CHAPTER 8

Managing Capacity

PROBLEMS
Additional homework problems are available at www.prenhall.com/bozarth. These problems use Excel
to generate customized problems for different class sections or even different students.
(* = easy; ** = moderate; *** = advanced)

1. (*) The Shelly Group has leased a new copier that costs $700 per month plus $0.10 for each copy.
What is the total cost if Shelly makes 5,000 copies a month? 10,000 copies? What is the per-copy
cost at 5,000 copies? At 10,000 copies?

TC = FC + VC*X Eq 8-1

FC = $700
VC = $.10/copy

TC = 700 + (.10*5000)
TC = $1200

TC = 700 + (.10*10,000)
TC = $1,700

Per copy price = TC/# of copies

PPC = 1200/5000
PPC = $0.24 @ 5000 copies

PPC = 1700/10000
PPC = $0.17 @ 10,000 copies
74 Chapter 8: Managing Capacity
2. Arktec Manufacturing must choose between two capacity options, shown below:

Fixed cost (per year) Variable cost (per unit)

Option 1 $500,000 $2 per unit
Option 2 $100,000 $10 per unit

a. (*) What would the cost be for each option if the demand level is 25,000 units per year?
75,000?

TC = FC + VC*X Eq 8-1

Option 1
FC = $500,000
VC = $2.00 per unit

TC = 500,000 + (2*25,000)
TC = $550,000 for Option 1 (25,000 units)

TC = 500,000 + (2*75,000)
TC = $650,000 for Option 1 (75,000 units)

Option 2
FC = $100,000
VC = $10/unit

TC = 100,000 + 250,000
TC = $350,000 for Option 2 (25,000 units)

TC = 100,000 + (10*75,000)
TC = $850,000 for Option 2 (75,000 units)

b. (**) In general, which option do you think would be better as volume levels increase?
Decrease? Why?

As the volume increases – Option 1 become more desirable because the variable costs
associated with each unit are significantly less.

c. (*) What is the indifference point?

TC(1) = TC (2)

FC + VC*X = FC + VC*X
500,000 + (2X) = 100,000 + (10X)
400,000 = 8X
50,000 units is the indifference point
 Instructor’s Solutions Manual 75

3. (*) Suppose the Shelly Group (Problem 1) has identified two possible demand levels for copies per
month:

Copies (per month) Probability

5,000 copies 50%
10,000 copies 50%

What is the expected cost, given the fixed and variable costs in Problem 1?

Using information from problem #1

Expected cost = (Option 1 cost * probability) + (Option 2 cost * probability)
Expected cost = $1200(50%) + 1700(50%)
Expected cost = 600 + 850
Expected cost = $1450

4. Consider the two capacity options for Arktec Manufacturing, shown in Problem 2. Suppose the
company has identified three possible demand scenarios:

Demand (per year) Probability

25,000 units 30%
60,000 40%
100,000 30%

a. (**) What is the expected value of each option? Which option would you choose, based on this
information?

TC = FC + VC*X Eq 8-1
I
EV j = ∑P C
i =1
i i Eq 8-2

Option 1
TC = 500,000 + (2*25,000) = $550,000
TC = 500,000 + (2*60,000) = $620,000
TC = 500,000 + (2*100,000) = $700,000

EV = 550,000(.3) + 620,000(.4) + 700,000(.3)

EV = $623,000 for Option 1 in costs

Option 2
TC = 100,000 + (10*25,000) = 350,000
TC = 100,000 + (10*60,000) = 700,000
TC = 100,000 = (10*100,000) = 1,100,000

EV = 350,000(.3) + 700,000(.4) + 1,100,000(.3)

EV = $715,000 for Option 2 in costs

I would choose Option 1 – costs are less at this point.

76 Chapter 8: Managing Capacity
b. (**) Suppose the lowest and highest demand levels were updated to 40,000 and 110,000.
Recalculate the expected values. What happened?

Option 1
TC = 500,000 + (2*40,000) = $580,000
TC = 500,000 + (2*60,000) = $620,000
TC = 500,000 + (2*110,000) = $720,000

EV = 580,000(.3) + 620,000(.4) + 720,000(.3)

EV = $572,000 for Option 1 in costs

Option 2
TC = 100,000 + (10*40,000) = 400,000
TC = 100,000 + (10*60,000) = 700,000
TC = 100,000 = (10*110,000) = 1,200,000

EV = 400,000(.3) + 700,000(.4) + 1,200,000(.3)

EV = $790,000 for Option 2 in costs

Costs rose for Option 2 while they decreased for Option 1 – again it is a larger volume and this
would be expected.

5. Problem 2 identified two capacity options for Arktec Manufacturing, while Problem 4 identified three
possible demand outcomes.

a. (**) Draw the decision tree for Arktec Manufacturing. When drawing your tree, assume that
management must select a capacity option before they know what the demand level will actually
be.
 Instructor’s Solutions Manual 77

$550,000
25,000 units
Option 1
EV = $623,333 $620,000
In costs 60,000 units

$700,000
100,000 units
Select
Capacity $350,000
25,000 units
Option
$700,000
60,000 units
$1,100,000
Option 2 100,000 units
EV = $716,667
In costs

Each leg has an equal probability = 33.333% = 1/3, use capacity estimates from
4a.
EV1 = 550,000(1/3) + 620,000(1/3) + 700,000(1/3) = $623,333.33
EV2 = 350,000(1/3) + 700,000(1/3) + 1,100,000(1/3) = $716,666.67

b. (**) Calculate the expected value for each decision branch. Which option would you prefer?
Why?

Option 1
TC = 500,000 + (2*25,000) = $550,000
TC = 500,000 + (2*60,000) = $620,000
TC = 500,000 + (2*100,000) = $700,000

EV = 550,000(1/3) + 620,000(1/3) + 700,000(1/3)

EV = $623,333 for Option 1 in costs

Option 2
TC = 100,000 + (10*25,000) = 350,000
TC = 100,000 + (10*60,000) = 700,000
TC = 100,000 = (10*100,000) = 1,100,000

EV = 350,000(.3) + 700,000(.4) + 1,100,000(.3)

EV = $716,667 for Option 2 in costs

I would choose Option 1 – costs are less at this point. (Based on answers from problem 5a.)
78 Chapter 8: Managing Capacity
6. You are the new CEO of Dualjet, a company that makes expensive, premium kitchen stoves for home
use. You must decide whether to assemble the stoves in-house, or have a Mexican company do it.
The fixed and variable costs for each option are shown below:

Fixed Variable
Cost Cost

Assemble in-house $55,000 $620

Mexican assembler $0 $880

a. (**) Suppose DualJet’s premium stoves sell for $2500. What is the break-even volume point
for doing it in-house?

FC
BEP = eq 8-3
R − VC

FC = 55,000
VC = 620
R = 2500

BEP = (55,000)/(2500 – 620)

BEP = 29.2 units or 30 to break even

b. (*) At what volume level do the two capacity options have identical costs?

FC + (VC*X) = FC + (VC*X)
55,000 + 620X = 0 + 880X
55,000 = 260X
211.54 units

c. (**) Suppose the expected demand for stoves is 3,000. Which capacity option would you
prefer from a cost perspective?

I would use the in-house option. If the expected sales quantity is greater than 211 units, I will
make a better profit building them in-house.

7. Emily Watkins, a recent college graduate, faces some tough choices. Emily must decide whether to
accept an offer for a job that pays $35,000, or hold out for another job that pays $45,000 a year.
Emily figures there is a 75% chance she will get an offer for the higher paying job. The problem is,
Emily has to make a decision on the lower paying job within the next few days, and she will not
know about the higher paying job for two weeks.
 Instructor’s Solutions Manual 79
a. (**) Draw out the decision tree for Emily Watkins.

b. (**) What is the key decision facing Emily? What is the expected value of each decision
branch?
45,000 * 75%
OptionWhich
1 job to take is Emily’s decision? Is a job in hand better than a probability of a higher
Higherpaying
payingjob?
job EV for the higher paying job is $33,750 and the EV of the lower paying job is
$35,000.
EV = $33,750

c. (**) What other factors might Emily consider, other than expected value?
0 * 25%

She might go ahead and take the lower paying job and then quit if she gets the higher paying job.
Select
The Job
decision tree only accounts for taking one 35,000
job or the other not taking both. She may also
* 100%
consider yet another higher paying job – how long is too long to wait for employment.

8. (*) Philip Neilson owns a fireworks store. Philip’s45,000

fixed costs
* 0%are $12,000 a month, and each
Option 2
fireworks assortment he sells costs, on average, $8. The average selling price for an assortment is
Lower paying job
$25. What is the break-even point for Philip’s fireworks store?
EV = $35,000
FC
BEP = eq 8-3
R − VC

BEP = 12,000/(25-8)
BEP = 705.88 or 706 units

9. Suppose Philip Neilson (Problem 8) decides to expand his business. His new fixed expenses will be
$20,000, but the average cost for a fireworks assortment will fall to just $5 due to Philip’s higher
purchase volumes.

a. (*) What is the new break-even point?

FC
BEP = eq 8-3
R − VC

BEP = 20,000/(25-5)
BEP = 1000 units

b. (**) At what volume level is Philip indifferent to the two capacity alternatives outlined in
Problems 8 and 9?

FC + (VC*X) = FC + (VC*X)
12,000 + 8X = 20,000 + 5X
3X = 8,000
2666.67 or 2667 units

10. Merck is considering the launch of a new drug called Laffolin. Merck has identified two possible
demand scenarios, shown below:

Demand level Probability

1,000,000 patients 30%
80 Chapter 8: Managing Capacity
2,000,000 patients 70%

Merck also has the following information:

Revenue: $140 per patient

Fixed costs to manufacture & sell Laffolin: $70 million
Variable costs to manufacture & sell Laffolin: $80 per patient
Maximum number of patients that Merck can handle: 3,000,000

a. (*) How many patients must Merck have in order to break even?

FC
BEP = eq 8-3
R − VC

BEP = 70,000,000/(140 – 80)

BEP = 1166666.67 or 1,166,667 patients
 Instructor’s Solutions Manual 81
b. (**) How much money will Merck make if demand for Laffolin is 1,000,000 patients? If demand
is 2,000,000 patients?

Profit = Revenue/patient – Costs per patient

Profit = 140,000,000 – (FC + VC*X)
Profit = 140,000,000 – 150,000,000
Profit = - $10,000,000 it is a loss at 1,000,000 patients

Profit = 280,000,000 – (230,000,000)

Profit = $50,000,000 at 2,000,000 patients

c. (**) What is the expected value of making Laffolin?

EV = (-10,000,000)*.3 + (50,000,000)*.7
EV = $32,000,000

d. (**) Draw the decision tree for the Laffolin decision, showing the profits for each branch (Total
revenues – total variable costs – fixed cost) and all expected values.

- $10,000,000
Make Laffolin
EV = $32,000,000 1 million patients

$50,000,000

Drug 2 million patients

Not make Laffolin 0

EV = 0
82 Chapter 8: Managing Capacity
11. Clay runs a small hotdog stand in downtown Chapel Hill. Clay can serve about
30 customers an hour. During lunch time, customers randomly arrive at the rate
of 20 per hour.

a. (*) What percentage of the time is Clay busy?

λ
ρ= [8-5]
µ

ρ = 20/30
ρ = 66.7%

b. (*) On average, how many customers are waiting to be served? How many are in the system
(waiting and being served)?

λ2
CW = [8-6]
µ( µ − λ)

( 20 ) 2
CW =
30 (30 − 20 )

CW =1.333 average number of customers waiting to be served

λ
CS = [8-7]
µ −λ

( 20 )
CS =
30 − 20

C S = 2 customers, on average, in the system

 Instructor’s Solutions Manual 83
c. (*) On average, how long will a customer wait to be served? How long will a customer be in
the system?

λ
TW = [8-8]
µ( µ − λ)

20
TW =
30 (30 − 20 )

TW = .0667 hours average time spent waiting or 4 minutes

1
TS = [8-9]
µ −λ

1
TS =
30 − 20

TS = .1 hours average time spent in the system or 6 minutes

12. Peri Thompson is the sole dispatcher for Thompson Termite Control. Peri’s job is to take customer
calls, schedule appointments, and in some cases resolve any service or billing questions while the
customer is on the phone. Peri can handle about 15 calls an hour.

a. (*) Typically, Peri gets about 10 calls an hour. Under these conditions, what is the average
number of customers waiting, and what is the average waiting time?
λ2
CW = [8-6]
µ( µ − λ)

(10 ) 2
CW =
15 (15 −10 )

CW =1.33 average number of customers waiting to be served.

λ
TW = [8-8]
µ( µ − λ)

10
TW =
15 (15 −10 )

TW = .1333 hours average time spent waiting or 8 minutes average time waiting
84 Chapter 8: Managing Capacity
b. (**) Monday mornings, however, are unusually busy. During these peak times, Peri will receive
around 13 calls an hour, on average. Recalculate the average number of customers waiting, and
the average waiting time. What can you conclude?
λ2
CW = [8-6]
µ( µ − λ)

(13 ) 2
CW =
15 (15 −13 )

CW = 5.63 average number of customers waiting to be served.

λ
TW = [8-8]
µ( µ − λ)

13
TW =
15 (15 −13 )

TW = .4333 hours average time spent waiting or 26 minutes average time waiting

Peri needs help on Monday mornings or customers will get tired of waiting on the phone for 26 minutes.

13. Benson Racing is training a new pit crew for its racing team. For their first practice run, the pit crew
is able to complete all the tasks in exactly thirty seconds – not exactly world-class. The second time
around, they shave 4.5 seconds off their time.

a. (*) Estimate the learning rate for the pit crew, based on the times for the first two practice runs.

Learning rate = 25.5/30

Learning rate = .85 or 85%

b. (**) Mark Benson, owner of Benson Racing, says that the pit crew must be able to complete all
the tasks in less than 15 seconds in order to be competitive. Based on your answer to Part a, how
many times will the pit crew need to practice before they break the 15 second barrier?

Tn = T1 * n b [8-11]

15sec n =30 *1 n ln(Learning percentage) / ln2

15sec n =30 *1 n ln(.85) / ln2
15sec n =30 *1 n −.234465
−.234465
.5 = n
−.234465
ln .5 = ln n
-.693147 = -.234465 ln n
2.956 = ln n
19.22 or 20 practices needed to get to 15 seconds
 Instructor’s Solutions Manual 85
c. (**) Is it realistic to expect the pit crew to experience learning improvements indefinitely?
Explain.

No, while it is possible mathematically tasks can only be performed so fast. It will always take
some amount of time.

14. Wake County has a special emergency rescue team. The team is practicing rescuing dummies
from a smoke-filled building. The first time they tried, it took 240 seconds (4 minutes). The
second time took 180 seconds (3 minutes).

a. (*) What is the estimated learning rate for the rescue team, based on the information above?

Learning rate = 180/240

Learning rate = .75 or 75%

b. (**) Suppose the team's learning rate for the rescue exercise is 80%. How many times will
they need to repeat the exercise until the time is less than 120 seconds (50% of the original
time)?

Tn = T1 * n b [8-11]

120sec n =240 *1 n ln(Learning percentage) / ln2

120sec n =240 *1 n ln(.80) / ln2
120sec n =240 *1 n −.3219
−.3219
.5 = n
−.3219
ln .5 = ln n
-.693147 = -.3219 ln n
2.153 = ln n
8.61 or 9 repeats to get the time below 120 seconds at the 80% learning rate.

c. (**) How long would it take the emergency team to perform their 20th rescue if the learning
rate is 80%?

Tn = T1 * n b [8-11]

Tn = 240 * .381 (from Table 8-6)

Tn = 91.44 seconds
86 Chapter 8: Managing Capacity
Problems 15 through 17: TriangCom

15. After graduating from college, some friends and you start an Internet auction service called
TriangCom. Business has been fantastic, with 10 million customer visits -- or "hits" -- to the site
in the last year. You have several capacity decisions to consider. One key decision involves the
number of computer servers needed. You are considering putting in 10, 20, or 30 servers. Costs
and capacity limits are as follows:

No. of Servers Fixed cost per year Variable cost per hit Maximum hits per yr.
10 $50,000 $.005 20 million
20 $90,000 $.003 40 million
30 $120,000 $.002 60 million

In addition, Marketing has developed the following demand scenarios:

Yearly demand Probability

15 million hits 30%
30 million hits 60%
45 million hits 10%

Finally, TriangCom generated $5 million last year based on 10 million "hits.” Put another way, each
"hit" generated, on average, $0.50 in revenue.

a. (**) Calculate the break-even point for each capacity alternative.

FC
BEP = eq 8-3
R − VC

50, 000
BEP10 =
(.5) − (.005)
BEP10 = 101,010 hits

90, 000
BEP 20 =
(.5) − (.003)
BEP 20 = 181,086 hits

120, 000
BEP 30 =
(.5 − .002)
BEP 30 = 240,963 hits

b. (**) At what demand level would you be indifferent to having either 10 or 20 servers?

50,000 + (.005*X) = 90,000 + (.003*X)

.002X = 40,000
20 million hits, which is the high end for 10 servers leaving no room for error.
 Instructor’s Solutions Manual 87
c. (***) Calculate the expected value for each capacity alternative. (Hint: Don't forget about
capacity constraints that can limit the number of “hits” each capacity alternative can handle.)
Which alternative would you prefer if you wanted to maximize the expected value?

TC = FC + VC*X Eq 8-1
I
EV j = ∑P C
i =1
i i Eq 8-2

Option 1 (10 servers and 20,000,000 hit limitation)

EV=(((50,000+(.005*15,000,000))*.3)+(((50,000+(.005*20,000,000))*.6)+(((50,000+
(.005*20,000,000))*.1)
EV = (37,500)+(90,000)+(15,000)
EV for option 1 is $142,500 in costs

EV=(((15,000,000*.5)-(37,500))*.3)+(((20,000,000*.5)-(90,000))*.6) + (((20,000,000*.5)-
(90,000))*.1)
EV=(2,238,750)+(5,946,000)+(991,000)
EV for Option 1 is $9,175,750 in net profits

Option 2 (20 servers and 40,000,000 hit limitation)

EV=(((90,000+(.003*15,000,000))*.3)+(((90,000+(.003*30,000,000))*.6)+(((90,000+
(.003*40,000,000))*.1)
EV = (27,013.50)+(108,000)+(21,000)
EV for option 2 is $156,013.50 in costs

EV=(((15,000,000*.5)-(27,013.50))*.3)+(((30,000,000*.5)-(108,000))*.6) + (((30,000,000*.5)-
(21,000))*.1)
EV=(2,241,895.95)+(8,935,200)+(1,497,900)
EV for Option 2 is $12,674,995.95 in net profits

Option 3 (30 servers and 60,000,000 hit limitation)

EV=(((120,000+(.002*15,000,000))*.3)+(((120,000+(.002*30,000,000))*.6)+(((120,000+
(.002*45,000,000))*.1)
EV = (45,000)+(108,000)+(129,000)
EV for option 1 is $282,000 in costs

EV=(((15,000,000*.5)-(45,000))*.3)+(((30,000,000*.5)-(108,000))*.6) + (((45,000,000*.5)-
(129,000))*.1)
EV=(2,236,500)+(8,935,200)+(2,237,100)
EV for Option 3 is $13,408,800 in net profits

Using Expected Costs

Option 1 maximizes your investment dollars but does not realize your potential dollars. Since
you have a 30% probability of 15 million hits and a 60% probability of 30 million, I would use
Option 2, it will cover over 90% of the hit probability.

Using Expected Net Profit

Option 3
88 Chapter 8: Managing Capacity

16. TriangCom has hired Donna Olway to code programs. Donna completes her first job in 5 weeks and
her second job in 4 weeks. Assuming that 1) Donna continues to learn at this rate, and 2) her time
improvements will follow a learning curve:

a. (**) How long would you expect Donna to take to complete her 6th job?

Tn = T1 * n b [8-11]
learning curve is 80% (4weeks/5weeks)

Tn = 5 weeks * .562 (from Table 8-6)

Tn = 2.81 weeks or a little more than 14 days (five day weeks)

b. (**) How long would you expect Donna to take to complete the next five jobs (Jobs 3 through 7)?

Tn = 5 weeks * .702 (from Table 8-6)

Tn = 3.51 weeks or 7.55 days (five day weeks) for Job 3.

Tn = 5 weeks * .640 (from Table 8-6)

Tn = 3.20 weeks or 16 days (five day weeks) for Job 4.

Tn = 5 weeks * .596 (from Table 8-6)

Tn = 2.98 weeks or 14.9 days (five day weeks) for Job 5.

Tn = 5 weeks * .562 (from Table 8-6)

Tn = 2.81 weeks or 14.05 days (five day weeks) for Job 6.

Tn = 5 weeks * .534 (from Table 8-6)

Tn = 2.67 weeks or 13.35 days (five day weeks) for Job 7.
 Instructor’s Solutions Manual 89
17. With thousands of customers, TriangCom has established a hot-line to take customer calls. The
hot-line is staffed by one person, 24 hours a day. You have the following statistics:

Service rate for calls 15 per hour, on average

Arrival rate for calls 11 per hour, on average

As part of your customer service policy, you have decided that the average waiting time should
not exceed 2.5 minutes.

a. (*) What is the average number of callers being served?

λ
ρ= [8-5]
µ

ρ = 11/15
ρ = 73.3%

b. (*) On average, how many callers are waiting to be served?

λ2
CW = [8-6]
µ( µ − λ)

(11) 2
CW =
15(15 − 11)

CW = 2.02 average number of customers waiting to be served

c. (**) What is the average waiting time for a customer? Is this acceptable, given the customer
service policy?

11
TW = [8-8]
15(15 − 11)

20
TW =
30 (30 − 20 )
TW = .1833 hours average time spent waiting or 11 minutes - no this is not acceptable by the
company policy.
90 Chapter 8: Managing Capacity
Problems 18 through 20: Sawyer Construction

Rich Sawyer runs a landscaping firm. Each year, Rich contracts for labor and equipment hours from a
local construction company. The construction company has given Rich three different capacity options,
shown below:

Capacity Options Labor hours Equipment hours

High capacity 9000 6000
Medium capacity 6750 4500
Low capacity 4500 3000

Cost per labor hour: $10 per hour

Cost per equipment hour: $20 per hour

Once Rich has chosen a capacity option, he cannot change it later. In addition, the cost for each capacity
option is fixed. That is, Rich must pay for all labor and equipment hours he contracted for, even if he
doesn't need it all. Therefore, there are essentially no variable costs. Rich also has information
concerning the amount of revenue, labor and equipment hours needed for the "typical" landscaping job:

Job Revenue: $2,000 per job

Labor hours per job: 30 hours
Equip. hours per job: 20 hours

Finally, Rich has identified three possible demand levels. These demand levels, with their associated
probabilities, are shown below:

Demand Level # Jobs Probability

High demand 300 30%
Medium demand 200 40%
Low demand 120 30%

18. (***) Determine the total fixed cost and break-even point for each capacity option. What
is the maximum number of jobs that can be handled under each capacity option?

Capacity Options Labor hours Equipment hours FC

High capacity 9000 10 6000 20 $210,000
Medium capacity 6750 10 4500 20 $157,500
Low capacity 4500 10 3000 20 $105,000
 Instructor’s Solutions Manual 91
FC = (labor hours * $10/hour) + (equipment hours * $20/hour)

Capacity Options FC VC Revenue BEP (in jobs)

High capacity 210,000 0 2000 105
Medium capacity 157,500 0 2000 78.75 or 79
Low capacity 105,000 0 2000 52.5 or 53
FC
BEP =
R − VC

Capacity Options Labor hours Equipment hours Jobs

High capacity 9000/30 300 6000/20 300 300
Medium capacity 6750/30 225 4500/20 225 225
Low capacity 4500/30 150 3000/20 150 150

19. (***) Draw a decision tree for Sawyer. What are the nine possible outcomes Rich is
facing? (Hint: One is "Rich subcontracts for low capacity and demand turns out to be low.") What is
the profit (Revenue - fixed costs) associated with each of the nine outcomes? Be sure to consider the
capacity limits of each alternative when calculating revenues.

TC = FC + VC*X Eq 8-1
I
EV j = ∑P C
i =1
i i Eq 8-2

EV = FC for costs

Net Profit = Revenue - Costs

Capacity Demand Jobs Revenue FC Profit ($)

Options Options ($) ($) (jobs*revenue)-FC
High (300) High 300 2000 210,000 390,000
Medium 200 2000 210,000 190,000
Low 120 2000 210,000 30,000
Medium (225) High 225 2000 157,500 292,500
Medium 200 2000 157,500 242,500
Low 120 2000 157,500 240,000
Low (150) High 150 2000 105,000 195,000
Medium 150 2000 105,000 195,000
Low 120 2000 105,000 135,000
92 Chapter 8: Managing Capacity

Capacity Demand Profit Prob. EV

Options Options (%) Profit * Probability
High (300) High 390,000 30 117,000
Medium 190,000 40 76,000
Low 30,000 30 9,000
Medium (225) High 292,500 30 87,750
Medium 242,500 40 97,000
Low 240,000 30 72,000
Low (150) High 195,000 30 58,500
Medium 195,000 40 78,000
Low 135,000 30 40,500

120 Jobs (30%) $40,500

150 jobs (40%) $78,000

Demand
Low
Demand
Outcome
Capacity
nd 150 jobs (30%) $58,500

EV =
$177,000

120 Jobs (30%) $72,000

Select 200 Jobs (40%) $97,000

Capacity
Transportation Medium
Demand
Option Outcome
Capacity
225 Jobs (30%) $87,750

EV =
$256,750

120 Jobs (30%) $9,000

200 Jobs (40%) $76,000

High
Demand
Outcome
Capacity
300 Jobs (30%) $117,000

EV =
$202,000
 Instructor’s Solutions Manual 93
20. (***) Using the information from Problem 19, calculate the expected profit of each
capacity alternative. Which option would Rich prefer if he wanted to maximize expected profit?

High Capacity = $202,000

Medium Capacity = $256,750
Low Capacity = $177,000

I would choose option #2. Option 2, medium capacity, will cover up to 225 jobs. The expected
increase in costs to improve capacity an additional 75 jobs will cause Rich to lose money in the long
term.

21. (***) (Microsoft Excel problem). The figure below shows an expanded version of the
Excel spreadsheet described in the section, Using Excel in Capacity Management. In addition to the
break-even and indifference points, the expanded spreadsheet calculates financial results for three
capacity options under three different demand scenarios. Re-create this spreadsheet in Excel. You
should develop the spreadsheet so that the results will be recalculated if any of the values in the
highlighted cells are changed. Your formatting does not have to be exactly the same, but the numbers
should be. (As a test, see what happens if you change the “max output” and variable cost for
Capacity Option A to 250 units and $35, respectively. Your new expected value for Capacity Option
A should be $14,218.75.)
94 Chapter 8: Managing Capacity
A B C D E F
1 Evaluating Alternative Capacity Options
2 (Enter inputs in shaded cells)
3
4 Revenue per unit of output: $100.00
5
Variable cost
per unit of
6 Capacity Option Fixed cost output Max. output
7 Option A $0.00 $30.00 200
8 Option B $1,250.00 $15.00 300
9 Option C $4,000.00 $7.50 400
10
Demand
11 Scenario Demand level Probability
12 Low 125 25%
13 Medium 275 55%
14 High 425 20%
15 Total: 100%
16
17 **** Indifference Points ****
*** Break-even
18 point *** Option A Option B Option C
19 Option A 0.00 ---
20 Option B 14.71 83.33 ---
21 Option C 43.24 177.78 366.67 ---
22
23 *** Results for different capacity / demand combinations ***
24
*** Expected
25 Low Medium High value ***
26 Option A $8,750.00 $14,000.00 $14,000.00 $12,687.50
27 Option B $9,375.00 $22,125.00 $24,250.00 $19,362.50
28 Option C $7,562.50 $21,437.50 $33,000.00 $20,281.25
 Instructor’s Solutions Manual 95
CASE STUDY - Forster’s Market

Introduction

Forster’s Market is a retailer of specialty food items, including premium coffees, imported crackers and
cheeses, and the like. Last year, Forster’s sold 14,400 pounds of coffee. Forster’s pays a local supplier
$3 per pound, and then sells the coffees for $7 a pound.

The Roaster Decision

While Forster’s makes a handsome profit on the coffee business, owner Robbie Forster thinks he can do
better. Specifically, Robbie is considering investing in a large industrial-sized coffee roaster that can
roast up to 40,000 pounds per year. By roasting the coffee himself, Robbie would be able to cut his
coffee costs down to $1.60 a pound. The drawback is that the roaster would be quite expensive; fixed
costs (including the lease, power, training, and additional labor) would run about $35,000 a year.
The roaster capacity would also be significantly more than the 14,400 pounds that Forster’s
needs. However, Robbie thinks he would be able to sell coffee to area restaurants and coffee shops for
$2.90 a pound. Robbie has outlined three possible demand scenarios:

Low demand: 18,000 pounds per year

Medium demand: 25,000 pounds
High demand: 35,000 pounds

These numbers include the 14,400 pounds sold at Forster’s Market. In addition, Robbie thinks all
three scenarios are equally likely.

Questions

1. What are the two capacity options that Robbie needs to consider? What are their fixed
and variable costs? What is the indifference point for the two options? What are the implications of
the indifference point?

Two capacity options: buy a roaster or continue as now.

No Roaster
FC = $0
VC = $3.00/pound
Roaster
FC = $35,000
VC = $1.60/pound

FC + (VC*X) = FC + (VC*X)
0 + (3X) = 35,000 + 1.6X
1.4X = 35,000
X = 25,000

25,000 pounds of coffee is the indifference point.

96 Chapter 8: Managing Capacity
2. Draw the decision tree for the roaster decision. If Forster’s does not invest in the roaster,
does Robbie need to worry about the different demand scenarios outlined above? Why or why not?

Total sales = 18,000 lbs  Profit = $52,240

Purchase Roaster

33%
EV = $59,440
Total sales = 25,000 lbs  Profit = $56,540

33%
33%
Total sales = 35,000 lbs  Profit = $69,540
Roaster
33%
Not purchase roaster
EV = $57,600
33% 14,400 pounds
$57,600

3. Calculate the expected value for the two capacity options. Keep in mind that, for the
roaster option, any demand above 14,400 pounds would generate revenues of only $2.90 a pound.
Update the decision tree to show your results.

Demand Original Sales Restaurant FC VC Profit

R = $7.00/lb Sales (R* = per (R + R*) - FC - VC
2.90/lb) lb.
Low 14,400 3,600 35,000 1.60 100,800+10,440-35,000-
28,800 = $47,440
Medium 14,400 10,600 35,000 1.60 100,800+30,740-35,000-
40,000 = $56,540
High 14,400 20,600 35,000 1.60 100,800+59,740-35,000-
56,000 = $69,540

See tree for EV results.

 Instructor’s Solutions Manual 97
4. What is the worst possible financial outcome for Forster’s? The best possible financial
outcome? What other factors – core competency, strategic flexibility, etc. – should Robbie consider
when making this decision?

The worst possible outcome is that Robbie invests in the new roaster and demand is only 15,000 lbs.
In that case, he makes $52,240. The best case is that Robbie invests in the roaster and demand is
35,000 lbs., in which case he makes $69,540. All in all, though, if the demand estimates are
reasonably accurate, Robbie should make money regardless of what he does.
Of course, there is the question of strategic flexibility and core competency. Does Robbie want to get
into the roasting business? If he does invest, it reduces his flexibility to use his time and money
somewhere else.