chapter 5 capacity planning

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1 Presented by: Peter Ventura Monterey Avendano Rod Steven Vasquez Charina Rose Ventura

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PRODMAN LECTURE

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Page 1: Chapter 5 Capacity Planning

1

Presented by:

Peter Ventura

Monterey Avendano

Rod Steven Vasquez

Charina Rose Ventura

Page 2: Chapter 5 Capacity Planning

2

Capacity Planning

• Capacity– The upper limit or ceiling on the load that an

operating unit can handle– Goal

• To achieve a match between the long-term supply capabilities of an organization and the predicted level of long-run demand.

Page 3: Chapter 5 Capacity Planning

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Capacity Planning Questions

• Key Questions:– What kind of capacity is needed?

– How much capacity is needed to match demand?

– When is it needed?

• Related Questions:– How much will it cost?

– What are the potential benefits and risks?

– Are there sustainability issues?

– Should capacity be changed all at once, or through several smaller changes

– Can the supply chain handle the necessary changes?

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Capacity Decisions Are Strategic

impact the ability of the organization to meet future demands

affect operating costs are a major determinant of initial cost often involve long-term commitment of resources can affect competitiveness affect the ease of management are more important and complex due to globalization need to be planned for in advance due to their consumption

of financial and other resources

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Defining and Measuring Capacity

• Measure capacity in units that do not require updating– Why is measuring capacity in dollars problematic?

• Two useful definitions of capacitya) Design capacity

• The maximum output rate or service capacity an operation, process, or facility is designed for

b) Effective capacity

• Design capacity minus allowances such as personal time and maintenance

Page 6: Chapter 5 Capacity Planning

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Measuring System Effectiveness

• Actual output– The rate of output actually achieved– It cannot exceed effective capacity

• Efficiency

• Utilization

capacity effective

output actualEfficiency

capacitydesign

output actualnUtilizatio

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Example 1:

Given the following information, compute the

efficiency and the utilization of the vehicle repair

department:

Design Capacity = 50 trucks per day

Effective Capacity = 40 trucks per day

Actual Output = 36 trucks per day

Page 8: Chapter 5 Capacity Planning

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Solution:

=36 trucks per day

40 trucks per day

= 90%

capacity effective

output actualEfficiency

Page 9: Chapter 5 Capacity Planning

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Solution:

=36 trucks per day

50 trucks per day

= 72%

capacitydesign

output actualnUtilizatio

Page 10: Chapter 5 Capacity Planning

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Determinants of Effective Capacity

Page 11: Chapter 5 Capacity Planning

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Determinants of Effective Capacity

Page 12: Chapter 5 Capacity Planning

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Determinants of Effective Capacity

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Strategy Formulation

• Capacity strategy for long-term demand• Demand patterns• Growth rate and variability• Facilities

– Cost of building and operating

• Technological changes– Rate and direction of technology changes

• Behavior of competitors• Availability of capital and other inputs

Page 14: Chapter 5 Capacity Planning

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Capacity Cushion

– Extra capacity used to offset demand uncertainty– Capacity cushion = 100% - Utilization– Capacity cushion strategy

• Organizations that have greater demand uncertainty typically have greater capacity cushion

• Organizations that have standard products and services generally have greater capacity cushion

Page 15: Chapter 5 Capacity Planning

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Steps in Capacity Planning

1. Estimate future capacity requirements

2. Evaluate existing capacity and facilities; identify gaps

3. Identify alternatives for meeting requirements

4. Conduct financial analyses

5. Assess key qualitative issues

6. Select the best alternative for the long term

7. Implement alternative chosen

8. Monitor results

Page 16: Chapter 5 Capacity Planning

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Forecasting Capacity Requirements

• Long-term vs. short-term capacity needs

• Long-term relates to overall level of capacity such as facility size, trends, and cycles

• Short-term relates to variations from seasonal, random, and irregular fluctuations in demand

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Calculating Processing Requirements

P r o d u c tA n n u a l

D e m a n d

S t a n d a r dp r o c e s s i n g t i m e

p e r u n i t ( h r . )P r o c e s s i n g t i m e

n e e d e d ( h r . )

# 1

# 2

# 3

4 0 0

3 0 0

7 0 0

5 . 0

8 . 0

2 . 0

2 , 0 0 0

2 , 4 0 0

1 , 4 0 0 5 , 8 0 0

P r o d u c tA n n u a l

D e m a n d

S t a n d a r dp r o c e s s i n g t i m e

p e r u n i t ( h r . )P r o c e s s i n g t i m e

n e e d e d ( h r . )

# 1

# 2

# 3

4 0 0

3 0 0

7 0 0

5 . 0

8 . 0

2 . 0

2 , 0 0 0

2 , 4 0 0

1 , 4 0 0 5 , 8 0 0

Page 18: Chapter 5 Capacity Planning

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The Challenges of Planning Service Capacity

IMPORTANT FACTORS IN PLANNING SERVICE CAPACITY:

1.The need to be near customers

2.The inability to store services

3.The degree of volatility

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MAKE OR BUY? FACTORS:

1. Available capacity

2. Expertise

3. Quality considerations

4. The nature of demand

5. Cost

6. Risk

Page 20: Chapter 5 Capacity Planning

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Developing Capacity Alternatives

1. Design flexibility into systems

2. Take stage of life cycle into account Introduction phase Growth phase Maturity phase Decline phase

Page 21: Chapter 5 Capacity Planning

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Developing Capacity Alternatives

3. Take a “big picture” (i.e., systems) approach to capacity changes

Bottleneck operations

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Developing Capacity Alternatives

4. Prepare to deal with capacity “chunks”

5. Attempt to smooth out capacity requirements

6. Identify the optimal operating level Economies of Scale Diseconomies of Scale

7. Choose a strategy if expansion is involved

Page 23: Chapter 5 Capacity Planning

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Evaluating Alternatives

Economic considerations:• Will an alternative be economically feasible?• How much will it cost?• How soon can we have it?• What will operating and maintenance cost be?• What will its useful life be?• Will it be compatible with present personnel

and present operations?

Page 24: Chapter 5 Capacity Planning

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Techniques used for Evaluating Capacity Alternatives

1) Financial Analysis

2) Waiting Line analysis

3) Decision Theory

4) Cost-Volume Analysis

Page 25: Chapter 5 Capacity Planning

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FINANCIAL ANALYSIS

Important terms:

Cash flow- refers to the difference between the cash

received from sales (of goods of services) and other sources and the cash outflow for labor, materials, overhead and taxes.

Present Value- expresses in current value the sum of all

future cash flows of a investment proposal.

Page 26: Chapter 5 Capacity Planning

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FINANCIAL ANALYSIS - Methods

a) Payback- is a simple but widely used method that

focuses on the length of time it will take for an investment to return its original cost.

Payback period = Payback period = Investment required Net annual cash inflow

Investment required Net annual cash inflow

Page 27: Chapter 5 Capacity Planning

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FINANCIAL ANALYSIS - Methods

b) Present Value- method summarizes the initial cost of an

investment, its estimated annual cash flows and any expected salvage value in a single value called the equivalent current value, taking into account the time value of money, w/c is the interest rates.

Page 28: Chapter 5 Capacity Planning

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FINANCIAL ANALYSIS - Methods

c) Internal Rate of Return- summarizes the initial cost, expected annual

cash flows, and estimated future salvage of an investment proposal in an equivalent interest rate.

Investment required Net annual cash flows Investment required Net annual cash flows

PV factor for theinternal rate of return

PV factor for theinternal rate of return ==

Page 29: Chapter 5 Capacity Planning

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WAITING-LINE ANALYSIS

• It’s goal is to minimize the sum of two costs: customer waiting cost and service capacity cost.

• Analysis of lines is often useful for designing for modifying service systems.

Page 30: Chapter 5 Capacity Planning

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DECISION THEORY

• Is a helpful tool for financial comparison of alternatives under conditions of risk or uncertainty.

• It is suited to capacity decisions and to a wide range of other decisions managers must make.

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TOOLS FOR ANALYZING DECISION PROBLEM

1) Decision Trees:

- a schematic representation of the available alternatives and their possible consequences.

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DECISION THEORY

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TOOLS FOR ANALYZING DECISION PROBLEM

2) Sensitivity Analysis:

• Provides a range of probability over which the choice of alternatives would remain the same.

• Determining the range of probability for which an alternative has the best expected payoff.

• A graphical solution• Makes use of Algebra

Page 34: Chapter 5 Capacity Planning

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COST VOLUME ANALYSIS

• It focuses on relationship between cost and volume of output.

• It’s purpose is to estimate the income of an organization under different operating conditions and it’s particularly useful as a tool for comparing capacity alternatives.

Page 35: Chapter 5 Capacity Planning

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COST VOLUME ANALYSIS

Fixed Cost

Variable Cost

Page 36: Chapter 5 Capacity Planning

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TERMS

P = Profit

TR = Total Revenue

TC = Total Cost

R = Revenue

Q = Quantity or volume of output

FC = Fixed Cost

v = Variable cost /unit

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COST VOLUME RELATIONSHIPS

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COST VOLUME RELATIONSHIPS

TR = R X Q

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COST VOLUME RELATIONSHIPS

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TOTAL PROFIT

P = TR – TC

P = R X Q – (FC + v X Q)

P= Q(R-v)-FC

P+FC=Q (R-v)

Q=(P+FC)/(R-v)

P = Profit

TR = Total Revenue

TC = Total Cost

R = Revenue

Q = Quantity or volume of output

FC = Fixed Cost

v = Variable cost /unit

Page 41: Chapter 5 Capacity Planning

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CONTRIBUTION MARGIN

• The difference between revenue per unit and variable cost per unit, R – v

P + FCR - v

Q =

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BREAK-EVEN POINT

• The volume of output at which total cost and total revenue are equal.

FCR - v

QBEP =

FC(R – v)/R

QBES =

Page 43: Chapter 5 Capacity Planning

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COST VOLUME RELATIONSHIPS

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COST VOLUME RELATIONSHIPS

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EXAMPLE

The owner of Old-Fashioned Berry Pies, S. Simon, is contemplating adding a new line of pies, which will require leasing new equipment for a monthly payment of $6,000. Variable costs would be $2.00 per pie and pies would retail for $7.00 each.

Page 46: Chapter 5 Capacity Planning

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EXAMPLE

a. How many pies must be sold in order to break even in units & dollar?

b. What would the profit (loss) be if 1,000 pies are made and sold in a month?

c. How many pies must be sold to realize a profit of $4,000?

d. If 2,000 can be sold and a profit target is $5,000, what price should be charged per pie?

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SOLUTIONa) How many pies must be sold in order to break even in

units?

Given: FC: $6,000 VC:$2/pie Rev:$7/pie

= $6,000 $7 - $2

= 1,200 pies/month

FCR - v

QBEP =

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SOLUTIONa) How many pies must be sold in order to break even in

dollar?

Given: FC: $6,000 VC:$2/pie Rev:$7/pie

= $6,000 ($7 - $2)/$7

= $8,400 pies/month

FC(R – v)/R

QBES =

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SOLUTION:

b. What would the profit (loss) be if 1,000 pies are made and sold in a month?

= 1,000 ($7-$2)-$6,000

= -$1,000

P= Q(R-v)-FC

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SOLUTION:

c. How many pies must be sold to realize a profit of $4,000?

= $4,000+$6,000$7-$2

= 2,000 pies

P + FCR - v

Q =

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SOLUTION:

d. If 2,000 can be sold and a profit target is $5,000, what price should be charged per pie?

$5,000= 2,000 (R-$2)-$6,000

R = $7.50

P= Q(R-v)-FC

Page 52: Chapter 5 Capacity Planning

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EXAMPLE

The Business Owner of a sports good factory in Sialkot is contemplating adding a new line of cricket bats, which will require leasing new equipment for a monthly payment or P60,000. Variable costs would be P200 per bat and bats would sold for P2,000 only.

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EXAMPLE

1. How many bats would be sold in order to break-even?

2. What would be the profit or loss if the 100 bats are made and sold in 1 month?

3. How many bats must be sold to realize a profit of P40,000?

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SOLUTION1. How many bats would be sold in order to break-even?

Given: FC: P60,000 VC:P200/batRev:P2,000/bat

= P60,000 P2,000 – P200

= 33.33 bats

FCR - v

QBEP =

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SOLUTION:

2. What would be the profit or loss if the 100 bats are made and sold in 1 month?

P= 100(P2,000 – P200)-P60,000

P = P120,000

P= Q(R-v)-FC

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SOLUTION:

3. How many bats must be sold to realize a profit of P40,000?

Q= P40,000+P60,000 P2,000-P200Q = 56 bats

P + FCR - v

Q =

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CAPACITY ALTERNATIVES:

Step Cost:- which are costs

that increase stepwise

as potential volume

increases.

FC1 machine

FC2 machines

FC3 machines

TC=

FC+ VC

TC=

FC+ VC

TC=

FC+ VC

Page 58: Chapter 5 Capacity Planning

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CAPACITY ALTERNATIVES:

Multiple

Break-Even:

1

2

3

TC

BEP

BEP

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EXAMPLE:

A manager has the option of purchasing one, two or

three machines. Fixed costs and potential volumes are

as follows:

VC = $10/unit Rev = $40/unit

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Problem & Solution

a) Determine the break-even point for each range.

QBEP = $9,600 $40-$10 320 units

QBEP = $15,000 $40-$10

500 units

QBEP = $20,000 $40-$10 666.67 units

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Problem & Solution:

b) If projected annual demand is between 580 and 660 units, how many machines should the manager purchase?

P = TR – TCP = Q(R-v)-FC

P = 580($40-$10)-$15,000P = $2,400

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Problem & Solution:

b) If projected annual demand is between 580 and 660 units, how many machines should the manager purchase?

P = TR – TCP = Q(R-v)-FC

P = 660($40-$10)-$20,000

P = ($200)

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Problem & Solution:

b) If projected annual demand is between 580 and 660 units, how many machines should the manager purchase?

2M- P = $2,400

3M – P= ($200)

1 2 3

TC

$20,200

$26,600

$23,200

$26,400

Choose 2 MachinesChoose 2 Machines

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Cost Volume Analysis valuable tool to Capacity Alternatives:

1. One product is involved.2. Everything produced can be sold.3. The variable cost per unit is the same regardless of

the volume.4. Fixed cost do not change with volume changes, or

they are step changes.5. The revenue per unit is the same regardless of

volume.6. Revenue per unit exceeds variable cost per unit.

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Operations Strategy

• Capacity planning impacts all areas of the organization– It determines the conditions under which operations

will have to function– Flexibility allows an organization to be agile

• It reduces the organization’s dependence on forecast accuracy and reliability

• Many organizations utilize capacity cushions to achieve flexibility

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Operations Strategy

– Bottleneck management is one way by which organizations can enhance their effective capacities.

– Capacity expansion strategies are important organizational considerations

• Expand-early strategy

• Wait-and-see strategy

– Capacity contraction is sometimes necessary• Capacity disposal strategies become important under

these

conditions

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Problem 1:A firm’s manager must decide whether to make or buy a certain item

used in the production of vending machines. Making the item would involve annual lease costs of $150,000. Cost and volume estimates are as follows:

Make BuyAnnual fixed cost $150,000 NoneVariable cost/unit $60 $80Annual volume (units) 12,000 12,000 a. Given those numbers, should the firm buy or make this item?b. There is possibility that volume could change in the future. At what volume would the manager be indifferent between making and buying?

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Problem 2:A small firm produces and sells automotive items in a five-state

area. The firm expects to consolidate assembly of its battery charges line at a single location. Currently, operations are in three widely scattered locations. The leading candidate for location will have a monthly fixed cost of $42,000 and variable costs of $3 per charger. Charges sell for $7 each.

Required:1. Prepare a table that shows total profits, fixed costs, variable cost,

and revenues for monthly volumes of 10,000; 12,000 and 15,000 units.

2. What is the break-even point?

Page 71: Chapter 5 Capacity Planning

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Problem 3:

A small firm produces and sells automotive items in a five-state area. The firm expects to consolidate assembly of its battery charges line at a single location. Currently, operations are in three widely scattered locations. The leading candidate for location will have a monthly fixed cost of $42,000 and variable costs of $3 per charger. Charges sell for $7 each.

Required:

Determine profit when volume equals 22,000 units.

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Problem 4:

A manager must decide which type of equipment to buy, Type A or Type B. Type A equipment cost $15,000 each and Type B cost $11,000 each. The equipment can be operated 8 hours a day, 250 days a year.

Either a machine can be used to perform two types of chemical analysis, C1 & C2. Annual service requirements and processing times are shown in the following table.

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Problem 4:

Required:

Which type of equipments should be purchased, and how many that type will be needed? The goal is to minimize total purchase cost.

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Answer Question no.1:

a. Given those numbers, should the firm buy or make this item?

TC= FC+Q(VC)

Make = $150,000+12,000($60) = $870,000

Buy = 0+12,000($80) = $960,000

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Answer Question no.1:

b. There is possibility that volume could change in the future. At what volume would the manager be indifferent between making and

buying?

TCmake= TCbuy

$150,000 + Q($60) = 0 + Q($80)$80Q-$60Q=$150,000

$20Q=$150,000Q=$7,500

Page 76: Chapter 5 Capacity Planning

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Answer Question no.2:

a. Prepare a table that shows total profits, fixed costs, variable cost, and revenues for monthly volumes of 10,000; 12,000 and 15,000 units.

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Answer Question no.2:

b. What is the break-even point?

Q=$42,000

$7-$3

Q=10,500 units per month

P + FCR - v

Q =

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Answer Question no.3:

Determine profit when volume equals 22,000 units.

P=Q($7-$3)-$42,000

$4(22,000)-$42,000

=$46,000

P= Q(R-v)-FC