Solution Manual of Operations and Supply Chain Management 14 Edition By Jacobs – Test Bank

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Chapter 05 – Strategic Capacity Management

CHAPTER 5

STRATEGIC CAPACITY MANAGEMENT

Discussion Questions

1. 2. 3. What capacity problems are encountered when a new drug is introduced to the market?

The primary concerns come from uncertain demand for the drug and the high capital investment

typically needed for modern drug production. Being a new drug, there are no historical sales data on

which to base forecasts of future demand. If forecasts are too high, significant capital resources will

be underutilized. If forecasts are too low, there may be insufficient capital resources to meet the

actual demand, resulting in lost sales when the price for the new drug is typically highest.

List some practical limits to economies of scale; that is, when should a plant stop growing?

The obvious answer is that a plant should stop growing when its long-run average cost curve hits the

inflection point and starts increasing. Factors leading to this situation include difficulties

coordinating and managing a facility of that size, demand variations that can lead to regular periods

of low capacity utilization, and capacity imbalance within the facility.

What are some capacity balance problems faced by the following organizations or facilities?

a. An airline terminal

Congested flight arrival/departure scheduling typically leads to problems throughout the system,

including waiting areas, distances from boarding gates, ground crew requirements, runways,

baggage handling, etc.

b. A university computing lab

The number of computer workstations, the size of each workstation (room for student papers, etc.),

the mix of different computer types (Mac or PC), the number of printers, the capacity of the network

access, study space for students waiting. These problems are exacerbated by surges in demand

during certain points in the semester (e.g. finals week).

c. A clothing manufacturer

Many manufacturers now use highly decentralized shops to make clothes. This means that capacity

of multiple sites must be accounted for in planning production.

4. At first glance, the concepts of the focused factory and capacity flexibility may seem to contradict

each other. Do they really?

This is not necessarily true. This will depend on the available technology of the facility and on the

type of industry it competes in. An FMS plant may, for example, use flexible processes to enlarge the

variety of products produced and delivered in a very short time. Therefore, it can choose to compete

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on fast delivery of customized products rather than on cost. The PWP concept can capitalize on the

overall facility economies of scale while maintaining focus within each individual PWP.

5. Management may choose to build up capacity in anticipation of demand or in response to

developing demand. Cite the advantages and disadvantages of both approaches.

6. 7. The strategy of building up capacity ahead of demand is a risk-taking stance. Investment is based on

projections. This investment involves costs for new facilities, equipment, human resources, and

overhead. If the demand materializes, the investment is worthwhile since the firm may capture a

large amount of market share. If it does not materialize, the firm must redirect the invested

resources. This strategy is most appropriate in high growth areas.

If the demand materializes, but the capacity planning strategy is risk averse, i.e., building capacity

only as demand develops, then most likely market share will be lost. The growth in demand will

encourage new entrants, resulting in more competition. The risk averse strategy may be most

appropriate for small firms who cannot afford to invest in unproven prospects. To prevent potential

loss of market share, firms may choose to incrementally increase capacity to match the increase in

demand.

What is capacity balance? Why is it hard to achieve? What methods are used to deal with capacity

imbalances?

In a perfectly balanced plant, the output of each stage provides the exact input requirement for the

subsequent stage. This continues throughout the entire operation. This condition is difficult to

achieve because the best operating levels for each stage generally differ. Variability in product

demand and the processes may also lead to imbalance, in the short run.

There are various ways of dealing with capacity imbalances. One is to add capacity to those stages

that are the bottlenecks. This can be achieved by temporary measures such as overtime, leasing

equipment, or subcontracting. Another approach is to use buffer inventories so that

interdependence between two departments can be loosened. A third approach involves duplicating

the facilities of one department upon which another is dependent.

What are some reasons for a plant to maintain a capacity cushion? How about a negative capacity

cushion?

A plant may choose to maintain a capacity cushion for a number of reasons. If the demand is highly

unstable, maintaining cushion capacity will ensure capacity availability at all times. Also, capacity

cushions can be useful if high service quality levels are established. Some organizations choose to use

capacity cushions as a competitive weapon to create barriers to entry for competitors.

Negative capacity cushions may be maintained when demand is expected to decrease rapidly and

capacity investment is high enough to discourage short run capacity acquisitions. It may also make

sense where capital investment needed to achieve a capacity cushion is extremely expensive, and

capacity can be easily increased in the short run by methods such as overtime or subcontracting.

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8. Will the use of decision tree analysis guarantee the best decision for a firm? Why or why not? If

not, why bother using it?

No they cannot, due to the effect of future chance events. First, the probabilities are not known with

certainty, but are just estimates. However, even if the probabilities used are accurate, we are still

just computing expected values. For any one decision, there is no guarantee it will be the best

possible decision. Then why use it? For any one decision you are going with the “best odds” so to

speak. For a series of decisions over time, the best long-term results will come from decision tree

analysis with accurate probabilities.

9. Consider the example in Exhibit 5.5. Can you think of anything else you might do with that example

that would be helpful to the ultimate decision maker?

As with the probabilities in the prior question, the rate of return used in NPV analysis is only an

estimate. The analyst could repeat the decision tree analysis with multiple rates of return,

performing sort of a sensitivity analysis on the decision model with respect to the rate of return. If

the same solution results from all of the analyses, the decision maker can feel more confident in

choosing the recommend approach.

10. What are some major capacity considerations in a hospital? How do they differ from those of a

factory?

Some capacity considerations are size and composition of nursing staff (RNs vs. LPNs), balance

between operating room and intensive care units, emergency rooms, etc., and, of course, how many

beds are to be available. One of the differences in capacity considerations between a hospital and a

factory is that a hospital can add capacity rather quickly in the short run, through “simply” adding

more staff and more beds. A factory is usually technologically limited, and, therefore, must plan well

in advance to add major chunks of capacity. On the other hand, though, the general uncertainty

which surrounds the demand for hospital services on any given day is much greater than would be

faced by a factory. Additionally, factory management generally has the ability to backlog demand in

such a way as to achieve more efficient levels of capacity utilization than does a hospital. Sick and

injured patients cannot be put on a shelf and made to wait during periods of peak demand.

11. Refer to Exhibit 5.6. Why is it that the “critical zone” begins at a utilization rate of about 70 percent

in a typical service operation? Draw upon your own experiences as either a customer or a server in

common service establishments.

Uncertainty in the arrival and service rates is the key problem here. The utilization rate of 70 percent

is based on the average arrival rate and service rate. As most of us have observed, both can vary

widely throughout the day or even from one customer to the next. Sometimes things just “get busy”

as more customers than average arrive during a short time window. Also, a “problem customer” or

two can greatly extend the time to service them and consume valuable resources. Even though the

average utilization rate may be 70 percent, these issues can make the short term utilization rate

exceed 100 percent occasionally.

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Objective Questions

1. A manufacturing shop is designed to operate most efficiently at an output of 550 units per day. In

the past month the plant produced 490 units. What was their capacity utilization rate last month?

2. A company has a factory that is designed so that it is most efficient (average unit cost is minimized)

when producing 15,000 units of output each month. However, it has an absolute maximum output

capability of 17,250 units per month, and can produce as little as 7000 units per month without

corporate headquarters shifting production to another plant. If the factory produces 10,925 units in

October, what is the capacity utilization rate in October for this factory?

3. Hoosier Manufacturing operates a production shop that is designed to have the lowest unit

production cost at an output rate of 100 units per hour. In the month of July, the company operated

the production line for a total of 175 hours and produced 16,900 units of output. What was its

capacity utilization rate for the month?

4. AlwaysRain Irrigation, Inc., would like to determine capacity requirements for the next four years.

Currently two production lines are in place for making bronze and plastic sprinklers. Three types of

sprinklers are available in both bronze and plastic: 90-degree nozzle sprinklers, 180-degree nozzle

sprinklers, and 360-degree nozzle sprinklers. Management has forecast demand for the next four

years as follows:

Both production lines can produce all the different types of nozzles. The bronze machines

needed for the bronze sprinklers require two operators and can produce up to 12,000

sprinklers. The plastic injection molding machine needed for the plastic sprinklers requires four

operators and can produce up to 200,000 sprinklers. Three bronze machines and only one

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injection molding machine are available. What are the capacity requirements for the next four

years? (Assume that there is no learning.)

Solution:

Plastic Year 1 Year 2 Year 3 Year 4

Demand for plastic sprinklers 97 115 136 141

Bronze Year 1 Year 2 Year 3 Year 4

Percentage of capacity used 48.5% 57.5% 68.0% 70.5%

Demand for bronze sprinklers 21 24 29 34

Machine requirements .485 .575 .680 .705

Percentage of capacity used 58.3% 66.7% 80.6% 94.4%

Labor requirements 1.94 2.30 2.72 2.82

Machine requirements 1.75 2.00 2.42 2.83

Labor requirements 3.50 4.00 4.83 5.66

There is sufficient capacity to meet expected demand over the 4-year planning horizon. The only concern

might be year 4 on the bronze line. Capacity is approaching 100% in that year, and forecast error might

lead to an over-capacity situation. It is probably not a large concern at this point in time, but

management should pay special attention to that point in time as forecasts are updated in the future.

5. Requirements for plastic remain unchanged.

Bronze Year 1 Year 2 Year 3 Year 4

Demand for bronze sprinklers 32 36 41 52

Percentage of capacity used 88.9% 100.0% 113.9% 144.4%

Machine requirements 2.67 3 3.42 4.33

Labor requirements 5.33 6 6.83 8.67

It is obvious that not enough capacity is available after year two to meet the increased demand.

AlwaysRain will have to consider purchasing additional machines for the bronze operations.

6.

Bronze Year 1 Year 2 Year 3 Year 4

Demand for bronze sprinklers 32 36 41 52

Percentage of capacity used 0 0 0 0

Machine requirements 0 0 0 0

Labor requirements 5.33 0 6.83 8.67

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No. An additional machine will provide enough capacity cushion until the third year. AlwaysRain

must consider additional ways of meeting the fourth year demand. This can include purchasing or

leasing an additional machine, or outsourcing some of the demand.

7.

Year 1 Year 2 Year 3 Year 4

Labor requirements-bronze 5.33 6.00 6.83 8.67

Labor requirements-plastic 1.94 2.30 2.72 2.82

Total labor requirements 7.27 8.30 9.55 11.49

AlwaysRain will face a problem of not having enough trained personnel for running the equipment

after the third year. At that time, they will need to either hire new trained employees or initiate a

training program for existing employees from other workstations who can be utilized at the bronze

or plastic molding machines.

8.

$12.0 million

High growth

P = .40

$10.8 million

Build Small Factory

EV = $10.8 – 6.0 million

EV = $4.8 million

$10.0 million

Low growth

P = .60

Do Nothing, EV = $0

Build Large Factory

EV = $11.6 – 9.0 million

EV = $2.6 million

$14.0 million

High growth

P = .40

$11.6 million

Low growth

P = .60

$10.0 million

For the small facility,

NPV = .40 ($12 Million) + .60 ($10 Million) – $6 Million = $4.8 Million

Do nothing,

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NPV = $0

For the large facility

NPV = .40($14 Million) + .60($10 Million) – $9 Million = $2.6 Million

Therefore, build the small facility.

9.

Do Nothing

EV = $0

Sell to dept. chain @ $4.0 million

1

P = .70

EV = $4.3 – 1.0 million = $3.3 million

Sell to insurance co. @ $5.0 million

P = .30

Buy/Develop Property

EV = $2.94 – 2.0 million

EV = $940,000

3

Rezoned

P = .60

EV = $2.94 million

1,500 apts. @ $3,000 = $4.5 million

High price

P = .60

2

EV = $3.9 – $1.0 million = $2.9 million

1,500 apts. @ $2,000 = $3.0 million

Low price

P = .40

Not Rezoned

P = .40

Build 600 homes @ $4,000 = $2.4 million

The “Do Nothing” option is included here for completeness.

Rezoned shopping center (includes $1.0 rezoning costs):

Point 1: Expected value = .70($4 Million) + .30($5 Million) – $1.0 million = $3.3 Million

Rezoned apartments:

Point 2: Expected value = .60($4.5 Million) + .40($3 Million) – $1.0 million = $2.9 Million

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Since a shopping center has more value, prune the apartment choice. In other words, if rezoned, build

a shopping center with a revenue of $4.3 Million – $1 Million = $3.3 Million. (The purchase cost could

be included here if desired, but would need to be included in the calculations for all development

options. This solution shows it at the leftmost part of the tree.)

If not rezoned the revenue will be $2.4 million from building homes:

Point 3: Expected value of developing the land is .6*($3.3 million) + .4*($2.4 million) = $2.94

million.

Expected profit of buying and developing the land is $2.94 million – $2 million purchase cost =

$940,000. Since this is a positive expected value, prune the option of doing nothing.

10. A local restaurant is concerned about their ability to provide quality service as they continue to grow

and attract more customers. They have collected data from Friday and Saturday nights, their busiest

time of the week. During these time periods about 75 customers arrive per hour for service. Given

the number of tables and chairs, and the typical time it takes to serve a customer, they figure they

can serve on average about 100 customers per hour. During these nights, are they in the zone of

service, the critical zone, or the zone of non-service?

According to the text, this restaurant is in the critical zone on these nights.

11. The restaurant in the prior problem anticipates that in one year, their demand will double as long

as they can provide good service to their customers. How much will they have to increase their

service capacity to stay out of the critical zone?

If demand doubles, they will be receiving about 150 customers per hour on average. Find the service

rate necessary to result in a utilization rate of 70%.

Therefore, the restaurant will have to increase capacity to at least 215 customers per hour to stay out

of the critical zone. That will be quite an expansion.

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Chapter 05 – Strategic Capacity Management

Case: Shouldice Hospital – A Cut Above

1. Mon. – Fri. Operations with 90 beds (30 patients per day)

Beds Required

Monday Tuesday Wednesday Thursday Friday Saturday Sunday

Monday Tuesday Wednesday Thursday Friday

Saturday

Sunday 30 30 30

30 30 30

30 30 30

30 30 30

30 30 30

Total 60 90 90 90 60 30 30 450

66.7% 100.0% 100.0% 100.0% 66.7% 33.3% 33.3% 30 30 30

Utilization 2. Mon. – Sat. Operations with 90 beds (30 patients per day)

Beds Required

Monday Tuesday Wednesday Thursday Friday Saturday Sunday

Monday Tuesday Wednesday Thursday Friday Saturday

Sunday Total 71.4%

30 30 30

30 30 30

30 30 30

30 30 30

30 30 30

60 90 90 90 90 60 60 540

Utilization 66.7% 100.0% 100.0% 100.0% 100.0% 66.7% 66.7% 85.7%

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45 45 45

Chapter 05 – Strategic Capacity Management

3. Mon. – Fri. Operations with 135 beds (minimum)

Beds Required

Monday Tuesday Wednesday Thursday Friday Saturday Sunday

Monday Tuesday Wednesday Thursday Friday

Saturday

Sunday Total 45 45 45

45 45 45

45 45 45

45 45 45

90 135 135 135 90 45 45 675

Utilization 66.7% 100.0% 100.0% 100.0% 66.7% 33.3% 33.3% 71.4%

4. Can the capacity of the rest of Shouldice keep up?

One operating room can handle about 1 patient every hour. Since there are five operating rooms,

each must be able to handle 45/5 or 9 patients per day. This means they must be operated 9 hours

a day. In order to finish operating early enough for all patients to recover by the evening, Shouldice

would probably have to add operating room capacity although it might be easy to just start earlier in

the day. With 45 patients each day the total number of operations each week is 225. The 12

surgeons would need to do between 18 and 19 each week or between 3 and 4 a day. This should be

feasible and even if it were not Shouldice could hire some additional surgeons. These guys would be

making over $450,000/year (3 ops/day x 5 days/week x 50 weeks/yr x $600 = $450,000)!

Using the financial data given in the fourth discussion question it is easy to justify the expansion to

135 beds. The following is the analysis as presented in the spreadsheet. Based on average costs and

full capacity utilization, the hospital would pay back its investment in about 86 weeks, or 1.72 years.

Beds Required

Mon Tues Wed Thurs Fri Sat Sun

Mon Tues Wed Check-in day Thurs Fri

Sat

Sun Total Beds Total 135 Utilization 45 45 45

45 45 45

45 45 45

45 45 45

45 45 45

90 66.7% 135 100.0% 135 100.0% 135 100.0% 90 66.7% 45 33.3% 45 33.3% 675

71.4%

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Operating Rooms Operations 45

5 Oper/Room 9

Surgeons

12 Oper/Surg 3.75

Cost of expansion Beds 45

Cost/Bed $100,000

Total $4,500,000

Incremental

Revenue

Rev/Oper $1,300

Surgeon $600

Incr Rev $700

Additional Oper/Week 75

Rev/Week $52,500

Payback 85.7 Weeks

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