation costs,
distance to market, labor supply, energy sources). The layout of the work
area can determine how smoothly work can be performed.
Product and Service Factors: The more uniform the output, the more
opportunities there are for standardization of methods and materials. This
leads to greater capacity.
Process Factors: Quantity capability is an important determinant of capacity,
but so is output quality. If the quality does not meet standards, then output
rate decreases because of need of inspection and rework activities. Process
improvements that increase quality and productivity can result in increased
capacity. Another process factor to consider is the time it takes to change
over equipment settings for different products or services.
Human Factors: the tasks that are needed in certain jobs, the array of
activities involved and the training, skill, and experience required to perform
a job all affect the potential and actual output. Employee motivation,
absenteeism, and labor turnover all affect the output rate as well.
Policy Factors: Management policy can affect capacity by allowing or not
allowing capacity options such as overtime or second or third shifts
Operational Factors: Scheduling problems may occur when an organization
has differences in equipment capabilities among different pieces of
equipment or differences in job requirements. Other areas of impact on
effective capacity include inventory stocking decisions, late deliveries,
purchasing requirements, acceptability of purchased materials and parts, and
quality inspection and control procedures.

Supply Chain Factors: Questions include: What impact will the changes have
on suppliers, warehousing, transportation, and distributors? If capacity will be
increased, will these elements of the supply chain be able to handle the
increase? If capacity is to be decreased, what impact will the loss of business
have on these elements of the supply chain?
External Factors: Minimum quality and performance standards can restrict
management's options for increasing and using capacity.
Inadequate planning can be a major limiting determining of effective
capacity.

The most important parts of effective capacity are process and human
factors. Process factors must be efficient and must operate smoothly, if not
the rate of output will dramatically decrease. Human factors must be trained
well and have experience, they must be motivated and have a low
absenteeism and labor turnover. In resolving constraint issues, all possible
alternative solutions must be evaluated. This is possible by using CVP
analysis and the Break-Even Point formula.

Steps in the Capacity Planning Process

1. Estimate future capacity requirements
2. Evaluate existing capacity and facilities and identify gaps
3. Identify alternatives for meeting requirements
4. Conduct financial analyses of each alternative
5. Assess key qualitative issues for each alternative
6. Select the alternative to pursue that will be best in the long term
7. Implement the selected alternative
8. Monitor results

Questions:
1. All of the following factors are part of determining effective capacity
except:
a. Human
b. External
c. Facility
d. Design
e. all of the above are factors
answer:d design factors...page 181

2. The capacity planning process DOES NOT include which of the following?
a. Estimate future requirements
b. Implement selected alternative
c. Access key quantitative issues
d. Identify alternatives
e. Both a & d
answer:c page 183

3. All of the following are true of Capacity decisions except:

a. impact the ability of the organization to meet future demands
b. affect operating costs
c. are a major determinant of initial cost
d. are a major determinant of variable cost
e. often involve long term commitment of resources.

answer: d

4. Which of the following industries measure capacity?

a. Farming
b. Theater
c. Retail Sales
d. Hospital
e. All of the above
answer e. page 180

5. Which of the following describes the initial cost of an investment?

a. Internal rate of return
b. proceeds
c. Present value
d. cash flow
e. Both a & d
answer: c. page 196

6) Which statement best describes a constraint of capacity planning?

a. Facilitates the performance of a process or system in achieving its goal
b. Limits the performance of a process or system in achieving its goal
c. Enhances the performance of a process or system in achieving its goal
d. Excels the performance of a process or a system in achieving its goal.
e. Maximizes the performance of a process or a system in achieving its goal

Answer: B answer on page 201 in the margin

7) What are the three primary strategies in capacity planning?

a. growing,leading, tracking
b. leading, moving, tracking
c. leading, following, tracking
d. tracking, analyzing, leading
e. synthesizing, leading, tracking

Answer: C found on page 191

8) Which of the following is NOT a determinant of effective capacity planning?

a. supply chain
b. external forces
c. human considerations
d. operational factors
e. all the above are determinants of effective capacity planning

Answer: E all the above, answer found on page 189

9) What are the major difference between design capacity and effective
capacity?
a. the size of the facility vs the effectiveness of the facility
b. the design and aesthetics of the facility vs. the size of the facility
c. the design and aesthetics of the facility vs. the effectiveness of the facility
d. the actual amount of output vs. the potential maximum amount of output
e. there is no difference

Answer: D actual output vs. potential maximum output

10) Which answer(s) defines why capacity decisions are important?

a. capacity decisions have a real impact on whether or not a company will
meet future demands
b. capacity decisions affect operating costs
c. capacity decisions are generally a major determinant of initial cost
d. capacity decisions affect competitiveness and management
e. all of the above are components of capacity decision importance

Answer: E all of the above

11) When would a company incorporate a capacity cushion?

a. when demand is certain

b. when demand is uncertain
c. when the company has very standard products
d. when the company sales are declining
e. when the company sales are increasing

Answer: B demand is uncertain (192)

12) Which of the following is a reason a company would want to outsource?

a. The organization does not have the necessary skills
b. The organization has unique quality requirements
c. Demand is high and steady
e. none of the above

answer: E none of the above (195)

13) What is the evidence of an unbalanced system?

a. system is flexible
b. stage of life cycle is taken into account
c. capacity requirements are smoothed out
d. a bottleneck operation exists
e. the company is in the growth phase
Answer: E bottleneck operation exists (197)

14) At the break even point

a.TC=TR
b. The firm is obtaining a profit
c. TFC=TVC
d. Volume of output is TC > TR
e. none of the above

answer: (A) total cost and total revenue are equal (203)

15) Dis-economies of scale happen when

a. the output rate is less than the optimal level
b. the firm should increase the output rate in order to decrease average unit
costs
c. the output rate is more than the optimal level
d. none of the above
e. both a and b

answer: C the output rate is more than the optimal level (200)

16) Reasons for strategic capacity planning include all of the following
except :
a) Changes in the environment
b) Changes in technology
c) Changes in demand
d) Strengths and weaknesses
e) Opportunities and threats

D. Strengths and weaknesses (pg 185)

17) Strategic capacity planning for services differs from that for goods due to:
a) The inability to store services in advance
b) Demand volatility
c) Degree of customization
d) The need for customer convenience
e) All of the above

E. All of the above (pg 194)

18) Relevant criteria in determining whether to outsource production include:

a) Location
b) Quality
c) Current in-house capacity
d) Costs

e) All of the above

E. All of the above (pg 195)

19) In dis-economies of scale, average unit costs after the optimal level are:
a) Larger
b) Smaller
c) Lowest
d) Constant
e) None of the above

A. Larger (pg 200)

20) Which of the following assumptions must be satisfied in order to use Cost
Volume Analysis?
a) Variable cost per unit is greater than revenue per unit
b) Variable cost per unit is constant
c) More than one product in involved
d) Fixed costs change with volume
e) Revenue per unit changes with volume

B. Variable cost per unit is constant (pg 205)

21) Which of the following is NOT a primary capacity strategy?

a) continuous
b) leading
c) following

d) tracking
e) both b and d
Answer: a, page 191

22) Which is an important factor in planning service capacity?

a) availability of capacity
b) the need to be near customers
c) the degree of volatility of demand
d) both b and c
e) none of the above
Answer: d, page 194

23)The maximum designed service capacity or output rate is known as?

a) capacity cushion
b) bottleneck operation
c) effective capacity
d) design capacity
e) both c and d
Answer: d, page 188

24) Given the following information, compute the efficiency: Effective

capacity = 40 trucks per day, Actual output = 36 trucks per day
a) 82%
b) 99%
c) 90%
d) 89.7%
e) 54%

Answer: c, page 189

25) Which of the following are steps in the capacity planning process?
a) estimate future capacity requirements
b) conduct financial analysis
c) monitor results
d) implement the selective alternative
e) all of the above
Answer: e, page 192

26) Which of these are NOT determinants of effective capacity?

a) Facilities
b) Process Factors
c) Human Factors
d) Policy Factors
e) All of above are determinants of effective capacity
Answer E (page 190)

27) What is a constraint?

a) Something that allows a system to perform more effectively and efficiently.
b) Something that hinders performance of a system in achieving its goals.
c) Something that attempts to smooth out capacity requirements.
d) Something that monitors results
e) Something that can never be overcome.
Answer B (page 201)

28) Which assumptions must be satisfied in order for cost-volume analysis to

be a valuable tool?
a) Variable cost/unit exceeds revenue/unit
b) Everything produced may not be sold
c) Only one product involved
d) Revenue per unit may change depending on volume
e) Variable cost per unit may differ depending on volume
Answer C (page 205)

29) What is the correct formula for the break even point in units?
a) FC / (Revenue per unit - VC per unit)
b) VC/(FC-Revenue)
c) Revenue/(VC - FC)
d) FC/(VC-Revenue)
e) None of the above
Answer A (page 204)

30) What is the best way to measure capacity for a steel mill?
a) In dollars
b) In number of workers
c) In the size of the mill
d) In tons of steel produced per day
e) In number of resources used
Answer D (page 188)

31) What is the first step in the capacity planning process?

A. Evaluate existing capacity

B. Estimate future capacity

C. Determine future capacity price
D. Select alternative capacity
E. Find key quality issues
Answer = B. Page 192

32) Which of these is a determinant of effective capacity?

A. Facilities
B. Product factors
C. Human factors
D. Operational factors
E. All of these
Answer = E. Page 190

33) What is the first step in strategy formulation?

A. Determine Product/Service
B. Formulate policy
C. Locate facilities
D. Formulate process
Order operations
Answer = C. Page 191

34) When is it best to use simulation?

A. For short tem goals
B. For long term goals
C. For current goals

D. For customer wants

E. For what if analysis
Answer = E. Page 207

35) Decision theory is best used in which of the following?

A. Finance
B. Inventory
C. Long term analysis
D. Consumer demand
E. Short term analysis
Answer = A. Page 207

36) What is capacity?

I. The upper limit or ceiling on the load that an operating unit can handle.
II. The lower limit or bottom on the load that an operating unit can handle.
III. A systems potential for producing goods or delivering services over a
specified time interval.
IV. A ceiling on output and a major determinant of operating costs.

a.) I and II
b.) II and III
c.) I, II, and IV
d.) I, III, and IV
e.) I and IV

Answer: D. Found on pages 185, 207

37) What is the difference between efficiency and utilization?

a.) Efficiency is the ratio of actual output to effective capacity, while capacity
utilization is the ratio of actual output to design capacity.
b.) Efficiency is expressed as a percentage, while capacity utilization is not.
c.) Efficiency is a measure of system effectiveness, while capacity utilization
measures capacity tailored to a situation.
d.) Utilization is the ratio of actual output to effective capacity, while
efficiency is the ratio of actual output to design capacity.
e.) Utilization is expressed as a percentage, while efficiency is not.

Answer: A. Found on page 188

38) Find the design capacity when utilization = 72 and actual output = 36
trucks per day.

a.) 35 trucks per day

b.) 40 trucks per day
c.) 45 trucks per day
d.) 50 trucks per day
e.) 55 trucks per day

Answer: D. Found on page 189 (Utilization = [Actual Output/ Design Capacity]

x 100)
Therefore: [36/x] x 100 = 72
36 x 100x = 72x
36 = .72x

x = 50

39) An operation in a sequence of operations whose capacity is lower than

that of the other operations is known as:

a.) Effective Capacity

b.) Design Capacity
c.) Bottleneck Operation
d.) Capacity Cushion
e.) Effective Operation

Answer: C. Found on page 197

40) Which of the following is NOT one of the five steps used to resolve
constraint issues:

a.) Identify the most pressing constraint.

b.) Change the operation to achieve the maximum benefit, given the
constraint.
c.) Make sure other portions of the process are supportive of the constraint.
d.) Explore and evaluate ways to overcome the constraint.
e.) Allow the constraint to limit performance when a strategy is expanding.

Answer: E. Found on page 201 and 202

Possible Future Demand

Alternatives
Low
Moderate
High
Small Facility
$10
$11
$11
Medium Facility
7
12
12
Large Facility
(3)
2
16

41. Use the information above to answer this question. If the company uses
Maxi-min Criterion to choose the best alternative, what would be the best
choice for this company?
a) Small Facility
b) Medium Facility
c) Large Facility
d) Do Nothing
e) They are all incorrect answers.
Answer is A found on page 217 (Supplement to Chapter 5)

42. What is Capacity cushion? If utilization is 38%.

a) 72%
b) 74%
c) 12%
d) 22%
e) 62%

Answer is E found on page The formula is Capacity cushion = 100% Utilization

Product
Annual Demand
Standard Processing Time per Unit (Hr)
Processing Time Needed (Hr)
1
300
5.00
1,500
2
400
8.00
3,200
3
700
2.00
1,400

Total
6,100

43. Use the information in the table to answer this question. Note:
department is working one 8-hour shift 250 days a year. How many machines
would be needed to handle the required volume? (Round your answer to the
whole number)
a) 3 machines
b) 1 machines
c) 5 machines
d) 2 machines
e) 4 machines
Answer is A found on page 194.

Based on the information below answer the following Questions 44-47.

The owner of Cookies Inc., Zoya, is contemplating adding a new line of

cookies, which require leasing for a monthly payment of $4,000. Variable
costs would be $2 per cookie, and cookies retail price for $6 each.

44. How many cookies must be sold in order to break-even?

a) 1000 cookies/month
b) 1200 cookies/moth
c) 2100 cookies/moth
d) 1100 cookies/moth
e) None of the above.

Answer is A found on page 204. FC=$4,000; VC=$2 per cookie: Rev.=$6 per
cookie; Q=FC/(Rev-VC); Q=$4,000/($6-$2)=1000 cookies/month.

45. What would be the profit (loss) if 900 cookies are made and sold in a
month?

a) 400 profit
b) 400 loss
c) 4000 profit
d) 4000 loss
e) None of the above.

Answer is B found on page 204. P = Q(R - v) - FC

46. How many cookies must be sold to realize a profit of $10,000?

a) 3500 cookies
b) 5300 cookies
c) 3000 cookies
d) 3200 cookies
e) 2300 cookies

Answer is A found on page 204. Q=($10,000+$4,000)/($6-$2)=3,500 cookies

47. If 2,500 cookies can be sold, and a profit is $8,000, what price should be
charged per cookie?

a) $7.00
b) $7.50
c) $6.80
d) $6.50
e) $7.80

Answer is C found on page 204.

Profit = Q(R - v) - FC
$8,000=2,500(R-$2)-$4,000
$8,000+$4,000=2,500R-$5,000
$17,000=2,500R
R=$6.8

Number of Machines

Total Annual Fixed Costs

Corresponding Range of Output

$12,00

0 to 300

15,000

301 to 600

24,000

601 to 900

Variable Cots is $12 per unit, and revenue is $42 per unit.

Use the table above to answer the following Questions 8-10.

48. Determine the break-even point for range (0 to 300).

a) 400 units
b) 320 units
c) 420 units
d) 380 units
e) 520 units

Answer is A found on page 205. Q=FC/(R-v); 12,000/($42-$12)=400 units.

49. Determine the break even point for range (301 to 600).

a) 500 units
b) 400 units
c) 320 units
d) 420 units
e) 520 units

Answer is A found on page 205.

50. If projected annual demand is between 580 and 650 units, how many
machines should the manager purchase. If break-even point for
One machine: 400 units Range (0 to 300)
Two machines: 500 units Range (301 to 600)
Three machines: 800 units Range (601 to 900)
a) 2 machines
b) 3 machines
c) 1 machine
d) a&b both are correct
e) None of the above; the manager should do nothing.

Answer is A found on page 205.

Comparing the projected range of demand to the two ranges for which a
break -even point, you can see that the break-even point is 500 units, which
is in the range 301 to 600. This means that even if demand is at the low end
of the range, it would be above the break even point and thus yield a profit.
That is not true of range 601 to 900. At the top end of projected demand, the
volume would still be less than the break-even point for that range, so there
would be no profit. Thus, the manager should choose two machines.

51) If the output rate is less than the optimal level, increasing the output rate
results in decreasing average unit costs according to:
a) diseconomies of scale
b) economies of scale
c) capacity cushion
d) efficiency
e) utilization

Answer B (Page 200)

52) If: Design capacity= 60 trucks per day, effective capacity = 40 trucks per
day, actual output = 36 trucks per day, compute the efficiency:

a) 20%
b) 30%
c) 40%
d) 50%
e) 90%

Answer E (Efficiency=Actual output/effective capacity=36trucks per day/40

trucks per day=90%) (Page 188)

54) What is capacity cushion?

a) Extra amount of capacity intended to offset uncertainty in demand

b) Estimate in future capacity requirement

c) Common demand pattern
d) External service or good
e) All of the above

Answer A (Page 192)

55) What do long term considerations relate to?

a) demand
b) capacity cushion
c) supply
d) overall level of capacity requirements
e) short term events

Answer D (Page 192)

56) What are the three primary strategies of a strategy formulation?

a. leading, following, and concluding

b. start up, following, and tracking
c. leading, following, and tracking
d. start up, leading, and follow up
e. leading, processing, concluding
answer is c. (found on page 191)