capacity and resource planning

8/10/2019 Capacity and Resource Planning

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CAPACITYANDRESOUPLANNING

Charan Kamal S

Fiza Behal

Mahima NandaRinki Gupta


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A) CAPACITY: DEFINITION,MEASURESOFCAPACITY, TIME

HORIZONINCAPACITYPLANNICAPACITYPLANNINGFRAMEWOALTERNATIVESFORCAPACITYAUGMENTATION.


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WHATISCAPACITYANDCAPACITYPLANNING? Capacity is the rate of productive capability of a facility. Capacity is usually expre

of output per time period.

Capacity planning is the process of determining the production capacity organization to meet changing demand for its products.

The objectives of capacity planning are:

To identify and solve capacity problem in a timely manner to meet consumer needs.

To maintain a balance between required capacity and available capacity.

The goal of capacity planning is to minimize this discrepancy.

Capacity is calculated: (number of machines or workers) (number of shifts)(efficiency).


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THE NEED FOR CAPACITY PLANNING:

Capacity planning is the first step when an organization

decided to produce more or a new product. Once capacity is evaluated and a need for a newexpanded facility is determined, facility location andprocess technology activities occur.

Capacity planning is done in order to estimate whetherthe demand is higher than capacity or lower thancapacity. That is comparison between demand versuscapacity is done.

It helps an organization to identify and plan the actionsnecessary to meet customers present and futuredemand.


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CAPACITYHASA SIGNIFICANTIMPACTONCOSTOFOPERATION

Capacity investments are large and

fixed in nature. Therefore, itmanifests fixed cost of the system.

Since the total cost can come down

by using a fixed investment more,

firms can experience cost benefits

from using the available capacity to

produce more by judicious planning.

A well known economic principle,

economies of scale, indicates the

relationship between cost and

capacity in an operating system.


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ECONOMIESOFSCALE

When output increases in an operating system, the system is likely to experience cost aaccount several factors. Due the following reasons the average unit cost begins to fall woutput level

Spreading the fixed costs of capacity over a larger output

Improved utilization of several resources in the system

Cost benefit in procurement on account of increased volume.

Efficient use of supervisory and management staff.

The economies of scale cease to occur beyond a level of production or output. This is caDiseconomies of scale. There can be several reasons for this:

- Inefficient management due to largeness of operation and resultant lack of coo

- Overuse of machineries and break down of material handling equipments

- Over hiring of employees, or excessive overtime.

- Service slowdowns due to increasing complexities

- Increase in quality problems because of mismanagement and lack of focus.


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HOW IS CAPACITY MEASURED?

Capacity can be expressed in terms of input & output,depending on the nature of business.

For some organization capacity is simple to measure. GeneralMotors Corporation can use numbersof automobiles per year.

But what about organization whose product lines are morediverse? For these firms, it is hard to find a common unit ofoutput.

As a substitute, capacity can be expressed in terms of input.

A legal office may express capacity in terms of the number of

attorneys employed per year. A custom job shop or an auto repair shop may express capacity

in terms of available labour hours and/or machine hours perweek, month, or year.


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HOW IS CAPACITY MEASURED?.......

Design Capacity:maximum attainable output.

Effective Capacity :maximum possible output with schedulingdifficulties, machine maintenance & so on.

capacityDesign

outputActualnUtilizatio

Both measures expressed in percentage

capacityEffective

outputActualEfficiency


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HOW IS CAPACITY MEASURED?......


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TIME HORIZON IN CAPACITY PLANNING

Capacity planning issues vary markedly with respect

to the time horizon which the decisions are made.

Time horizon are divided into three types

Long term

Medium term

Short term


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CAPACITYPLANNINGISSUESINVARYINGTIMEHORIZONS

Criterion

Time horizon for planning

Long term Medium term Short te

Time frame 2-5 years Typically 1 year 1 week to 3

Planning premiseAugmenting capacity for

projected growth

Balancing

demand - supply

Maximizing av

Efficient use of

Key decisions made

Capacity augmentation;

Capital budgetingexercises

Adjusting demand and

supply attributes tobalance available capacity

to requirement

Resource dep

strategies, Maroutines, Impr

projects to be u

Tools and techniques

used

Investment planning;

Break- even analysis.

Discounted cash flow

techniques; Decision trees

Aggregate production

planning; make or buy

Planning & scTotal prod

maintenance

elimination by c

improvement; S

Waiting line


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CAPACITY PLANNING FRAMEWORK

Capacity planning framework consists of three

important steps:

Estimate the planning requirements

for the planning horizonCompute the available capacity and

identify the quantum of capacity to be

augmented

Identify the available alternatives and select

the best one for capacity augmentation


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Estimate the planning requirements for the

planning horizon

Capacity calculations are done on the basis of man hour and machine hour requirements per

unit of product manufactured.

Estimating labour requirements

The capacity requirements (labour) = D x SL

EL

Where

Projected demand per unit time during the planning horizon = D

Standard labour hours required per unit of product = SL

Efficiency of labour = EL


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Estimating machine requirements

The capacity requirements (labour) = D x SM

EM

WhereProjected demand per unit time during the planning horizon = D

Standard labour hours required per unit of product = SM

Efficiency of labour = EM


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Computing Capacity Availability

Availability of capacity in a system is a function of two parameters.

One is the system availability and the second is theresource availability.

System availability

Number of working days in the planning horizon : Nd

Number of working hours per day : h

System availability (hours) = NdXh

Resource availability

Number of machine available: NM

Machine time lost in breakdowns and maintenance = b%

Number of workers available = NL

Labour : Absenteeism of workers = a%

Capacity available in system (hours)

Machine: NdX h X NmX(1-b/100)

Labour: NdX h X NLX(1-a/100)


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Process Mapping and Capacity Analysis

Process mapping is representation of all the available resources, the

patterns and the extent to which each of these resources are being used.

Using this information, we can compute the capacity of each resource

available in the shop and the limiting capacity for the entire shop.

Comparisonof availability and requirement

The next step is to compare the available capacity with the capacity required.


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Process Mapping and Capacity Analysis

First

operation

Fabrication

Shop Paint ShopElectrical

and wiringAssembly

and testing

Shearing

unit

NCC Press

brake

63 tonnes

ECC Press

Hydraulic

Press

CNC Turret

Press

Pressing

unitWelding

unit

Denotes

Bottleneck in proc

Hierarchies in capacity planning exercise e.g.: turret press


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ALTERNATIVESFORCAPACITYAUGMENTATION

Straightforward option in case of deficient capacity is to addmore unit or resource i.e. increase the machines and/or hire

more labour.

But the cost of expansion is always large and it may significantly

impact long term operational costs of the system.

Therefore, alternatives for capacity augmentation is required.

Alternatives:

Waste elimination

Multi skilling of workforceSub-contracting or Outsourcing


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Waste Elimination

Uncover capacity from system by elimination of waste.

Sources of waste includes waste due to human resources

waste due to materials waste due to operations waste due to start-up waste due to equipment

De - bottlenecking operations can help to increase capacity.

De - bottlenecking helps in significant increase in capacity incase ofprocess industries as the system is a continuous flow of material from

raw material to finished goods.


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Multi-skilling of workforce

Capacity constraints manifest on account of non-availability of skills even whenadequate capacity is available in machines and other resources.

Multi-skilling not only solves the problem of providing each operating unit or a sub-

division with the required skills but also increases the flexibility of operating suchunits.

Employee absenteeism does not affect the working seriously.

At the shop floor level, multi-skilling in a machine shop would mean picking up theskills required for operating all the machines and in the assembly shop it would

mean working at all stages of assembly.

In the fabrication shop it would call for proficiency in fitting, welding, shearing etc.

At the supervisory level and shop floor managerial level, it would meandischarging various manufacturing support functions such as production planning

and control, inventory and stores management and procurement.


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Sub-contracting or outsourcing

The logic of sub-contracting decision closely follows make or buy decision.

Firms can react much faster to market requirements by using subcontracting.

Sub-contracting is also very useful for managing peak hour demand.

Factors which influence sub-contracting decision:

1. Primary is the lack of capacity to meet the current demand.2. The technical intensity and criticality of the item for which the item being

sub - contacted.

3. CostWhen the cost of performing the activity in-house is much higherthen what is available outside.

S b i i


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Sub-contracting or outsourcing

Advantages :

Flexibility to handle fluctuations in demand. By investing in in-house capacity,the firm may run the risk of under-utilization in case the demand for the

product/service come down in the future. In house capacity augmentation is a time consuming process. Firms can react much faster to market requirements by using subcontracting. Subcontracting is also very useful to mange peak hour demand.

Disadvantages :

Major challenge is to identify an suitable vendor for providing sub-contractedservices.

If the selection of the vendor is not carefully done, poor performance of thevendors will impact the firmsbusiness and market standing adversely.


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B)DESIGNOFEFFECTIVECAPACPLANNING, CAPACITYPLANNIN

FORSERVICES(DIFFERENCESIFFROMCAPACITYPLANNINGFORGOODS).


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FACTORSDETERMININGEFFECTIVECAPACITYPLANN

Facilities

Product and Service factors Process factors

Human factors

Policy factors

Operational factors

Supply chain factors

External factors


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FACTORSDETERMININGEFFECTIVECAPACITYPLANNING(CONTD..)

Facilities

The design of facilities ,including size and provision for expansionLocational factors, such as transportation costs, distance to market

supply ,energy sources and room for expansion are also important.

Likewise, layout of the work area and environment factors also play

significant role.

Product and services factors:Has a tremendous effect on the capacity.

The more uniform an output is, the more opportunities there are for

standardization of methods and material.


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FACTORSDETERMININGEFFECTIVECAPACITYPLANNING(CONTD..)

Process Factors

The quantity capability of a process is an obvious determinant of casubtle determinant is the influence of output quality.

Process improvement that increases quality and productivity can reincreased capacity.

Human factors

The task that makes up a job ,the variety of activities involved,also

,skill and experience required to perform a job all have an impact opotential and actual ouput.

Employee motivation has a very basic relationship to capacity,as doabsenteeism.


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FACTORSDETERMININGEFFECTIVECAPACITYPLANNING(CONTD..) Policy factor:

Management policy can affect capacity by allowing or not allowing capasuch as overtime or second or third shifts.

Operational factor:

Inventory stocking decisions, late deliveries, purchasing requirements, of purchased materials, quality inspection and control procedures also impact on effective capacity.

Supply chain factors:

Must be taken into account in capacity planning if substantial capacity cinvolved.

External factors:

Product standards, especially minimum quality and performance standrestrict managements option for increasing capacity.


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STEPSINTHECAPACITYPLANNINGPROCESS

Estimate future capacity requirements.

Evaluate existing capacity and facilities and identify gap

Developing Capacity Alternatives.

Evaluating each Capacity Alternative.

Assess key qualitative issues for each alternative.

Select the alternative to pursue that will be best in long Implement the selected alternative.

Monitor results.


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ESTIMATINGFUTURECAPACITYREQUIREMENTS

Capacity requirements can be evaluated from the two extreme

perspectives

Short term

Demand Forecasts: Managers plan for the capacity according to the dem

products for 12 months down the line.

Long term

Difficult to determine, as future demand and technology are uncertain

Use of Marketing plans, product development and life cycle of product.

Change in process technology also needs to be estimated


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STRATEGIESFOREXISTINGCAPACITYMODIFICATION

Adjusting equipment and processes- which might include purch

additional machinery or selling/leasing existing machinery. Making Staffing changes

Improving methods to increase throughput

Redesigning the product to facilitate more throughput(For faster

processing).

CAPACITY MODIFICATION TECHNIQUES


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CAPACITYMODIFICATIONTECHNIQUES

If there is mismatch in the demand and Capacity

Short Term: Increasing/Decreasing the labor force or creating and cinventory in lean period

Long term: Create new facility or expand existing facility or excess

sold/closed.


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Design flexibility into system

Provision for future expansion.

Take Stages of lifecycle into account

Capacity requirements are often closely linked to the stage of lifec

product or service.

Take a Big picture approach to capacity changes

When developing capacity alternatives, it is important to consider

the systems interrelate.

GrowthMaturit

yDecline

Introducti

on

DEVELOPINGCAPACITYALTERNATIVES


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DEVELOPINGCAPACITYALTERNATIVES (CONT..

Prepare to deal with capacity chunks.

No machine comes in continuous capacities.

Identify the optimal operating level.Production units typically have an ideal or optimal level of operation in termsoutput.

Economies of scaleIf the output rate is less than the optimal level, increasing the output rate results in decreasing a

Reasons for economies of scale:1. Fixed costs are spread over a larger number of units.

2. Construction costs increases at a decreasing rate as facility size increases.

3. Processing costs decreases due to standardization.


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EVALUATINGCAPACITYALTERNATIVES

Techniques used for evaluating the capacity alternatives are:

Cost-Volume Analysis Financial Analysis

Decision Tree


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COSTVOLUMEANALYSIS

Cost-Volume Symbols

FC = Fixed CostVC = Variable cost per unit

TC = Total Cost

TR = Total Revenue

R = Revenue per unit

Q = Quantity or volume of output

QBEP

= Break-Even Quantity

SP = Specified Profit


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COSTVOLUMEANALYSIS (CONTD..)

TC = FC + (VC x Q)

TR = R x Q

P = TR TCP = (R X Q) [FC + (VC X Q)]

Volume = SP + FCR - VC

QBEP= FCR - VC

Cost- Volume Formulas


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Most Commonly used methods are:

Payback: focuses on the length of time it will take for an inreturn its original cost

Present Value(PV)-summarizes the initial cost of an investmeestimated annual cash flows, and any expected salvage valuvalue called the equivalent current value, taking into accounvalue of money

Internal Rate of Return(IRR)- summarizes the initial cost, exannual and estimated future salvage value of an investmenan equivalent interest rate

FINANCIALANALYSIS


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THECHALLENGEOFPLANNINGSERVICECAPACITY

Three important factors in planning service capacity:

Theneed to be near customersConvenience for customers is often an important aspect of services. Gservice must be located near the customer.

The inability to store service

Speed of the delivery ,or customer waiting time becomes a major conceservice capacity planning.

The degree of demand volatility:Demand volatility presents problem for capacity planners.

Demand volatility tend to be higher for services than goods , not only indemand, but also in amount of time required to the service individual cu


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Once capacity requirements have been determined , the organiz

decide whether to produce a good or provide a service itself, oroutsource(buy) from another organization.

MAKEORBUYDECISIONS


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FACTORSFORMAKEORBUYDECISIONS

Available capacity

If an organization has available equipments, necessary skills ,and time makes sense to produce an item of perform a service in house. The adwould be relatively small compared with those required to buy items or services.

Expertise

If a firm lacks the expertise to do the job satisfactory buying might be realternative.

Quality considerations

Firm that specialize can usually offer higher quality than an organizatioitself. conversely unique quality requirements or the desire to closely mmay cause an organisation to perform a job itself.


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FACTORSFORMAKEORBUYDECISIONS (CONTD..)

The nature of demand

When demand for an item is high and steady , the organization is bettethe work itself.

Cost

Any cost savings achieved from buying of making must weighted againpreceding factors. Cost savings might come from the item itself or fromtransportation cost savings. If there are fixed costs associated with makthat can not be reallocated if the service or product outsourced, that ha

recognized in the analysis. Risk

Outsourcing may involve certain risks. One is loss of control over operAnother is need to disclose proprietary information.


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C) DECISIONTREEFOCAPACITYPLANNING


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The capacity planning exercise requires methods by which alter

options are evaluated. Two metrics are useful to perform the evaluation:

a)Cost based method

b) Operational-performance based method


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Decision trees are useful to evaluate alternative capacity choice

basis of cost of the capacity and the benefits. A decision tree is a schematic model in which different seq

steps involved in a problem and the consequences of the d

are systematically portrayed.


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A decision tree comprises of

Nodes- Each node represents the decision point. Branches- These represent the potential outcomes of the decis

The consequence of each outcome is measured as the cost of the

and the uncertainty associated with each outcome could be ass

the requisite branch.


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Once the tree is constructed, each branch in the tree is evaluate

respect to the costs, benefits and uncertainty.

The tree is evaluated from Right to Left. As we move from end t

beginning, the unattractive portions of the tree are eliminated to

final decision.


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EXAMPLE

Q= A manufacturer of computer accessories has a capacity of 40,0

per month. The business strategy group for the company recent

performed a forecasting exercise to assess the emerging dema

accessories in the next 5 yrs.

The study revealed that:

40 % probability is of strong growth in demand of accessories.

60% probability of moderate growth in demand

The study identified 3 options for the manufacturer to augment c


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The study identified 3 options for the manufacturer to augment c

which were:

1) Expanding the capacity by adding new capacity

2) To augment capacity in the existing factory itself by some de-b

operation3) To go for sub-contracting. If there is a strong demand in growt

new capacity could be added a year later.


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ADDITIONALINFORMATION

Options Cost Revenue in case of

strong growth

Revenu

modera

1: Adding new capacity Rs 7,50,000 Rs, 8,50,000 Rs 4,00

2: Augmenting/

Expanding capacity in

the existing factory

Rs 2,75,000 Rs 5,50,000 Rs 3,00

3: Go for sub-

contracting

Negligible Rs 3,50,000 Rs 1,80

Also, the cost of adding new capacity goes up by 5% if it is deferred by an year.

Arrive at an appropriate capacity planning strategy using a decision tree.

(All revenues are yearly figures)


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SOLUTION

There are 3 decision alternatives at the 1ststage.

After 1 year there are only two decision alternatives i.e. either toexpansion or continue with the sub-contracting.

At each stage there are 2 possible outcomes for the demand.

The decision points are denoted by square nodes and the outco

circular nodes.


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N A


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NODEA

Revenue in case of high demand= 8,50,000*5 = 42,50,000

Revenue in case of moderate demand= 4,00,000*5 = 20,00,000 Expected Revenue of node A:

E[A]= (42,50,000*0.40+ 20,00,000*0.60)= 29,00,000

Cost of adding new capacity= 7,50,000

Net revenue= 21,50,000

N B


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NODEB

Revenue in case of high demand= 5,50,000*5 = 27,50,000

Revenue in case of moderate demand= 3,00,000*5 = 15,00,000 Expected Revenue of node B:

E[B]= (27,50,000*0.40+ 15,00,000*0.60)= 20,00,000

Cost of expanding the capacity= 2,75,000


D


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DECISIONPOINT2

Revenue from adding new capacity= Rs 8,50,000*4= Rs 34,00,

Cost of adding new capacity= Rs 7,87,500 Net Revenue from this option=Rs 26,12,500

Revenue from sub contracting option= Rs 3,50,000*4= Rs 14,00

Therefore the best option at this stage is to go for adding new ca

NODE C


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NODEC

Revenue in case of high demand= Rs 26,12,500(From last 4 yrs

3,50,000(From 1styr)= Rs 29,62,500

Revenue in case of moderate demand= 1,80,000*5 = 9,00,000

Expected Revenue of node C:

E[C]= (29,62,000*0.40+ 9,00,000*0.60)= 17,05,000

Cost of sub contracting= Nil


FINAL RESULT


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FINALRESULT

Since the expected value of Node A is the highest, we go with t

of adding new capacity at the beginning itself rather than just de

bottlenecking or waiting for a year to sense the demand.


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D) RESOURCEPLANNING: CRPDRP, MRP, ERPANDRESOUR

PLANNINGFORSERVICES

RESOURCEPLANNING


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Planning methodologies (1960s)- problem of high inventories in manufactu

organizations.

Process of determining the production capacity required to meet demand.

Capacity- maximum workload in certain time.

(Capacity demand) = inefficiency (minimize).

Types of Inventories:

1. Operating (material and capacity resources)2. Distribution(market consumption)

OPERATIONSPLANNING

L i


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Long-range

>year, general, first, major decisions

Intermediate/medium range

6-18 months, minor changes in

capacity

Short range

Few days - few weeks, detspecific.

Dependent & Independent Demand

Nature of demand

Goal

Service levelDemand occurrence

Estimation of demand

How much to order?

When to order

No uncertainty, dependent

Make availability meetrequirements exactly

100% a necessity, feasible toachieve

Often lumpy

By production planning

Known with certainty

Very critical, can be estimated

Considerably independent

For a targeted

100% Not feasOften continuo

By forecasting

Estimate basedconsumption

Cannot be ans

BUILDING BLOCKS OF RESOURCE PLANNING


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BUILDINGBLOCKSOFRESOURCEPLANNING(a) The existence of multiple levels of dependency

- Parent child relationship

- Level-by-level

- Explosion- Iterative process and moving down.

(b) Product StructureBill of Materials

- Depicts the relationship among various items

- Low level coding

Bill of Materials (BOM)- list of all parts, ingredients, or materials needed to ass

together one unit of a product. Alternative representation of PS

BUILDINGBLOCKS(CONT.)


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(c) Time phasing the requirement

- answer when rather than how much

- time bucket (computational efficiency & accurate ormation)

- integrated (cycle counting) inventory data

(d) Determining the Lot Size

- process of determining the size of the order quantities of each o

in a product.

- large lot sizes- fewer setups-huge inventory, long time.

- smaller lot- several setups- increased setup costs

THREELOTSIZINGRULES


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Lot - for - Lot (LFL)

- Size= net requirement during every period

- cost from one period to next is very high.

- sparse and highly discontinuous demand.

Fixed order Quantity (FOQ)

- orders placed always for a fixed order quantity

- continuous demand

Periodic Order Quantity (POQ)

- to cover requirements of P periods (successive)

- *review cycle *economic order quantity

(e) Incorporating Lead Time Information


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( ) p g

- to correctly schedule launch of work order

- consists (set up, processing, waiting, move) time

(f) Establishing the Planning Premises

- Master Production Schedule (MPS)

disaggregates the information contained in an aggregate plan, links

varieties of the product being manufactured and specifies the exact

requirement.

M TE I L E UI EMENT L NNIN(MRP)d h f l hi d i


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( ) structured approach for launching and ensurin

availability of orders

LeadTime

Procure

ment

BOM

LotSizingRule

MPS

InventoryStatus

Net Lot

OffsetExplode

USINGTHEMRP

Ad t


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Advantages: Reduction in inventory.

Increased visibility of items & dependencies.

Inculcate a certain discipline.

Major Problems:1. Low data integrity.

2. Updation not as and when changes happen.

3. Uncertainty with several issues.4. Large computation.

Updating MRP Schedules - (i)Regeneration(ii) net change

Safety Stock & Safety Lead Timeabsorb uncertainties.

MANUFACTURING REQUIREMENTS PLANNI(MRP-II)


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( )

Enlarged version of MRP.

Expanded application through Computing power and software.

Covers following modules:

Advantage:provide numerous feedback loops, minim

closing more and more gaps

Business Planning

Forecasting/demand

Management

Order entry andmanagement

MPS

MRP

CRP

PurchasingInventory control

Shop Floor C

DRP

SRP

Accounting

CAPACITYREQUIREMENTSPLANNING(CRP)

Technique that applies to MRP logic to address the capacity issues in an o


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Technique that applies to MRP logic to address the capacity issues in an o

Develops schedules for planned releases of capacities.

Output of MRPbasis for CRP. (MPS-MRP-CRP)

CRP

MRPPlanned

orderReleases

Capacity

Status

LoadingSchedulesfor Each

Resources

RoutingFile

(ProcessPlan)

Criteria for

Comparison

MRP C

Input BOM R

MPS M

Lead Time Data L

Inventory C

Lot Sizing

Output Purchase C

Work orders C

DISTRIBUTIONREQUIREMENTSPLANNING(DRP)


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Extension of MRP in downstream supply chain.

Helps organizations and S.C. partners to jointly plan and r

investment in inventory.

Unlike MRP, relies on planned order releases.

Advantagerespond to changes, sudden surges & drops, cos

operation, good service.

Lossesdue to information sharing- inventory build up (shortages)

increased costs of operation.


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RESOURCES PLANNING IN SERVICES


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Similar to the manufacturing situation, one can develop a Bill of R

in the case of service organizations and employ a similar planning

schedule service deliveries and associated resources and materials.

Ex- treated eye patient and telephone instrument.


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E) EQUIPMENTSELECTION

Operation Managers often initiate proposals for the purchase of


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such as production and office machinery, software, cars and truc

reasons for its purchase include the following:

1: New equipment is required for the production of new products

services. 2: Increased sales volume demand an expansion of the availabl

3: Existing equipment has become obsolete and/or changes in t

are required to maintain competitiveness.

4: Existing equipment has entered the wear-out phase of its life

replaced.


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Equipment Selection is the process of identifying a set of suitable e

which are most suitable for processing a set of products.

FACTORSAFFECTINGCHOICEOFEQUIPMENT:


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1: Capacity

2: Compatibility

3: Availability of associated equipment

4: Reliability and after service

5: Ease of Maintenance

6: Ease of Learning to use


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7: Ease of Preparation

8: Safety

9: Ease of Installation

10: Delivery

11: State of Development

12: Effect on existing organisation

ECONOMICAPPRAISALCONCEPTS


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There are a number of ways of carrying out an economic analys

whatever technique is used, it must be consistently applied to a

equipment. An analysis is useful in distinguishing between different items of

The aim of an economic analysis is to appraise thecost of prod

given piece of equipment, not just the cost of the plant itself. Th

considered to be made up of 2 parts:


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The Standing cost, which is the cost incurred by the equipmen

and ready for use but not being operated;

The Running cost, which sets down the cost of running the equorder to generate the required products or service.

THESTANDINGCOST


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For calculating standing cost, executives decisions have to be m

notably, What depreciation should be considered, what is the ex

return on investment capital, etc These together with the purchase price, are summed to give an

annual standing cost. This applies, when equipment is purchase


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Other ways of obtaining equipment are:

a) Hire Purchase

b) Leasing

c) Hiring

All these methods should be considered as they may have cash flo

advantages over outright purchase.

THERUNNINGCOST


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To calculate the average running cost, a knowledge of the avera

total output is required.

For equipment producing for stock,this info is derivable fromforecast.

For equipment used to produce entirely to customers orde

service req,the details of output required cannot be forecasted

The most satisfactory approximation is obtained by forecasting t

anticipated average output.

DEPRECIATIONANDOBSOLESCENCE


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An installed equipment immediately starts losing its value becau

a)Depreciation-Decrease in the intrinsic value of an asset due to u

and/or lapse of time, and is a result of normal usage, bad handlmaintenance, accidents or wear due to disease or chemical acti


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b)Obsolescence-Loss in the intrinsic value of an asset due to

session, and is a result of a reduction in market for the product o

which the equipment is intended, a change in the design of equchange in legislation.

THELIFEOFEQUIPMENT:


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An equipment has several different life spans-

Physical

Technological

Product

Book

Economic


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capacity and resource planning

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