CAPACITY PLANNING

CAPACITY PLANNING

Introduction
Capacity can be defined as the maximum
output rate that can be achieved by a
facility.
The facility may be an
entire organization,
a division, or
only one machine.

Introduction
Planning for capacity in a company is
usually performed at two levels, each

corresponding to either
strategic or
tactical decisions.
The first level of capacity decisions is strategic
and long-term in nature.
This is where a company decides what
investments in new facilities and equipment it
should make.

Introduction
Because these decisions are strategic in
nature, the company will have to live with them
for a long time.
Also,
they
require
large
capital
expenditures and will have a great impact
on the companys ability to conduct business.
The second level of capacity decisions is
more tactical in nature, focusing on shortterm issues that include planning of workforce,
inventories, and day-to-day use of machines.

Importance of Capacity Planning

Importance of Capacity Planning

Capacity planning is the process of establishing
the output rate that can be achieved by a
facility.

If a company does not plan its capacity correctly,

it may find that it either does not have enough
output capability to meet customer demands or
has too much capacity sitting idle.

In a bakery for example, not having enough

capacity would mean not being able to produce
enough baked goods to meet sales.

Importance of Capacity Planning

The bakery would often run out of stock,
and customers might start going somewhere
else.
Also, the bakery would not be able to take
advantage of the true demand available.
On the other hand, if there is too much
capacity, the bakery would incur the cost of an
unnecessarily large facility that is not being
used, as well as much higher operating
costs than necessary.

Importance of Capacity Planning

Planning for capacity is important if a

company wants to grow and take full

advantage of demand.
At the same time, capacity decisions are
complicated because they require longterm commitments of expensive resources, such
as large facilities.
Once these commitments have been made, it is
costly to change them.

Importance of Capacity Planning

Think about a business that purchases a larger

facility in anticipation of an increase in demand,

only to find that the demand increase does
not occur.

It is then left with a huge expense, no

return on its investment, and the need to
decide how to use a partially empty
facility.

Importance of Capacity Planning

Another issue that complicates capacity

planning is the fact that capacity is usually

purchased in chunks rather than in smooth
increments.
Facilities, such as buildings and equipment, are
acquired in large sizes, and it is virtually
impossible to achieve an exact match
between current needs and needs based on
future demand.

Importance of Capacity Planning

Because of the uncertainty of future
demand, the overriding capacity planning
decision becomes one of whether to
purchase a larger facility in anticipation of
greater demand or to expand in slightly
smaller but less efficient increments.
Each strategy has its advantages and
disadvantages.

When To & How Much

When to increase capacity and how much to
increase it are critical decisions.

Three basic strategies for the timing of

capacity expansion are:
1. Capacity lead strategy .
2. Capacity lag strategy.
3. Average
capacity
strategy
(Smoothing with inventories)

Leading & Lagging Strategies

Average Capacity Strategy

1.

Capacity Lead Strategy

Capacity is expanded in such a way that there is

always sufficient capacity to meet forecast
demand.
Capacity is expanded in anticipation of demand
growth.
This aggressive strategy is used to lure
customers from competitors who are capacity
constrained or to gain a foothold in a rapidly
expanding market.

1.

Capacity Lead Strategy

It also allows companies to respond to

unexpected surges in demand and to provide
superior levels of service during peak
demand periods.

2.

Capacity Lag Strategy

Capacity is expanded in such a way that the

demand is always equal to or greater

than capacity.

Capacity is increased after an increase in

demand has been documented.
This conservative strategy produces a
higher return on investment but may lose
customers in the process.
It is used in industries with standard products
and cost-based or weak competition.

2.

Capacity Lag Strategy

The strategy assumes that lost customers will

return from competitors after capacity has
expanded.

3.

Average Capacity Strategy

Capacity is increased in such a way that the

current capacity plus accumulated inventory
can always supply demand.
Capacity is expanded to coincide with average
expected demand.
This is a moderate strategy in which
managers are certain they will be able to sell at
least some portion of expanded output, and
endure some periods of unmet demand.

3.

Average Capacity Strategy

Approximately half of the time capacity leads

demand, and half of the time capacity lags
demand.

Advantages/Disadvantages
Advantages

Capacityleading
Strategy

Disadvantages

1. Always sufficient capacity

1. Risks of greater (or
to meet demand, therefore
even permanent)
revenue is maximised and
over-capacity if
customers satisfied.
demand does not
2. Most of the time there is a
reach forecast levels.
capacity cushion which
2. Capital spending on
can absorb extra demand if
plant early.
forecasts are pessimistic.
3. Any critical start-up
problems with new plants
are less likely to affect
supply to customers.

Advantages/Disadvantages
Advantages

Capacitylagging
Strategy

Disadvantages

1. Always sufficient demand

1. Insufficient capacity to
to keep the plants working
meet demand fully,
at full capacity, therefore,
therefore, reduced
unit costs are minimised.
revenue and
2. Over-capacity problems are
dissatisfied customers.
minimised if forecasts are
2. No ability to exploit
optimistic.
short-term increases
3. Capital spending on the
in demand.
plants is delayed.
3. Under-supply position
even worse if there
are start-up problems
with the new plants.

Advantages/Disadvantages

Smoothingwithinventories
Strategy

Advantages

Disadvantages

1. All demand is satisfied,

therefore, customers are
satisfied and revenue
maximised.
2. Utilisation of capacity is
high and therefore costs
are low.
3. Very short-term surges in
demand can be met from
inventories.

1. The cost of inventories

in terms of working
capital requirement
can be high.
2. This is especially
serious at a time when
the company requires
funds for its capital
expansion.
3. Risks of product
deterioration and
obsolescence.

Measuring Capacity

Measuring Capacity
Although our definition of capacity seems
simple, there is no one way to measure it.
people
have
different
interpretations of what capacity means, and
the units of measurement are often very
different.

Different

Table shows some examples of how capacity

might be measured by different organizations.

Measuring Capacity
Type Of Business

Input Measures Of
Capacity

Output Measures Of
Capacity

Car Manufacturer

Labour hours

Cars per shift

Hospital

Available beds per

month

Number of patients

Pizza shop

Worker hours per day No of pizzas per day

Retail store

Floor space in sq feet Revenues per day

Electricity company

Generator size

Megawatts of
electricity generated

Measuring Capacity
Note that each business can measure capacity
in different ways and that capacity can be
measured using either inputs or outputs.
Output measures, such as the number of cars
per shift, are easier to understand.
However, they do not work well when a
company produces many different kinds of
products.

Measuring Capacity
For example, if a television factory produces
only one basic model, the weekly capacity could
be described as 2000 televisions.
A government office may have the capacity to
print and post 500,000 tax forms per week.
In each case, an output capacity measure is the
most appropriate measure because the output
from the operation does not vary in its nature.

Measuring Capacity
But when a much wider range of outputs places
varying demands on the process, output
measures of capacity are less useful.
Here input capacity measures are frequently
used to define capacity.
For example, the hospital measures its capacity
in terms of its input resources (say beds),
because there is not a clear relationship
between the number of beds it has and the
number of patients it treats.

Measuring Available Capacity

Measuring Available Capacity

Suppose that on the average we can make 20
cakes per day.
However, if we are really pushed, such as during
holidays, maybe we can make 30 cakes per
day.
Which of these is our true capacity?
We can make 30 cakes per day at a maximum,
but we cannot keep up that pace for long.
Saying that 30 per day is our capacity would be
misleading.

Measuring Available Capacity

On the other hand, saying that 20 cakes per
day is our capacity does not reflect the fact that
we can, if necessary, push our production to 30
cakes.
Through this example you can see that
different measures of capacity are useful
because they provide different kinds of
information.

Measuring Available Capacity

Following are two of the most common
measures of capacity:-

1. Design capacity
2. Effective capacity

1.

Design capacity

Design capacity is the maximum output rate

that can be achieved by a facility under ideal

conditions.

In our example, this is 30 cakes/day.

Design capacity can be sustained only for a
relatively short period of time.
A company achieves this output rate by using
many temporary measures, such as
overtime, over-staffing, maximum use of
equipment, and subcontracting.

2.

Effective capacity

Effective capacity is the maximum output rate

that can be sustained under normal
conditions.
These conditions include realistic work schedules
and breaks, regular staff levels, scheduled machine
maintenance, and none of the temporary
measures that are used to achieve design capacity.
Effective capacity is usually lower than design
capacity.
In our example, effective capacity is 20
cakes/day.

Measuring Effectiveness of
Capacity Use
Regardless of how much capacity we have, we
also need to measure how well we are
utilizing it.
Capacity utilization simply tells us how much of
our capacity we are actually using.
Certainly there would be a big difference if we
were using 50%of our capacity, meaning our
facilities, space, labour, and equipment, rather
than 90%.

Capacity Considerations
Capacity utilization can simply be computed as
the ratio of actual output over capacity:

Utilization =

actual output rate

capacity

Capacity Considerations
However, since we have two capacity measures,
we can measure utilization relative to either
design or effective capacity

Utilizationeffective =

Utilizationdesign =

actual output
effective capacity
actual output
design capacity

Example
In the bakery example, we have established that
design capacity is 30 cakes per day and
effective capacity is 20 cakes per day. Currently,
the bakery is producing 27 cakes per day. What
is the bakerys capacity utilization relative to
both design and effective capacity?

Expanding Capacity
When expanding capacity, management has to
choose between one of the following two
alternatives:
1. Purchase one large facility, requiring
one large initial investment.
2. Add capacity incrementally in smaller
chunks as needed.

Expanding Capacity
Units

One Step
Expansion

Incremental
Expansion
Time

Expanding Capacity
The first alternative means that we would
have a large amount of excess
capacity in the beginning and that our initial
costs would be high.
We would also run the risk that demand might
not materialize and we would be left with
unused overcapacity.

On the other hand, this alternative allows us

to be prepared for higher demand in the future.

Expanding Capacity
Our best operating level is much higher
with this alternative, enabling us to operate
more efficiently when meeting higher
demand.
Our costs would be lower in the long run,
since one large construction project typically
costs less than many smaller construction
projects due to startup costs.
Thus, alternative 1 provides greater rewards but
is more risky.

Expanding Capacity
Alternative 2 is less risky but does not offer the
same opportunities and flexibility.
It is up to management to weigh the risks
versus the rewards in selecting an
alternative.

Capacity Considerations
We have seen that changing capacity is not as
simple as acquiring the right amount of
capacity to exactly match our needs.
The reason is that capacity is purchased in
discrete chunks.
Also, capacity decisions are long term and
strategic in nature.

Capacity Considerations
Some of the important implications of capacity
that a company needs to consider when
changing its capacity are:
1.
2.
3.
4.

Economies of Scale
Diseconomies of Scale
Focused Factories
Subcontractor Networks

1. Economies of Scale
Every production facility has a volume of output
that results in the lowest average unit cost.
This is called the facilitys best operating
level .

Figure illustrates how the average unit cost of

output is affected by the volume produced.

You can see that as the number of units
produced is increased, the average cost per
unit drops.

Average Unit Cost

1. Economies of Scale

Economies of Scale

Best Operating Level

Diseconomies of Scale
Output Produced in Units

1. Economies of Scale
The reason is that when a large amount of
goods is produced, the costs of production are
spread over that large volume.
These costs include the fixed costs of
buildings and facilities, the costs of materials,
and processing costs.
The more units are produced, the larger the
number of units over which costs can be
spreadthat is, the greater the economies

of scale .

1. Economies of Scale
The concept of economies of scale is
very well known.
It basically states that the average cost of a
unit produced is reduced when the
amount of output is increased.
You use the concept of economies of scale in
your daily life.
Suppose you decide to make cookies in your
kitchen. Think about the cost per cookie if you
make only five cookies.

1. Economies of Scale
There would be a great deal of effort
getting the ingredients, mixing the dough,
shaping the cookiesall for only five cookies.

2. Diseconomies of Scale
What if you continued to increase the
number of cookies you chose to produce?
For a while, making a few more cookies would
not require much additional effort.
However, after a certain point there would
be so much material that the kitchen would
become congested.
You might have to get someone to help
because there was more work than one

person could handle.

2. Diseconomies of Scale
You might have to make cookies longer than
expected, and the cleanup job might be
much more difficult.
You would be experiencing diseconomies

of scale .

Diseconomies of scale occur at a point

beyond the best operating level,
when the cost of each additional unit made
increases.

2. Diseconomies of Scale
Operating a facility close to its best operating
level is clearly important because of the impact
on costs.
However, we have to keep in mind that

different facility sizes have different

best operating levels.

2. Diseconomies of Scale
In our cookie example, we can see that the
number of cookies comfortably produced by
one person in a small kitchen would be
much lower than the number produced by
three persons in a large kitchen.
Figure shows how best operating level varies
between facilities of different sizes.

Average Unit Cost

2. Diseconomies of Scale
Small

Medium
Large

Output Produced in Units

3. Focused Factories
The concept of the focused factory holds that a
production facility works best when it focuses
on a fairly limited set of production objectives.
This means, for example, that a firm should
not expect to excel in every aspect of
manufacturing performance: cost, quality,
delivery speed and reliability, changes in
demand, and flexibility to adapt to new
products.

3. Focused Factories
Rather, it should select a limited set of tasks
that contribute
objectives.

the

most

to

corporate

For example, consider a company that

competes on using the highest quality
component parts in its products.
Due to the high quality of parts, the company
may not be able to offer the final product at
the lowest price.

3. Focused Factories
In this case, the company has made a tradeoff between quality and price.

Similarly, a company that competes on

making each product individually based on
customer specifications will likely not be
able to compete on speed.
Here, the trade-off has been made between
flexibility and speed.

3. Focused Factories
One way that large facilities with multiple products
can address the issue of trade-offs is using the
concept of plant-within-a-plant (PWP),
introduced by well-known Harvard professor
Wickham Skinner.
The PWP concept suggests that different areas of
a facility be dedicated to different products with
different competitive priorities.
These areas should be physically separated
from one another and should even have their
own separate workforce.

3. Focused Factories
As the term suggests, there are multiple plants
within one plant, allowing a company to
produce different products that compete on
different priorities.
For example, hospitals use PWP to achieve
specialization or focus in a particular area, such
as the cardiac unit, radiology, surgery, or
pharmacy.

4. Subcontractor Networks
Another alternative to having a large
production facility is to develop a large
network of subcontractors and suppliers who
perform a number of tasks.
This is one of the fastest-growing trends today.
Companies are realizing that to be successful in
todays market, they need to focus on their
core capabilitiesfor example, by hiring
third parties or subcontractors to take over
tasks that the company does not need to
perform itself.

4. Subcontractor Networks
Companies such as American Airlines and
Procter & Gamble have hired outside firms
to manage noncritical inventories.
Also, many companies are contracting with
suppliers to perform tasks that they used to
perform themselves.
A good example is in the area of quality
management.
Historically, companies performed quality
checks on goods received from suppliers.

4. Subcontractor Networks
Today, suppliers and manufacturers work
together to achieve the same quality standards,
and much of the quality checking of incoming
materials is performed at the suppliers site.
Another example can be seen in the auto
industry, where manufacturers are placing
more responsibility on suppliers to perform
tasks such as design of packaging and
transportation of goods.

4. Subcontractor Networks
more responsibility on
subcontractors and suppliers, a

By

placing

manufacturer can focus on tasks that are critical

to its success, such as product development
and design.

Making Capacity Planning Decisions

The three-step procedure for making capacity
planning decisions is as follows

1. Identify Capacity Requirements

2. Develop Capacity Alternatives
3. Evaluate Capacity Alternatives

1. Identify Capacity Requirements

Long-term capacity requirements are identified
on the basis of forecasts of future demand.
Companies look for long-term patterns such as
trends when making forecasts.
However, long-term patterns are not enough
at this stage.
Planning, building, and starting up a new facility
can take well over five years.
Much can happen during that time.

1. Identify Capacity Requirements

When the facilities are operational, they are
expected to be utilized for many years into
the future.
During this time frame numerous changes
can occur in the economy, consumer base,
competition,
technology,
and
demographic factors, as well as in
government regulation and political

events.

1. Identify Capacity Requirements

Following are the key steps performed while
identifying the capacity requirements:

a)Forecasting Capacity
b)Capacity Cushions
c) Strategic Implications

1.a.

Forecasting Capacity

Capacity requirements are identified on the basis of

forecasts of future demand.
Forecasting at this level is performed using
qualitative forecasting methods as already
discussed.
Qualitative forecasting methods, such as executive
opinion and the Delphi method , use subjective
opinions of experts.
These experts may consider inputs from
quantitative forecasting models that can
numerically compute patterns such as trends.

1.a.

Forecasting Capacity

However, because so many variables can

influence demand at this level, the experts use

their judgment to validate the quantitative
forecast or modify it based on their own
knowledge.
One way to proceed with long-range
demand forecasting at this stage is to first
forecast overall market demand.
Then the company can estimate its market
share as a percentage of the total.

1.a.

Forecasting Capacity

From that we can compute an estimate of

demand for our company for next few years
by multiplying the overall market demand
with the percentage held by our company.
That forecast of demand can then be
translated
into
specific
facility
requirements.

1.b.

Capacity Cushions

Companies often add capacity cushions to

their regular capacity requirements.
A capacity cushion is an amount of capacity
added to the needed capacity in order to
provide greater flexibility.
Capacity cushions can be helpful if demand is
greater than expected.
Also, cushions can help the ability of a
business to respond to customer needs
for different products or different volumes.

1.b.

Capacity Cushions

Finally, businesses that operate too close to

their maximum capacity experience many costs
due to diseconomies of scale and may
also experience deteriorating quality.

1.c.

Strategic Implications

Finally, a company needs to consider how much

capacity its competitors are likely to have.
Capacity is a strategic decision, and the position of
a company in the market relative to its
competitors is very much determined by its
capacity.

At the same time, plans by all major

competitors to increase capacity may signal the

potential for overcapacity in the industry.

1.c.

Strategic Implications

Therefore, the decision as to how much

capacity to add should be made carefully.

2. Develop Capacity Alternatives

Once a company has identified its capacity
requirements for the future, the next step is
to develop alternative ways to modify its
capacity.

One alternative is to do nothing and

re-evaluate the situation in the future.

With this alternative, the company would

not be able to meet any demands that exceed
current capacity levels.

2. Develop Capacity Alternatives

Choosing this alternative and the time to reevaluate the companys needs is a strategic

decision.
The other alternatives require deciding
whether to purchase one large facility now or
add capacity incrementally, as discussed earlier
in the slides.

3. Evaluate Capacity Alternatives

Decision Trees
There are a number of tools that we can use to
evaluate our capacity alternatives but the most
popular of these tools is the decision tree.
Decision trees are useful whenever we have to
evaluate interdependent decisions that must be
made in sequence and when there is uncertainty
about events.
For that reason, they are especially useful for
evaluating
capacity
expansion
alternatives given that future demand is
uncertain.

3. Evaluate Capacity Alternatives

Decision Trees
Remember that our main decision is whether to
purchase a large facility or a small one with the
possibility of expansion later.
A decision tree is a diagram that models the
alternatives being considered and the possible
outcomes.
Decision trees help by giving structure to a
series of decisions and providing an objective
way of evaluating alternatives.

3. Evaluate Capacity Alternatives

Decision Trees
Decision
trees
contain
the
following
information:
1. Decision points. These are the points in time
when decisions, such as whether or not to
expand, are made. They are represented by
squares, called nodes.
2. Decision alternatives. Buying a large facility
and buying a small facility are two decision
alternatives. They are represented by
branches or arrows leaving a decision
point.

3. Evaluate Capacity Alternatives

Decision Trees
3. Chance events. These are events that
could affect the value of a decision. For
example, demand could be high or low. Each
chance event has a probability or likelihood of
occurring. For example, there may be a 60
percent chance of high demand and a 40
percent chance of low demand. Remember
that the sum of the probabilities of all chances
must add up to 100 percent. Chance events
are branches or arrows leaving circular
nodes.

3. Evaluate Capacity Alternatives

Decision Trees
4. Outcomes. For each possible alternative an
outcome is listed. In our example, that may be
expected profit for each alternative (expand
now or later) given each chance event (high
demand or low demand).

Decision Trees EXAMPLE

Mr ABC, the owner of XYZ Company, has
determined that he needs to expand the facility.
The decision is whether to expand now with a
large facility, incurring additional costs and
taking the risk that demand will not materialize,
or expand now on a smaller scale, knowing that
he will have to consider expanding again in
three years.

Decision Trees EXAMPLE

He has estimated the following chances for
demand:
The likelihood of demand being high is 0.70.
The likelihood of demand being low is 0.30.

He has also
alternative:

estimated

profits

for

each

Large expansion has an estimated profitability of

either $300,000 or $50,000, depending on whether
demand turns out to be high or low.

Decision Trees EXAMPLE

Small expansion has a profitability of $80,000,
assuming that demand is low.
Small expansion with an occurrence of high demand
would require considering whether to expand
further. If he expands at that point, his profitability is
expected to be $200,000. If he does not expand
further, profitability is expected to be $150,000.

Develop a decision tree to solve Mr ABCs

problem.

Decision Trees SOLUTION

Procedure for Drawing a Decision Tree:
1. Draw a decision tree from left to right. Use
squares to indicate decisions and circles
to indicate chance events.
2. Write probability of each chance event in
parentheses.
3. Write out the outcome for each alternative in
the right margin.

Expand

$200,000

High Demand (0.7)

2
Dont Expand
Low Demand (0.3)

High Demand (0.7)

Low Demand (0.3)

$80,000

$300,000

$50,000

$150,000

Decision Trees SOLUTION

We drew the decision tree from left to right.
To evaluate it, we work backward, from right to
left, to determine the expected value (EV) .
EV is a weighted average of the chance events,
where each chance event is given a probability
of occurrence.
We start with the profitability of each
alternative, working backward and selecting the
most profitable alternative.

Decision Trees SOLUTION

For example, at node 2 we should decide to
expand further, because the profits from that
decision are higher ($200,000 versus
$150,000).
EV of profits at that point is written below node
2.
This is the expected value if we decide on a
small expansion and high demand occurs.

Expand

$200,000

High Demand (0.7)

2
$200,000
Dont Expand
Low Demand (0.3)

High Demand (0.7)

Low Demand (0.3)

$80,000

$300,000

$50,000

$150,000

Decision Trees SOLUTION

To compute the expected value ( EV) of the
small expansion, we evaluate it as a weighted
average of estimated profits given the
probability of occurrence of each chance event:
EVsmall expansion = 0.30($80,000) + 0.70($200,000)
= $164,000

Decision Trees SOLUTION

Similarly for large expansion:
EVlarge expansion = 0.30($50,000) + 0.70($300,000)
= $225,000
The large expansion gives the higher expected
value.
This means that Mr ABC should pursue a large
expansion now.

Decision Trees Q 1
The owner of Hackers Computer Store is
considering what to do with his business over
the next five years. Sales growth over the past
couple of years has been good, but sales could
grow substantially if a major electronics firm is
built in his area as proposed. Hackers owner
sees three options. The first is to enlarge his
current store, the second is to locate at a new
site, and the third is to simply wait and do
nothing.

Decision Trees Q 1
The decision to expand or move would take
little time, and, therefore, the store would not
lose revenue. If nothing were done the first year
and strong growth occurred, then the decision
to expand would be reconsidered. Waiting
longer than one year would allow competition
to move in and would make expansion no
longer feasible.

Decision Trees Q 1
The assumptions and conditions are as follows:
a) Strong growth as a result of the increased population
of computer fanatics from the new electronics firm has
a 55 percent probability.
b) Strong growth with a new site would give annual
returns of $195,000 per year. Weak growth with a new
site would mean annual returns of $115,000.
c) Strong growth with an expansion would give annual
returns of $190,000 per year. Weak growth with an
expansion would mean annual returns of $100,000.
d) At the existing store with no changes, there would be
returns of $170,000 per year if there is strong growth
and $105,000 per year if growth is weak.

Decision Trees Q 1
e) Expansion at the current site would cost $87,000.
f) The move to the new site would cost $210,000.
g) If growth is strong and the existing site is enlarged
during the second year, the cost would still be
$87,000.
h) Operating costs for all options are equal

Develop a decision tree to solve this problem.

Strong Growth (0.55)

R - MC
Move

R (Revenue)
Weak Growth (0.45)

R - MC

MC (Move Cost)

EC (Expand Cost)

Strong Growth (0.55)

R - EC
Expand

1
Weak Growth (0.45)

R - EC
Expand

Strong Growth (0.55)

2
Do
Nothing

Do
Nothing

Weak Growth (0.45)

R - EC

Decision Trees Q 1
ALTERNATIVE
Move to new location, strong growth
Move to new location, weak growth
Expand store, strong growth
Expand store, weak growth
Do nothing now, strong growth,
expand next year
Do nothing now, strong growth, do
not expand next year
Do nothing now, weak growth

REVENUE $
195,000 5 = 975000

COST $
210,000

VALUE $
765,000

Decision Trees Q 1
ALTERNATIVE

REVENUE $

COST $

VALUE $

Move to new location, strong growth

195,000 5 = 975000

210,000

765,000

Move to new location, weak growth

115,000 5 = 575000

210,000

365,000

Expand store, strong growth

190,000 5 = 950000

87,000

863,000

Expand store, weak growth

100,000 5 = 500000

87,000

413,000

Do nothing now, strong growth,

expand next year

170,000 1 +
190,000 4

87,000

843,000

Do nothing now, strong growth, do

not expand next year

170,000 5 = 850000

850,000

Do nothing now, weak growth

105,000 5 = 525000

525,000

= 930000

Strong Growth (0.55)

765,000
Move

R (Revenue)
Weak Growth (0.45)

365,000

MC (Move Cost)

EC (Expand Cost)

Strong Growth (0.55)

863,000
Expand

1
Weak Growth (0.45)

413,000
Expand

Strong Growth (0.55)

2
Do
Nothing

Do
Nothing

Weak Growth (0.45)

843,000

525,000

850,000