5-1 Capacity Planning

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.
5-2 Capacity Planning

Evaluating Alternatives
Figure 5.3
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
5-3 Capacity Planning

Evaluating Alternatives
 An organization would evaluate for capacity
planning, if it is facing some economic conditions.
 Will the alternative be feasible?
 How much will it cost?

 How soon can we have it?

 What would be the change in the operating and

Evaluating Alternatives
Figure 5.4
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
5-5 Capacity Planning

Evaluating Alternatives
 Fixed cost tends to remain constant regardless of
the value of output. e.g. rental cost, property taxes,
equipment cost, heating and cooling expenses etc.
 Variable cost varies directly with the level of
output. e.g. material and labor cost.
 Variable cost per unit remains same regardless of
volume of output.
5-6 Capacity Planning

Evaluating Alternatives
 Step I
 TC = FC + VC
 Step II
 TR = R x Q
 Step III
 P = TR – TC
= (R x Q) – [FC + (VC)Q]
= Q(R - VC) – FC
Q = P + FC
R - VC
5-7 Capacity Planning

Cost-Volume Relationships
Figure 5.5a

Amount (Rs.) C
+ F
VC C)
s
=
t t (V
s
c o co
t al le
b
To ri a
l va
o ta
T
Fixed cost (FC)

0
Q (volume in units)
5-8 Capacity Planning

Cost-Volume Relationships
Figure 5.5b

ue
en
e v
l r
a
Amount

t
To
(Rs.)

0
Q (volume in units)
5-9 Capacity Planning

Cost-Volume Relationships
Figure 5.5c

ue
e n fi t
ev Pr o
r
al
Amount

t st
o
To alc
(Rs.)

t
To

0 BEP units
Q (volume in units)
5-10 Capacity Planning

Example 1
 The business owner of a sports goods factory in Sialkot
is adding a new line of cricket bats which will require
leasing new equipment for a monthly payment of Rs.
60,000. Variable cost would be Rs. 200 per bat. The bat
would be sold for Rs. 2,000.
1. How many bats would be sold in order to breakeven?
2. What would be profit/loss, if 100 bats are sold per month?
3. How many bats must be sold to realize the profit od Rs.
40,000?
5-11 Capacity Planning

Solution
1. QBEP = FC
R – VC
= 60,000
2,000 – 200
= 60,000
18,000
QBEP = 33.3 bats or 33 bats
5-12 Capacity Planning

Solution
2. P = Q(R - VC) – FC
= 100(2,000 - 200) – 60,000
= 100(1,800) – 60,000
= 180,000 – 60,000
= Rs. 120,000
5-13 Capacity Planning

Solution
3. Q= P +FC
R – VC
= 40,000 + 60,000
2,000 – 200
= 100,000
1,800
= 55.56 bats or 56 bats
5-14 Capacity Planning

Example 2

No. of Machines Total annual Output

1. Determine breakeven point for each range?

Solution 2
Machine 1
 BEP = FC
R – VC
= 10,000
500 – 100
= 25 units
5-16 Capacity Planning

Solution 2
 Machine 2
BEP = FC
R – VC
= 20,000
500 – 100
= 50 units
5-17 Capacity Planning

Solution 2
 Machine 3
BEP = FC
R – VC
= 30,000
500 – 100
= 75 units
5-18 Capacity Planning

Break-Even Problem with Step Fixed Costs

C =
+ V
FC
TC
= TC
V C
+
FC 3 machines
T C
C =
V
F C + 2 machines

1 machine
Quantity
Step fixed costs and variable costs.
5-19 Capacity Planning

Break-Even Problem with Step Fixed Costs

$
BEP
3
TC
BEP2
TC
3
TC
2
TR 1
Quantity
Multiple break-even points