Chapter 6  Capacity Planning

Chapter

6 Planning Capacity

TRUE/FALSE

1. Capacity is the maximum rate of output of a process.

Answer: True
Reference: Introduction
Difficulty: Easy
Keywords: capacity, maximum output rate

2. Capacity decisions should be made separate from strategic decisions.

Answer: False
Reference: Introduction
Difficulty: Moderate
Keywords: capacity decision, strategic decisions

3. Capacity can be expressed by output or input measures.

Answer: True
Reference: Planning Long-Term Capacity
Difficulty: Moderate
Keywords: capacity, input measures, output measures

4. Input measures of capacity are inherently more accurate than output measures of capacity.
Answer: False
Reference: Planning Long-Term Capacity
Difficulty: Moderate
Keywords: input measures, output measures, capacity

5. Utilization is the degree to which equipment, space, or labor is currently being used.
Answer: True
Reference: Planning Long-Term Capacity
Difficulty: Easy
Keywords: utilization, equipment used, space used, labor used

6. One reason economies of scale drive down cost is the spreading of fixed costs.
Answer: True
Reference: Planning Long-Term Capacity
Difficulty: Moderate
Keywords: economies of scale, fixed cost

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 Chapter 6  Capacity Planning

7. Economies of scale drive down cost even though the cost of purchased materials can be
expected to increase.
Answer: False
Reference: Planning Long-Term Capacity
Difficulty: Moderate
Keywords: economies of scale, purchased materials cost

8. Diseconomies of scale is a concept that states that the average unit cost of a service or good
can be reduced by increasing its output rate.
Answer: False
Reference: Planning Long-Term Capacity
Difficulty: Easy
Keywords: diseconomies of scale, average unit cost, output rate

9. A capacity cushion is the amount of inventory that a firm maintains to handle sudden
increases in demand or temporary loss of production capacity.
Answer: False
Reference: Capacity Timing and Sizing Strategies
Difficulty: Moderate
Keywords: capacity cushion

10. A larger capacity cushion may be required due to variation in demand, changing product mix,
or supply uncertainty.
Answer: True
Reference: Capacity Timing and Sizing Strategies
Difficulty: Moderate
Keywords: capacity cushion, variation in demand, changing product mix, supply
uncertainty

11. A smaller capacity cushion may be required if a process is highly capital intensive.
Answer: True
Reference: Capacity Timing and Sizing Strategies
Difficulty: Moderate
Keywords: capacity cushion, capital intensity

12. A larger capacity cushion can help firms uncover process inefficiencies, so they can find
ways to correct them.
Answer: False
Reference: Capacity Timing and Sizing Strategies
Difficulty: Moderate
Keywords: capacity cushion, process inefficiencies

13. Capacity cushions may be lowered if companies smooth the output rate by raising prices
when inventory is low and decreasing prices when it is high.
Answer: True
Reference: Capacity Timing and Sizing Strategies
Difficulty: Moderate
Keywords: capacity cushion, output rate, changes in pricing, inventory levels

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 Chapter 6  Capacity Planning

14. An expansionist capacity strategy involves large, infrequent jumps in capacity, where a wait-
and-see strategy involves smaller, more frequent jumps.
Answer: True
Reference: Capacity Timing and Sizing Strategies
Difficulty: Moderate
Keywords: expansionist strategy, wait-and-see strategy, size and timing of capacity
increases

15. A wait-and-see capacity strategy minimizes the chances of lost sales due to insufficient
capacity.
Answer: False
Reference: Capacity Timing and Sizing Strategies
Difficulty: Moderate
Keywords: expansionist strategy, lost sales, insufficient capacity

16. A firm may preempt the expansion of competitive firms by using an expansionist capacity
strategy and announcing a large capacity expansion.
Answer: True
Reference: Capacity Timing and Sizing Strategies
Difficulty: Moderate
Keywords: expansionist strategy, capacity expansion

17. An expansionist capacity strategy minimizes the risks of overexpansion due to overly
optimistic demand forecasts.
Answer: False
Reference: Capacity Timing and Sizing Strategies
Difficulty: Moderate
Keywords: wait-and-see strategy, overexpansion, demand forecasts

18. A process’s capacity requirement states the future process capacity needed to meet projected
customer demands, and includes an allowance for the desired capacity cushion.
Answer: True
Reference: A Systematic Approach to Long-Term Capacity Decisions
Difficulty: Moderate
Keywords: capacity requirement, customer demand, capacity cushion

19. A planning horizon is defined as the period beyond which the company does not have
customer orders.
Answer: False
Reference: A Systematic Approach to Long-term Capacity Decisions
Difficulty: Moderate
Keywords: time horizon

20. Output measures are used for estimating capacity requirements when product variety and
process divergence are high.
Answer: False
Reference: A Systematic Approach to Long-Term Capacity Decisions
Difficulty: Moderate
Keywords: input measures, capacity requirements, product variety, process divergence

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 Chapter 6  Capacity Planning

21. When a firm makes a long-term capacity decision, selecting the base case alternative means
doing nothing and losing orders from any demand that exceeds current capacity, or incurring
costs due to excess capacity.
Answer: True
Reference: A Systematic Approach to Long-Term Capacity Decisions
Difficulty: Moderate
Keywords: base case alternative, capacity decisions, capacity

22. Waiting line models are often used for capacity planning.
Answer: True
Reference: Tools for Capacity Planning
Difficulty: Moderate
Keywords: waiting line models, capacity planning

MULTIPLE CHOICE

23. Long-term capacity plans deal with:

a. investments in new facilities.
b. workforce size.
c. inventories.
d. overtime budgets.
Answer: a
Reference: Planning Long-Term Capacity
Difficulty: Moderate
Keywords: long-term capacity, new facilities

24. Long-term capacity decisions that confront managers include all of the following except:
a. capital equipment.
b. additional land.
c. buildings.
d. workforce size.
Answer: d
Reference: Capacity Planning Over Longer Time Horizons
Difficulty: Moderate
Keywords: long-term capacity

25. Regarding the measurement of capacity, when a firm provides a relatively small number of
standardized products and services:
a. capacity cannot be determined reliably.
b. input measures are typically used.
c. output measures are typically used.
d. utilization becomes equal to capacity.
Answer: c
Reference: Planning Long-Term Capacity
Difficulty: Moderate
Keywords: output measure, capacity

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 Chapter 6  Capacity Planning

26. Input measures include such metrics as:

a. the number of customers served per hour.
b. the number of trucks produced per day.
c. the number of machine hours available.
d. the number of bills processed in a week.
Answer: c
Reference: Planning Long-Term Capacity
Difficulty: Moderate
Keywords: input measure, capacity

27. The degree to which equipment, space, or labor is being used is commonly referred to as:
a. capacity.
b. output.
c. utilization.
d. cushion.
Answer: c
Reference: Planning Long-Term Capacity
Difficulty: Moderate
Keywords: utilization, capacity

28. A manufacturing plant is capable of producing 10 tons of product per day when run three
shifts with no breakdowns and plenty of raw materials. Over the past week, the plant has
produced an average of 7.3 tons per day because the third shift has devoted much of their
time to preventive maintenance. What is the utilization of the plant?
a. 10 tons/day
b. 7.3 tons/day
c. 137%
d. 73%
Answer: d
Reference: Planning Long-Term Capacity
Difficulty: Moderate
Keywords: utilization, capacity

29. A manufacturing plant is capable of producing 10 tons of product per day when run three
shifts with no breakdowns and plenty of raw materials. Over the past week, the plant has
produced an average of 7.3 tons per day since the third shift has devoted much of their time to
preventive maintenance. What is the capacity of the plant?
a. 10 tons/day
b. 7.3 tons/day
c. 73%
d. 137%
Answer: a
Reference: Planning Long-Term Capacity
Difficulty: Moderate
Keywords: utilization, capacity

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 Chapter 6  Capacity Planning

30. A lumber mill is capable of producing 10,000 board feet of lumber per day when run ten
hours per day with minimal breaks. Over the past year, forestry legislation has reduced the
availability of raw materials, so the mill has produced an average of 4,575 board feet per day.
What is the capacity of the plant?
a. 4,575 board feet/day
b. 10,000 board feet/day
c. 45.75%
d. 219%
Answer: b
Reference: Planning Long-Term Capacity
Difficulty: Moderate
Keywords: utilization, capacity

31. A lumber mill is capable of producing 10,000 board feet of lumber per day when run ten
hours per day with minimal breaks. Over the past year, forestry legislation has reduced the
availability of raw materials, so the mill has produced an average of 4,575 board feet per day.
What is the utilization of the plant?
a. 4,575 board feet/day
b. 10,000 board feet/day
c. 219%
d. 45.75%
Answer: d
Reference: Planning Long-Term Capacity
Difficulty: Moderate
Keywords: utilization, capacity

32. The transition from economies of scale to diseconomies of scale:

a. is more likely to occur in a service operation.
b. is more likely to occur in a manufacturing operation.
c. is more likely to occur when utilization is low.
d. contains the point at which average unit costs are at their lowest.
Answer: d
Reference: Capacity Planning Over Longer Time Horizons
Difficulty: Moderate
Keywords: economies of scale, diseconomies of scale

33. Large, infrequent jumps in capacity are characteristic of companies that:

a. have an expansionist strategy.
b. have a wait-and-see strategy.
c. have low utilization.
d. have high utilization.
Answer: a
Reference: Capacity Timing and Sizing Strategies
Difficulty: Moderate
Keywords: expansionist capacity strategy

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 Chapter 6  Capacity Planning

34. Which one of the following factors usually motivates a smaller capacity cushion?
a. Unevenly distributed demands
b. High capital intensity
c. High penalty costs for overtime usage
d. Requests for quick customer services
Answer: b
Reference: Capacity Timing and Sizing Strategies
Difficulty: Moderate
Keywords: capacity cushion, capital intensity

35. Which one of the following factors usually calls for a larger capacity cushion?
a. Uncertain demand
b. High capital intensity
c. More reliable equipment
d. High worker flexibility
Answer: a
Reference: Capacity Timing and Sizing Strategies
Difficulty: Moderate
Keywords: capacity cushion, demand variability

36. Which one of the following statements about capacity cushions is best?
a. Companies with flexible flow processes tend to have small capacity cushions.
b. Companies with high capital costs tend to have large capacity cushions.
c. Companies that have considerable customization tend to have larger capacity cushions.
d. Constant demand rates require larger-capacity cushions.
Answer: c
Reference: Capacity Timing and Sizing Strategies
Difficulty: Moderate
Keywords: capacity cushion, customization

37. Which one of the following statements concerning capacity cushions is best?
a. Large capacity cushions are used more often when future demand is level and known.
b. Small capacity cushions are used extensively in capital intensive firms.
c. Capacity cushions are used primarily in manufacturing organizations, not in service
organizations.
d. Small cushions are used in organizations where the products and services produced often
change.
Answer: b
Reference: Capacity Timing and Sizing Strategies
Difficulty: Moderate
Keywords: capacity cushion, capital intensity

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 Chapter 6  Capacity Planning

38. If a system is well balanced, which one of the following changes usually calls for a larger
capacity cushion?
a. Higher capital intensity
b. Higher worker flexibility
c. Requests for fast delivery times
d. Higher inventories
Answer: c
Reference: Capacity Timing and Sizing Strategies
Difficulty: Moderate
Keywords: balanced system, cushion capacity

39. If a system is well balanced, which one of the following changes usually calls for a smaller
capacity cushion?
a. Higher customization
b. More of a flexible-flow strategy
c. Higher yield losses
d. Higher capital intensity
Answer: d
Reference: Capacity Timing and Sizing Strategies
Difficulty: Moderate
Keywords: capacity cushion, capital intensity

40. An expansionist capacity strategy:

a. lags behind demand.
b. reduces the risk of overexpansion based on overly optimistic demand forecasts.
c. can preempt expansion by competitors by announcing a large capacity expansion.
d. meets capacity shortfalls with overtime, temporary workers, subcontracting, and stockouts.
Answer: c
Reference: Capacity Timing and Sizing Strategies
Difficulty: Moderate
Keywords: capacity cushion, capacity expansion

41. A wait-and-see capacity strategy:

a. involves small, frequent jumps in capacity.
b. minimizes the chance of lost sales due to insufficient capacity.
c. can result in economies of scale and a fast rate of learning, yielding reduced manufacturing
costs.
d. stays ahead of demand.
Answer: a
Reference: Capacity Timing and Sizing Strategies
Difficulty: Moderate
Keywords: capacity cushion, capacity jumps

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 Chapter 6  Capacity Planning

42. A wait-and-see capacity strategy does all of the following EXCEPT:

a. lag behind demand.
b. minimize the chance of lost sales due to insufficient capacity.
c. meet capacity shortfalls with overtime, temporary workers, subcontracting, and stockouts.
d. reduce the risk of overexpansion based on overly optimistic demand forecasts.
Answer: b
Reference: Capacity Timing and Sizing Strategies
Difficulty: Moderate
Keywords: capacity cushion, lost sales, insufficient capacity

43. An expansionist capacity strategy does all of the following EXCEPT:

a. stay ahead of demand.
b. minimize the chance of lost sales due to insufficient capacity.
c. result in economies of scale and a fast rate of learning, yielding reduced manufacturing
costs.
d. involve small, frequent jumps in capacity.
Answer: d
Reference: Capacity Timing and Sizing Strategies
Difficulty: Moderate
Keywords: capacity cushion, capacity jumps

44. The time required to change a machine from making one product or service to the next is
called:
a. cycle time.
b. setup time.
c. queue time.
d. hold time.
Answer: b
Reference: A Systematic Approach to Long-Term Capacity Decisions
Difficulty: Moderate
Keywords: setup time

45. The single milling machine at Stout Manufacturing was severely overloaded last year. The
plant operates eight hours per day, five days per week, and 50 weeks per year. Management
prefers a capacity cushion of 15 percent. Two major types of products are routed through the
milling machine. The annual demand for product A is 3000 units and 2000 units for product
B. The batch size for A is 20 units and 40 units for B. The standard processing time for A is
0.5 hours/unit and 0.8 hours/unit for B. The standard setup time for product A is 2 hours and
8 hours for product B. How many new milling machines are required if Stout does not resort
to any short-term capacity options?
a. No new machines
b. 1 or 2 new machines
c. 3 or 4 new machines
d. More than 4 new machines
Answer: c
Reference: A Systematic Approach to Long-Term Capacity Decisions
Difficulty: Moderate
Keywords: capacity requirement, evaluate alternatives, select alternative

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 Chapter 6  Capacity Planning

Table 6.1
The Union Manufacturing Company is producing two types of products: A and B.
The demand forecasts, batch size, and time standards follow:

Product A Product B
Demand forecast (units/yr) 1,000 4,000
Batch size (units/batch) 20 10
Processing time (hr/unit) 3.2 4.5
Setup time (hr/batch) 10 20

Both products are produced on the same machine, called Mark I.

46. Using Table 6.1, what is the total number of hours required of Mark I equipment for the next
year?
a. Fewer than 29,000 hours
b. Between 29,000 and 30,000 hours
c. Between 30,000 and 31,000 hours
d. More than 31,000 hours
Answer: b
Reference: A Systematic Approach to Long-Term Capacity Decisions
Difficulty: Moderate
Keywords: capacity requirement, evaluate alternatives

47. Use the information in Table 6.1. The company works 250 days per year and operates two
shifts, each covering 8 hours. If a 15 percent capacity cushion is maintained, how many hours
of capacity can the company expect from each of its Mark I machines?
a. Fewer than 3000
b. Between 3000 and 3500
c. Between 3501 and 4000
d. More than 4000
Answer: b
Reference: A Systematic Approach to Long-Term Capacity Decisions
Difficulty: Moderate
Keywords: capacity requirement, evaluate alternatives

48. Use the information in Table 6.1. How many Mark I machines are required to produce Union
Manufacturing’s for the year’s production?
a. Fewer than 4 machines
b. More than 4 but fewer than or equal to 6 machines
c. More than 6 but fewer than or equal to 8 machines
d. More than 8 machines
Answer: d
Reference: A Systematic Approach to Long-Term Capacity Decisions
Difficulty: Moderate
Keywords: capacity requirement, evaluate alternatives, select alternative

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 Chapter 6  Capacity Planning

49. The Southeast Manufacturing Company is producing two types of products: A and B.
Demand forecasts for next year and other production-related information are provided in the
following table:

Product A Product B
Demand forecast (units/yr) 4,000 12,000
Batch size (units/batch) 80 150
Processing time (hr/unit) 2.5 2.0
Setup time (hr/batch) 18 24

Both of these products are produced at the same workstation, called the Automatic Lathe.
Currently, the company has 12 automatic lathes, and financial constraints prevent any
expansion for the next year. It works 250 days per year with two 8-hour shifts and desires a
25 percent capacity cushion. Which one of the following alternatives will allow next year’s
demand to be fully covered?
a. Do nothing.
b. Increase the capacity cushion to 30 percent.
c. Increase the batch size of product B to 300 units.
d. Decrease the capacity cushion by 1 percent.
Answer: c
Reference: A Systematic Approach to Long-Term Capacity Decisions
Difficulty: Moderate
Keywords: capacity requirement, evaluate alternatives, select alternative

50. Up, Up & Away is a producer of kites and windsocks. Relevant data concerning their
production for the upcoming fiscal year are as follows:

Assume: 1 shift/day, 8 hours/shift, 5 days/week, and 50 weeks/year;

They currently have four machines, and management wants a capacity cushion of 20 percent.

Which of the following alternatives will enable Up, Up & Away to meet all of the upcoming
year’s demand using the minimum number of machines?
a. Add six additional machines.
b. Add five additional machines.
c. Add four additional machines.
d. Add three additional machines.
Answer: b
Reference: A Systematic Approach to Long-Term Capacity Decisions
Difficulty: Moderate
Keywords: capacity requirement, evaluate alternatives, select alternative

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 Chapter 6  Capacity Planning

51. The lock box department at Bank 21 handles the processing of monthly loan payments to the
bank, monthly and quarterly premium payments to a local insurance company, and bill
payments for 85 of the bank’s largest commercial customers. The payments are processed by
machine operators, with one operator per machine. An operator can process one payment in
0.25 minute. Setup times are negligible in this situation. A capacity cushion of 20 percent is
needed for the operation. The average monthly (not annual) volume of payments processed
through the department currently is 400,000. However, it is expected to increase by 20
percent. The department operates eight hours per shift, two shifts per day, 260 days per year.
How many machines (not operators) are needed to satisfy the new total processing volume?
(Round up to the next whole integer.)
a. Fewer than 7
b. 7
c. 8
d. More than 8
Answer: c
Reference: A Systematic Approach to Long-Term Capacity Decisions
Difficulty: Hard
Keywords: capacity requirement, evaluate alternatives, select alternative

Table 6.2
High Tech, Inc. is producing two types of products: A and B. Both are produced at the same
sawing operation. Because of demand uncertainties, the operations manager obtained three
demand forecasts (pessimistic, expected, and optimistic). The demand forecasts, batch sizes
(units/batch), processing times (hr/unit), and setup times (hr/batch) follow.

Time Standard Demand Forecasts (000 units/yr)

Product Processing Setup Batch Size Pessimistic Expected Optimistic
A .20 2.0 40 200 240 300
B .15 3.0 50 160 180 200

The sawing machines operate on two 8-hour shifts, 5 days per week, and 50 weeks per year.
The manager wants to maintain a 10 percent capacity cushion.

52. Using the information from Table 6.2, what is the minimum total number of hours required of
sawing equipment for the next year?
a. Fewer than 85,000 hours
b. More than 85,000 but fewer than 95,000
c. More than 95,000 but fewer than 105,000
d. More than 105,000 hours
Answer: a
Reference: A Systematic Approach to Long-Term Capacity Decisions
Difficulty: Hard
Keywords: capacity requirement, evaluate alternatives

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 Chapter 6  Capacity Planning

53. Using the information from Table 6.2, how many hours of capacity can the company expect
from each of its sawing machines?
a. Fewer than 3500 hours
b. More than 3500 hours but fewer than 3700 hours
c. More than 3700 hours but fewer than 3900 hours
d. More than 3900 hours
Answer: b
Reference: A Systematic Approach to Long-Term Capacity Decisions
Difficulty: Hard
Keywords: capacity requirement, evaluate alternatives, select alternative

54. Using the information from Table 6.2, what is the minimum number of machines needed
(assuming no reliance on short-term options)?
a. Fewer than or equal to 22
b. More than 22 but fewer than or equal to 25
c. More than 25 but fewer than or equal to 28
d. More than 28
Answer: b
Reference: A Systematic Approach to Long-Term Capacity Decisions
Difficulty: Hard
Keywords: capacity requirement, evaluate alternatives, select alternative

55. Using the information from Table 6.2, what is the maximum number of machines needed
(assuming no reliance on short-term option)?
a. Fewer than or equal to 25
b. More than 25 but fewer than or equal to 28
c. More than 28 but fewer than or equal to 31
d. More than 31
Answer: d
Reference: A Systematic Approach to Long-Term Capacity Decisions
Difficulty: Hard
Keywords: capacity requirement, evaluate alternatives, select alternative

56. Using the information from Table 6.2, if the operation currently has 18 machines and the
manager is willing to expand capacity by 20 percent through short-term options, what is the
capacity gap (in terms of number of machines) if you assume the optimistic demand
forecasts?
a. Fewer than or equal to 10
b. More than 10 but fewer than or equal to 12
c. More than 12 but fewer than or equal to 14
d. More than 14
Answer: a
Reference: A Systematic Approach to Long-Term Capacity Decisions
Difficulty: Hard
Keywords: capacity requirement, evaluate alternatives, select alternative

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 Chapter 6  Capacity Planning

57. A company’s production facility, consisting of two identical machines, currently caters only
to product A. The annual demand for the product is 4000 units. Management has now decided
to introduce another product, B, which uses the same facilities as that of product A. Product
B has an annual demand of 2000 units. In view of the uncertainties involved in producing two
products, management desires to have an overall 10 percent capacity cushion. Given the
following additional information, how many more machines are required? (Assume 8
hours/shift, 2 shifts/day, 250 days/year, and that no overtime is allowed).

a. No additional machines are necessary.

b. One additional machine is necessary.
c. Two additional machines are necessary.
d. More than two additional machines are necessary.
Answer: c
Reference: A Systematic Approach to Long-Term Capacity Decisions
Difficulty: Moderate
Keywords: capacity requirement, evaluate alternatives, select alternative

58. The Northern Manufacturing Company is producing products A and B, using the
same machine called MASAC27A. Demand forecasts for next year and other
production-related information are provided in the following table.
Product A Product B
Demand forecast (units/yr) 4,000 12,000
Batch size (units/batch) 80 150
Processing time (hr/unit) 2.5 2.0
Setup time (hr/batch) 16 12

The company works 250 days per year and operates 2 shifts each day, each shift covering 8
hours. If 25 percent of capacity cushion is maintained throughout the year, how many
machines (MASAC27A) does the company need next year to meet the demand? (Round your
answer up to the next whole machine.)
a. Fewer than 11 machines
b. 11 machines
c. 12 machines
d. More than 12 machines
Answer: c
Reference: A Systematic Approach to Long-Term Capacity Decisions
Difficulty: Moderate
Keywords: capacity requirement, evaluate alternatives, select alternative

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 Chapter 6  Capacity Planning

Table 6.3
The North Bend Manufacturing Company is producing two types of products, A and
B. Demand forecasts for next year and other production-related information are
provided in the following table:
Product A Product B
Demand forecast (units/year) 4,000 12,000
Batch size (units/batch) 80 150
Standard processing time (hr/unit) 2.5 2
Standard setup time (hr/batch) 18 24

Both products A and B are produced at the same operation called MASAC27A.

59. Using the information in Table 6.3, what is the total number of hours required for
MASAC27A equipment for the next year?
a. 34,000 hours
b. 34,285 hours
c. 36,820 hours
d. 312,000 hours
Answer: c
Reference: A Systematic Approach to Long-Term Capacity Decisions
Difficulty: Moderate
Keywords: capacity requirement, evaluate alternatives

60. Use the information in Table 6.3 to help answer this question. Additionally, the company
works 250 days every year and operates 2 shifts, each of which covers 8 hours. If a 25
percent capacity cushion is maintained, how many machines does the company need next
year to fully cover the demand?
a. Fewer than 13 machines
b. 13 machines
c. 14 machines
d. More than 14 machines
Answer: b
Reference: A Systematic Approach to Long-Term Capacity Decisions
Difficulty: Moderate
Keywords: capacity requirement, evaluate alternatives, select alternative

61. Use the information in Table 6.3 to help answer this question. Currently, the company has 12
MASAC27A machines, and financial constraints prevent any expansion for the next year.
Which one of the following alternatives will allow next year’s demand to be fully covered?
a. Do nothing.
b. Increase the capacity cushion to 30 percent.
c. Increase the batch size of product B to 300 units.
d. Decrease the capacity cushion by 1 percent.
Answer: c
Reference: A Systematic Approach to Long-Term Capacity Decisions
Difficulty: Moderate
Keywords: capacity requirement, evaluate alternatives

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 Chapter 6  Capacity Planning

62. George P. Burdell owns a hot tub store that is experiencing significant growth. Burdell is
trying to decide whether to expand the store’s capacity, which currently is at $750,000 in
sales per quarter. He is thinking about expanding to the $850,000 level. The before-tax profit
from additional sales is 20 percent. Sales are seasonal, with peaks in the spring and summer
quarters. Forecasts of capacity requirements, expressed in ($000) sales per quarter, for next
year (year 2) are:

Demand in year 3 and beyond is expected to exceed $850,000 per quarter. Burdell is
considering expansion at the end of the fourth quarter of this year (year 1). How much would
before-tax profits in year 2 increase because of this expansion?
a. Less than $28,000
b. More than $28,000 but less than $32,000
c. More than $32,000 but less than $36,000
d. More than $36,000
Answer: d
Reference: A Systematic Approach to Long-Term Capacity Decisions
Difficulty: Moderate
Keywords: capacity requirement, before-tax profit

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 Chapter 6  Capacity Planning

63. Sleep Tight Motel has the opportunity to purchase an adjacent plot of land. Building on this
land would increase their capacity from the current sales level of $515,000/year to
$600,000/year. Sleep Tight experiences a 20 percent before-tax profit margin. It wishes to
estimate the additional before-tax profits that the expansion will produce. Using the following
information, how much more before-tax cash flow would be realized just in year 10 alone?

a. Less than or equal to $20,000

b. Greater than $20,000 but less than or equal to $25,000
c. Greater than $25,000 but less than or equal to $30,000
d. Greater than 30,000
Answer: a
Reference: A Systematic Approach to Long-Term Capacity Decisions
Difficulty: Moderate
Keywords: capacity requirement, cash flow

64. Innovative Inc. is experiencing a boom for the products it has introduced recently. The
estimated annual sales projected for the next five years are given in the following table. The
current capacity is equivalent to only $100 million sales. The company is considering the
alternative of expanding capacity to an equivalent of $250 million sales. Assume a 25 percent
pretax profit margin. What is the increase in total pretax cash flow (summed over all years)
that would be enjoyed because of the expansion?

a. Less than or equal to $40 million

b. More than $40 million but less than or equal to $70 million
c. More than $70 million but less than or equal to $100 million
d. More than $100 million
Answer: c
Reference: A Systematic Approach to Long-Term Capacity Decisions
Difficulty: Moderate
Keywords: capacity requirement, cash flow

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65. John Owen owns a drugstore that is experiencing significant growth. Owen is trying to decide
whether to expand its capacity, which currently is $200,000 in sales per quarter. Sales are
seasonal. Forecasts of capacity requirements, expressed in sales per quarter for the next year,
follow.

Owen is considering expanding capacity to the $250,000 level in sales per quarter. The
before-tax profit margin from additional sales is 15 percent. How much would before-tax
profits increase next year because of this expansion?
a. Less than $15,000
b. More than $15,000 but less than $16,000
c. More than $16,000 but less than $17,000
d. More than $17,000
Answer: c
Reference: A Systematic Approach to Long-Term Capacity Decisions
Difficulty: Moderate
Keywords: capacity requirement, evaluate alternatives, cash flow

Table 6.4
Mr. Lee is considering a capacity expansion for his supermarket. The annual sales
projected for the next five years follow. The current capacity is equivalent to
$300,000 sales. Assume a 20 percent pretax profit margin.

66. Using the information in Table 6.4, if Lee expands the capacity to an equivalent of $360,000
sales now (year 0), how much would pretax cash flow in year 1 increase because of this
expansion?
a. Less than $3000
b. More than $3000 but less than $5000
c. More than $5000 but less than $7000
d. More than $7000
Answer: a
Reference: A Systematic Approach to Long-Term Capacity Decisions
Difficulty: Moderate
Keywords: capacity requirement, evaluate alternatives, cash flow

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 Chapter 6  Capacity Planning

67. Using the information in Table 6.4, if Lee expands the capacity to an equivalent of $360,000
sales now (year 0), how much would pretax cash flow in year 5 increase because of this
expansion?
a. Less than $7000
b. More than $7000 but less than $10,000
c. More than $10,000 but less than $13,000
d. More than $13,000
Answer: c
Reference: A Systematic Approach to Long-Term Capacity Decisions
Difficulty: Moderate
Keywords: capacity requirement, evaluate alternatives, cash flow

68. Using the information in Table 6.4, if Lee expands the capacity to an equivalent of $360,000
sales now (year 0), and then expands the capacity to an equivalent of $400,000 sales at the
beginning of year 4, how much would pretax cash flow increase in total for all years (years 1
through 5)?
a. Less than $30,000
b. More than $30,000 but less than $40,000
c. More than $40,000 but less than $50,000
d. More than $50,000
Answer: c
Reference: A Systematic Approach to Long-Term Capacity Decisions
Difficulty: Moderate
Keywords: capacity requirement, evaluate alternatives, cash flow

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Table 6.5
The T. H. King Company has introduced a new product line that requires two work
centers, A and B for manufacture. Work Center A has a current capacity of 10,000
units per year, and Work Center B is capable of 12,500 units per year. This year (year
0), sales of the new product line are expected to reach 10,000 units. Growth is
projected at an additional 1,000 units each year through year 5. Pre-tax profits are
expected to be $30 per unit throughout the 5-year planning period. Two alternatives
are being considered:
1) Expand both Work Centers A and B at the end of year 0 to a capacity of
15,000 units per year, at a total cost for both Work Centers of $200,000;
2) Expand Work Center A at the end of year 0 to 12,500 units per year,
matching Work Center B, at a cost of $100,000, then expanding both Work
Centers to 15,000 units per year at the end of year 3, at an additional cost at
that time of $200,000.
The King Company will not consider projects that don’t show a 5th year positive net
present value using a discount rate of 15%.

69. Use the information in Table 6.5. What is the pre-tax cash flow (net present value) for
alternative #1 compared to the base case of doing nothing for the next five years?
a. Negative pre-tax cash flow
b. More than $0 but less than $40,000
c. More than $40,000 but less than $80,000
d. More than $80,000
Answer: c
Reference: A Systematic Approach to Long-Term Capacity Decisions
Difficulty: Moderate
Keywords: capacity requirement, evaluate alternatives, cash flow

70. Use the information in Table 6.5. What is the pre-tax cash flow (net present value) for
alternative #2 compared to the base case of doing nothing for the next five years?
a. Negative pre-tax cash flow
b. More than $0 but less than $40,000
c. More than $40,000 but less than $80,000
d. More than $80,000
Answer: b
Reference: A Systematic Approach to Long-Term Capacity Decisions
Difficulty: Moderate
Keywords: capacity requirement, evaluate alternatives, cash flow

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 Chapter 6  Capacity Planning

71. Use the information in Table 6.5. What action, if any, should the King Company take?
a. Do nothing--neither alternative provides a positive net present value after five years
b. Select Alternative #1
c. Select alternative #2
d. Either alternative may be selected, since the positive net present values are the same after
five years.
Answer: b
Reference: A Systematic Approach to Long-Term Capacity Decisions
Difficulty: Moderate
Keywords: capacity requirement, evaluate alternatives, cash flow

Table 6.6
Burdell Labs is a diagnostic laboratory that does various tests (blood tests, urine tests,
etc.) for doctors’ offices in the Indianapolis area. Test specimens are picked up at the
doctors’ offices and are transported to the testing facility, with uniform arrivals
throughout the day. All tests go through two testing centers in the testing facility, Test
Center A and Test Center B. A has a current capacity of 1,000 units per week, and B
is capable of 1,500 units per week. The facility operates 50 weeks per year. This year
(year 0), test volumes are expected to reach 1,000 units per week. Growth per week is
projected at an additional 200 units through year 5 (i.e., 1,200 per week in year #1,
1,400 per week in year #2, etc.). Pre-tax profits are expected to be $5 per test
throughout the 5-year planning period. Two alternatives are being considered:
1) Expand both Test Centers A and B at the end of year 0 to a capacity of
2,000 units per week, at a total cost for both Test Centers of $300,000;
2) Expand Test Center A at the end of year 0 to 1,500 units per week,
matching Test Center B, at a cost of $100,000, then expanding both Test
Centers to 2,000 units per year at the end of year 3, at an additional cost at
that time of $250,000.
Burdell Labs will not consider projects that don’t show a 5th year positive net present
value using a discount rate of 15%.

72. Use the information in Table 6.6. What is the pre-tax cash flow (net present value) for
alternative #1 compared to the base case of doing nothing for the next five years?
a. Negative pre-tax cash flow
b. More than $0 but less than $80,000
c. More than $80,000 but less than $160,000
d. More than $160,000
Answer: c
Reference: A Systematic Approach to Long-Term Capacity Decisions
Difficulty: Moderate
Keywords: capacity requirement, evaluate alternatives, cash flow

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 Chapter 6  Capacity Planning

73. Use the information in Table 6.6. What is the pre-tax cash flow (net present value) for
alternative #2 compared to the base case of doing nothing for the next five years?
a. Negative pre-tax cash flow
b. More than $0 but less than $80,000
c. More than $80,000 but less than $160,000
d. More than $160,000
Answer: d
Reference: A Systematic Approach to Long-Term Capacity Decisions
Difficulty: Moderate
Keywords: capacity requirement, evaluate alternatives, cash flow

74. Use the information in Table 6.6. What action, if any, should the Burdell Labs take?
a. Do nothing--neither alternative provides a positive net present value after five years
b. Select Alternative #1
c. Select alternative #2
d. Either alternative may be selected, since the positive net present values are the same after
five years
Answer: c
Reference: A Systematic Approach to Long-Term Capacity Decisions
Difficulty: Moderate
Keywords: capacity requirement, evaluate alternatives, cash flow

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Table 6.7
The B. Sharp Company has a rapidly growing product line that requires two work
centers, X and Y for manufacture. Work Center X has a current capacity of 50,000
units per year, and Work Center Y is capable of 55,000 units per year. This year (year
0), sales of the product line are expected to reach 50,000 units. Growth is projected at
an additional 3,000 units each year through year 3. Pre-tax profits are expected to be
$60 per unit throughout the 3-year planning period. Two alternatives are being
considered:
1) Expand both Work Centers X and Y at the end of year 0 to a capacity of
60,000 units per year, at a total cost for both Work Centers of $500,000;
2) Expand Work Center X at the end of year 0 to 55,000 units per year,
matching Work Center Y, at a cost of $300,000, then expanding both Work
Centers to 60,000 units per year at the end of year 2, at an additional cost at
that time of $350,000.
The Sharp Company will not consider projects that don’t show a 3rd year positive net
present value using a discount rate of 20%.

75. Use the information in Table 6.7. What is the pre-tax cash flow (net present value) for
alternative #1 compared to the base case of doing nothing for the next five years?
a. Negative pre-tax cash flow
b. More than $0 but less than $100,000
c. More than $100,000 but less than $200,000
d. More than $200,000
Answer: d
Reference: A Systematic Approach to Long-Term Capacity Decisions
Difficulty: Moderate
Keywords: capacity requirement, evaluate alternatives, cash flow

76. Use the information in Table 6.7. What is the pre-tax cash flow (net present value) for
alternative #2 compared to the base case of doing nothing for the next five years?
a. Negative pre-tax cash flow
b. More than $0 but less than $100,000
c. More than $100,000 but less than $200,000
d. More than $200,000
Answer: c
Reference: A Systematic Approach to Long-Term Capacity Decisions
Difficulty: Moderate
Keywords: capacity requirement, evaluate alternatives, cash flow

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 Chapter 6  Capacity Planning

77. Use the information in Table 6.7. What action, if any, should the Sharp Company take?
a. Do nothing—neither alternative provides a positive net present value after three years
b. Select Alternative #1
c. Select alternative #2
d. Either alternative may be selected, since the positive net present values are the same after
three years
Answer: b
Reference: A Systematic Approach to Long-Term Capacity Decisions
Difficulty: Moderate
Keywords: capacity requirement, evaluate alternatives, cash flow

Table 6.8
The Summerville Vitamin Company manufactures bottles of animal-shaped chewable
vitamins for children. This product line requires two work centers, tablet
manufacturing and packaging. The tablet manufacturing work center has a current
capacity of 140,000 bottles per month, and packaging is capable of 100,000 units per
month. This year (year 0), monthly sales of the product line are expected to reach
100,000 units. Growth per month is projected at an additional 25,000 units through
year 4 (i.e., 125,000 per month in year #1, 150,000 per month in year #2, etc.). Pre-tax
profits are expected to be $5 per unit throughout the 4-year planning period. Two
alternatives are being considered:
1) Expand both tablet manufacturing and packaging at the end of year 0 to a
capacity of 200,000 units per month, at a total cost for both work centers of
$2,250,000;
2) Expand packaging at the end of year 0 to 140,000 units per year, matching
tablet manufacturing, at a cost of $1,200,000, then expanding both work
centers to 200,000 units per month at the end of year 2, at an additional
cost at that time of $1,400,000.
Summerville will not consider projects that don’t show a 4th year positive net present
value using a discount rate of 25%.

78. Use the information in Table 6.8. What is the pre-tax cash flow (net present value) for
alternative #1 compared to the base case of doing nothing for the next four years?
a. Less than or equal to $5.1 million
b. More than $5.1 million but less than $5.3 million
c. More than $5.3 million less than $5.5 million
d. More than $5.5 million
Answer: d
Reference: A Systematic Approach to Long-Term Capacity Decisions
Difficulty: Moderate
Keywords: capacity requirement, evaluate alternatives, cash flow

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79. Use the information in Table 6.8. What is the pre-tax cash flow (net present value) for
alternative #2 compared to the base case of doing nothing for the next four years?
a. Less than or equal to $5.1 million
b. More than $5.1 million but less than $5.3 million
c. More than $5.3 million less than $5.5 million
d. More than $5.5 million
Answer: c
Reference: A Systematic Approach to Long-Term Capacity Decisions
Difficulty: Moderate
Keywords: capacity requirement, evaluate alternatives, cash flow

80. Use the information in Table 6.8. What action, if any, should Summerville take?
a. Find another option--neither alternative provides a positive net present value after four
years
b. Select Alternative #1
c. Select alternative #2
d. Either alternative may be selected, since the positive net present values are the same after
four years
Answer: b
Reference: A Systematic Approach to Long-Term Capacity Decisions
Difficulty: Moderate
Keywords: capacity requirement, evaluate alternatives, cash flow

81. Which of the following descriptions about waiting line models is best?
a. They account for major events such as competitor actions.
b. They account for the random, independent behavior of many customers.
c. They assume that each branch can give the highest expected payoff.
d. They deal with the certainty and stability in demand.
Answer: b
Reference: Tools for Capacity Planning
Difficulty: Moderate
Keywords: waiting line model

82. What information would managers use to choose the best cost-effective capacity to balance
customer service with the cost of adding capacity?
a. Decision trees
b. Economies of scale
c. Capacity cushion
d. Waiting line models
Answer: d
Reference: Tools for Capacity Planning
Difficulty: Moderate
Keywords: waiting line model

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83. When future demand is uncertain and sequential decisions are involved in capacity planning,
a manager should use a:
a. waiting line model.
b. cash flow analysis.
c. decision tree.
d. gap analysis.
Answer: c
Reference: Tools for Capacity Planning
Difficulty: Moderate
Keywords: decision tree, capacity planning

FILL IN THE BLANK

84. ____________ is the maximum rate of output for a process.

Answer: Capacity
Reference: Introduction
Difficulty: Easy
Keywords: capacity, maximum rate of output

85. Capacity decisions should be linked closely to ____________ and ____________ throughout
the organization.
Answer: processes, supply chains
Reference: Introduction
Difficulty: Moderate
Keywords: capacity decision, strategy, process, supply chains

86. ____________ is the degree to which equipment, space, or labor is currently being used.
Answer: Utilization
Reference: Planning Long-Term Capacity
Difficulty: Easy
Keywords: utilization, use of equipment, space, labor

87. The ____________ concept states that the average unit cost of a service or good can be
reduced by increasing its output rate.
Answer: economies of scale
Reference: Planning Long-Term Capacity
Difficulty: Easy
Keywords: economies of scale

88. ____________ occurs when the average cost per unit increases as the facility’s size increases.
Answer: diseconomies of scale
Reference: Planning Long-Term Capacity
Difficulty: Easy
Keywords: diseconomies of scale

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89. ____________ is the amount of reserve capacity that a firm maintains to handle a sudden
increase in demand or temporary losses of production capacity.
Answer: Capacity cushion
Reference: Capacity Timing and Sizing Strategies
Difficulty: Moderate
Keywords: capacity cushion, reserve capacity

90. If demand is increasing, and you also prefer to increase the time between capacity
increments, then the size of increments should ____________.
Answer: increase
Reference: Capacity Timing and Sizing Strategies
Difficulty: Moderate
Keywords: demand increase, time between capacity increments

91. A process’s ____________ is what its capacity should be for some future time period to meet
the demand of its customers, allowing for the desired capacity cushion.
Answer: capacity requirement
Reference: A Systematic Approach to Long-Term Capacity Decisions
Difficulty: Moderate
Keywords: capacity requirement

92. The ____________ is the set of consecutive time periods considered for planning purposes.
Answer: planning horizon
Reference: A Systematic Approach to Long-Term Capacity Decisions
Difficulty: Easy
Keywords: planning horizon

93. A ____________ is the difference between demand and current capacity.

Answer: capacity gap
Reference: A Systematic Approach to Long-Term Capacity Decisions
Difficulty: Easy
Keywords: capacity gap

94. The ____________ is the act of doing nothing and losing orders from any demand that
exceeds capacity, or incurs costs because capacity is too large.
Answer: base case
Reference: A Systematic Approach to Long-Term Capacity Decisions
Difficulty: Easy
Keywords: base case

SHORT ANSWERS

95. Define utilization and give a service process example of it.

Answer: Utilization is expressed as a percent and is the degree to which equipment,
space, or labor is currently being used. Examples will vary.
Reference: Planning Long-Term Capacity
Difficulty: Easy
Keywords: utilization, capacity

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96. Discuss the relationship between setup time and utilization.

Answer: Setup time is the time required to adjust a process when switching from making
one product to another and is unproductive time in the sense that no product is being built
during the setup. Utilization is the ratio of the average output rate to the maximum
capacity. As output rate increases, the resource is more productive and utilization rises.
Setups enable output but do not create it, so the faster a setup can be performed, the more
of the total time is productive, thus increasing utilization.
Reference: Planning Long-Term Capacity
Difficulty: Easy
Keywords: setup time, utilization

97. Give four principal reasons economies of scale can occur when output increases.
Answer: The four reasons are spreading fixed costs, reducing construction costs, cutting
costs of purchased materials, and finding process advantages.
Reference: Planning Long-Term Capacity
Difficulty: Moderate
Keywords: economies of scale, output

98. What factors should be considered when selecting the appropriate capacity cushion? How
does the choice of capacity cushion relate to other decisions in operations management? To
other functional areas?
Answer: The appropriate size of the capacity cushion varies by industry. Large cushions
are necessary when future demand is uncertain, resource flexibility is low, product mix
changes, uncertainty exists regarding suppliers, and employee absenteeism and penalty
costs for overtime and subcontracting exist. Small-capacity cushions reduce costs and
expose problems in the system. Capacity cushions are linked to competitive priorities,
quality management, capital intensity, resource flexibility, inventory, scheduling, and
location. Obviously, many of these decisions cut across functional boundaries.
Reference: Capacity Timing and Sizing Strategies
Difficulty: Hard
Keywords: capacity cushion

99. Define each of the following capacity strategies: expansionist, wait-and-see, and follow-the-
leader.
Answer: Expansionist means large, infrequent jumps in capacity. Wait-and-see means
smaller and more frequent jumps. Follow-the-leader means to expand when others do.
Reference: Capacity Timing and Sizing Strategies
Difficulty: Moderate
Keywords: capacity strategy, expansionist, wait-and-see, follow-the-leader

100. What are the four steps involved in making capacity decisions?
Answer: The steps are: 1) estimate future capacity requirements, 2) identify gaps by
comparing requirements with alternatives, 3) develop alternative plans for filling the
gaps, and 4) evaluate alternatives, both qualitatively and quantitatively, and make a final
choice.
Reference: A Systematic Approach to Long-Term Capacity Decisions
Difficulty: Moderate
Keywords: capacity decision, steps

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101. What is a waiting line model, and what information can it provide?
Answer: Waiting line models use probability distributions to estimate delay times, line
length, and utilization.
Reference: Tools for Capacity Planning
Difficulty: Moderate
Keywords: waiting line model, capacity planning

PROBLEMS

102. Lucy’s Pancake House, a no-frills diner along a major interstate, has discovered that if
precious employee time is not wasted on frivolous duties such as cleaning work surfaces,
properly storing ingredients, and pest control, they can achieve an average output rate of 25
customers per hour. If the diner was designed to accommodate a maximum of 30 customers
per hour, what is the utilization?

Answer:

Reference: Planning Long-Term Capacity

Difficulty: Easy
Keywords: utilization, capacity

103. The single milling machine at Fred’s Manufacturing was severely overloaded last year. The
plant operates 8 hours per day, 5 days per week, and 50 weeks per year. Management
prefers a capacity cushion of 20 percent. Two major types of products are routed through
the milling machine. The annual demand for product A is 4000 units and 3000 units for
product B. The batch size for A is 20 units and 30 units for B. The standard processing time
for A is 0.5 hours/unit and 0.8 for B. The standard setup time for product A is 2 hours and 8
hours for product B. How many new milling machines are required if Fred’s does not resort
to any short-term capacity options?
Answer:

where M = number of machines required, D = number of units forecast per year, p =

processing time in hours per unit, N = total number of hours per year that the process
operates, C = desired capacity cushion, Q = number of units in each batch, and s = setup
time.

machi

nes.

Reference: A Systematic Approach to Long-Term Capacity Decisions

Difficulty: Moderate
Keywords: capacity requirement

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104. The Union Manufacturing Company is producing two types of products: A and B. The
demand forecasts, batch size, and time standards for the Mark I operation follow:

Product A Product B
Demand forecast (units/yr) 1,000 4,000
Batch size (units/batch) 20 10
Processing time (hr/unit) 3.2 4.5
Setup time (hr/batch) 10 20

The company works 250 days per year and operates 2 shifts, each covering 8 hours. If a
20 percent capacity cushion is maintained, how many new Mark I machines are required
if Union does not resort to any short-term capacity options?
Answer:

where M = number of machines required, D = number of units forecast per year, p =

processing time (in hours per unit), N = total number of hours per year that the process
operates, C = desired capacity cushion, Q = number of units in each batch, and s = setup
time.

machines.

Reference: A Systematic Approach to Long-Term Capacity Decisions

Difficulty: Moderate
Keywords: capacity requirement

105. Larry’s Wickets, Inc. is producing two types of products: A and B. Both are produced at the
same machining operation. Because of demand uncertainties, the operations manager
obtained three demand forecasts (pessimistic, expected, and optimistic). The demand
forecasts, batch sizes (units/batch), processing times (hr/unit), and setup times (hr/batch)
follow.

Time Standard Demand Forecasts (000 units/yr)

Product Processing Setup Batch Pessimistic Expected Optimistic
Size
A .30 1.0 200 100 120 150
B .25 2.0 100 190 210 230

The machines operate on two 8-hour shifts, 5 days per week, and 50 weeks per year. The
manager wants to maintain a 20 percent capacity cushion.
a. What is the minimum number of hours required of the machining equipment for the next
year?
b. How many hours of capacity can the company expect from each machine?
c. What is the minimum number of machines needed (assuming no reliance on short-term
options)?
d. What is the maximum number of machines needed (assuming no reliance on
short-term options)?

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Answer:

Inputs
Solver—Capacity Requirements
Enter data in gray shaded areas.
Shifts/Day 2 Components 2
Hours/Shift 8
Days/Week 5 More Components
Weeks/Year 50 Fewer Components
Cushion (as %) 20%
Current Capacity

Processing Setup Lot Size Demand Forecasts

Components (hr/unit) (hr/lot) (units/lot) Pessimistic Expected Optimistic
A 0.30 1.0 200 100,000 120,000 150,000
B 0.25 2.0 100 190,000 210,000 230,000

Productive hours from

one capacity unit for a year 3,200

Pessimistic Expected Optimistic

Process Setup Process Setup Process Setup
A 30,000 500.0 36,000 600.0 45,000 750.0
B 47,500 3,800.0 52,500 4,200.0 57,500 4,600.0
77,500 4,300.0 88,500 4,800.0 102,500 5,350.0
Total hours required 81,800.0 93,300.0 107,850.0

Total capacity requirements (M) 25.56 29.16 33.70

Rounded 26 30 34
Scenarios that can be met with current systems/capacity:

a. 81,800 hours
b. 3,200 hours
c. 26 machines
d. 34 machines
Reference: A Systematic Approach to Long-Term Capacity Decisions
Difficulty: Hard
Keywords: capacity cushion, capacity requirement

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106. The T. H. King Company has introduced a new product line that requires two work
centers, A and B for manufacture. Work Center A has a current capacity of 10,000 units
per year, and Work Center B is capable of 12,500 units per year. This year (year 0), sales
of the new product line are expected to reach 10,000 units. Growth is projected at an
additional 1,000 units each year through year 5. Pre-tax profits are expected to be $30 per
unit throughout the 5-year planning period. Two alternatives are being considered:
1) Expand both Work Centers A and B at the end of year 0 to a capacity of 15,000 units
per year, at a total cost for both Work Centers of $200,000;
2) Expand Work Center A at the end of year 0 to 12,500 units per year, matching Work
Center B, at a cost of $100,000, then expanding both Work Centers to 15,000 units
per year at the end of year 3, at an additional cost at that time of $200,000.
The King Company will not consider projects that don’t show a 5th year positive net
present value using a discount rate of 15%. What are the pre-tax cash flows for the two
alternatives compared to the base case of doing nothing for the next five years, and what
action, if any, should the company take?

Answer: The following table summarizes demand and output capabilities for the two
alternatives:

ALT. #1 ALT. #1 ALT. #2 ALT. #2

CAPACITY ANNUAL CAPACITY ANNUAL
YEAR DEMAND A B OUTPUT A B OUTPUT
0 10,000 10,000 12,500 10,000 10,000 12,500 10,000
1 11,000 15,000 15,000 11,000 12,500 12,500 11,000
2 12,000 15,000 15,000 12,000 12,500 12,500 12,000
3 13,000 15,000 15,000 13,000 12,500 12,500 12,500
4 14,000 15,000 15,000 14,000 15,000 15,000 14,000
5 15,000 15,000 15,000 15,000 15,000 15,000 15,000

ALTERNATIVE #1 (volume #s in 000s) ALTERNATIVE #2(volume #s in 000s)

YEAR $ OUT $ IN $ OUT $ IN
0 200,000 100,000
1 (11 – 10)($30) = $30,000 (11 – 10)($30) = $30,000
2 (12 – 10)($30) = $60,000 (12 – 10)($30) = $60,000
3 (13 – 10)($30) = $90,000 200,000 (12.5 – 10)($30) = $75,000
4 (14 – 10)($30) = $120,000 (14 – 10)($30) = $120,000
5 (15 – 10)($30) = $150,000 (15 – 10)($30) = $150,000
Alternative #1 Net Present Value (in $000s)
= – 200 + 30/1.15 + 60/(1.15)2 + 90/(1.15)3 + 120/(1.15)4 + 150/(1.15)5
= – 200 + 26.1 + 45.4 + 59.2 + 68.6 + 74.6 = $73.9
Alternative #2 Net Present Value (in $000s)
= – 100 + 30/1.15 + 60/(1.15)2 + (75 – 200)/(1.15)3 + 120/(1.15)4 + 150/(1.15)5
= – 100 + 26.1 + 45.4 – 82.2 + 68.6 + 74.6 = $32.5
Both alternatives have a positive net present value after five years at a discount rate of
15%. However, Alternative #1 has a higher net present value after the five-year period
($73,900 versus $32,500) and should therefore be the alternative selected.
Reference: A Systematic Approach to Long-Term Capacity Decisions
Difficulty: Hard
Keywords: evaluating alternatives, net present value, pre-tax cash flow, discount rate

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107. Burdell Labs is a diagnostic laboratory that does various tests (blood tests, urine tests, etc.)
for doctors’ offices in the Indianapolis area. Test specimens are picked up at the doctors’
offices and are transported to the testing facility, with uniform arrivals throughout the day.
All tests go through two testing centers in the testing facility, Test Center A and Test Center
B. A has a current capacity of 1,000 units per week, and B is capable of 1,500 units per
week. The facility operates 50 weeks per year. This year (year 0), test volumes are expected
to reach 1,000 units per week. Growth is projected at an additional 200 units each week
through year 5 (i.e., 1,200 per week in year #1, 1,400 per week in year #2, etc.). Pre-tax
profits are expected to be $5 per test throughout the 5-year planning period. Two
alternatives are being considered:
1) Expand both Test Centers A and B at the end of year 0 to a capacity of 2,000 units
per week, at a total cost for both Test Centers of $300,000;
2) Expand Test Center A at the end of year 0 to 1,500 units per week, matching Test
Center B, at a cost of $100,000, then expanding both Test Centers to 2,000 units per
year at the end of year 3, at an additional cost at that time of $250,000.
Burdell Labs will not consider projects that don’t show a 5th year positive net present value
using a discount rate of 15%. What are the pre-tax cash flows for the two alternatives
compared to the base case of doing nothing for the next five years, and what action, if any,
should Burdell take?
Answer: The following table summarizes demand and output capabilities for the two
alternatives:
ALT. #1 ALT. #1 ALT. #2 ALT. #2
WEEKLY CAPACITY ANNUAL CAPACITY ANNUAL
YEAR DEMAND A B OUTPUT A B OUTPUT
0 1,000 1,000 1,500 1,000 1,000 1,500 1,000
1 1,200 2,000 2,000 1,200 1,500 1,500 1,200
2 1,400 2,000 2,000 1,400 1,500 1,500 1,400
3 1,600 2,000 2,000 1,600 1,500 1,500 1,500
4 1,800 2,000 2,000 1,800 2,000 2,000 1,800
5 2,000 2,000 2,000 2,000 2,000 2,000 2,000
ALTERNATIVE #1 (volume #s in 000s) ALTERNATIVE #2(volume #s in 000s)
YEAR $ OUT $ IN (ANNUAL) $ OUT $ IN (ANNUAL)
0 300,000 100,000
1 (1.2 – 1.0)($5)(50) = $50,000 (1.2 – 1.0)($5)(50) = $50,000
2 (1.4 – 1.0)($5)(50) = $100,000 (1.4 – 1.0)($5)(50) = $100,000
3 (1.6 – 1.0)($5)(50) = $150,000 250,000 (1.5 – 1.0)($5)(50) = $125,000
4 (1.8 – 1.0)($5)(50) = $200,000 (1.8 – 1.0)($5)(50) = $200,000
5 (2.0 – 1.0)($5)(50) = $250,000 (2.0 – 1.0)($5)(50) = $250,000
Alternative #1 Net Present Value (in $000s)
= – 300 + 50/1.15 + 100/(1.15)2 + 150/(1.15)3 + 200/(1.15)4 + 250/(1.15)5
= – 300 + 43.5 + 75.6 + 98.6 + 114.4 + 124.3 = $156.4
Alternative #2 Net Present Value (in $000s)
= – 100 + 50/1.15 + 100/(1.15)2 + (125 – 250)/(1.15)3 + 200/(1.15)4 + 250/(1.15)5
= – 100 + 43.5 + 75.6 – 82.2 + 114.4 + 124.3 = $175.6
Both alternatives have a positive net present value after five years at a discount rate of 15%.
However, Alternative #2 has a higher net present value after five years ($175,600 versus
$156,400) and should therefore be the alternative selected.
Reference: A Systematic Approach to Long-Term Capacity Decisions
Difficulty: Hard
Keywords: evaluating alternatives, net present value, pre-tax cash flow, discount rate

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