Advance Decision Models

Trimester 4th

Session 1 (Introduction)

Copyright 2007 The McGraw-Hill Companies. All rights reserved.

McGraw-Hill/Irwin 11

Learning Objectives
After completing this chapter, you should be able to: 1. Describe the importance of management science. 2. Describe the advantages of a quantitative approach to problem solving.

3. List some of the applications and use of management science models.

4. Discuss the types of models most useful in management science. 5. Demonstrate the basic building blocks and components of Excel.

Copyright 2007 The McGraw-Hill Companies. All rights reserved.

McGraw-Hill/Irwin 12

Learning Objectives (contd)

After completing this chapter, you should be able to: 6. Describe the basic nature and usefulness of breakeven analysis. 7. List and briefly explain each of the components of break-even analysis. 8. Solve typical break-even problems manually and with Excel.

Copyright 2007 The McGraw-Hill Companies. All rights reserved.

McGraw-Hill/Irwin 13

The Importance of Management Science

Management science
The discipline of applying advanced analytical methods to help make better decisions. Devoted to solving managerial-type problems using quantitative models

Applications of management science

Forecasting, capital budgeting, portfolio analysis, capacity planning, scheduling, marketing, inventory management, project management, and production planning.

Copyright 2007 The McGraw-Hill Companies. All rights reserved.

McGraw-Hill/Irwin 14

Table 12

Successful Applications of Management Science

Copyright 2007 The McGraw-Hill Companies. All rights reserved.

McGraw-Hill/Irwin 15

Table 12

Successful Applications of Management Science (contd)

Copyright 2007 The McGraw-Hill Companies. All rights reserved.

McGraw-Hill/Irwin 16

Problem Solving Approaches

Managers tend to use a qualitative approach to problem solving when 1. The problem is fairly simple. 2. The problem is familiar. 3. The costs involved are not great. Managers tend to use a quantitative approach when 1. The problem is complex. 2. The problem is not familiar. 3. The costs involved are substantial. 4. Enough time is available to analyze the problem.
McGraw-Hill/Irwin 17

Copyright 2007 The McGraw-Hill Companies. All rights reserved.

Advantages of the Quantitative Approach

Directs attention to the essence of an analysis: to solve a specific problem. Improves planning which helps prevent future problems Results in more objective decisions than purely qualitative analysis. Incorporates advances in computational technologies to managerial problem-solving.

Copyright 2007 The McGraw-Hill Companies. All rights reserved.

McGraw-Hill/Irwin 18

Models
A Model
An abstraction of reality. It is a simplified, and often idealized, representation of reality.
Examples : an equation, an outline, a diagram, and a map

By its very nature a model is incomplete. Provides an alternative to working with reality

Symbolic models
Use numbers and algebraic symbols

Mathematical models
Decision variables Uncontrollable variables
Copyright 2007 The McGraw-Hill Companies. All rights reserved. McGraw-Hill/Irwin 19

Deterministic versus Probabilistic Models

Deterministic models
Used for problems in which information is known with a high degree of certainty. Used to determine an optimal solution to the problem.

Probabilistic models
Used when it cannot be determined precisely what values (requiring probabilities) will occur (usually in the future).

Copyright 2007 The McGraw-Hill Companies. All rights reserved.

McGraw-Hill/Irwin 110

Type of Models
Models take many forms 1. Mental Models: To understand the world & to predict the outcomes of an action. E.G. Hiring Decisions. 2. Visual Models: Maps, Orgz. Charts which represents reporting relationships, reveals the locus of authority, major channels of commn. 3. Physical Models: are used extensively in Engg. To assist the design of bldg, airplanes etc.
Copyright 2007 The McGraw-Hill Companies. All rights reserved. McGraw-Hill/Irwin 111

Type of Models contd..

4. Mathematical Models: take many forms and are used throughout sience, engg. & public policy E.G. a groundwater models helps in determining the flood prone areas. Models in Business 4 Models types 1. One time decision Models 2. Decision Support Models 3. Models embedded in the computer systems 4. Models used in Business Education
Copyright 2007 The McGraw-Hill Companies. All rights reserved. McGraw-Hill/Irwin 112

Figure 11

The Management Science Approach

Copyright 2007 The McGraw-Hill Companies. All rights reserved.

McGraw-Hill/Irwin 113

Figure 12

DSS Framework

Source: E. Turban, Jay Aronson, and Ting-Peng Liang, Decision Support Systems and Intelligence Systems, 7th ed. (Upper Saddle River, NJ: Prentice Hall, 2005), p. 109.

Copyright 2007 The McGraw-Hill Companies. All rights reserved.

McGraw-Hill/Irwin 114

Exhibit 1-1

Excel Spreadsheet

Copyright 2007 The McGraw-Hill Companies. All rights reserved.

McGraw-Hill/Irwin 115

Exhibit 1-2

Functions Screen

Copyright 2007 The McGraw-Hill Companies. All rights reserved.

McGraw-Hill/Irwin 116

Exhibit 13

Add-in Options

Copyright 2007 The McGraw-Hill Companies. All rights reserved.

McGraw-Hill/Irwin 117

Breakeven Analysis
Breakeven analysis (cost-volume analysis)
Is concerned with the interrelationship of costs, volume (quantity of output or sales), and profit.

The Break-Even Point (BEP)

The volume for which total revenue and total cost are equal. The dividing line between profit and loss; sales higher than the break-even point will result in a profit, while sales that is lower than the break-even point will result in a loss. Where you get out of the red.

Copyright 2007 The McGraw-Hill Companies. All rights reserved.

McGraw-Hill/Irwin 118

Breakeven Analysis
Breakeven analysis (cost-volume analysis)
Is concerned with the interrelationship of costs, volume (quantity of output or sales), and profit.

Components of Break-Even Analysis

Volume: the level of output of a machine, department, or organization, or the quantity of sales. Revenue: the income generated by the sale of a product. Total revenue = revenue per unit (selling price per unit) multiplied by units (volume) sold. Costs: costs that must be taken into account
Fixed costs are not related to the volume of output. Variable costs increase and decrease with output.
Copyright 2007 The McGraw-Hill Companies. All rights reserved. McGraw-Hill/Irwin 119

Assumptions of Break-Even Analysis

The revenue per unit is the same for all volumes. The variable cost per unit is the same for all volumes. Fixed cost is the same for all levels of volume. Only one product is involved. All output is sold. All relevant costs are accounted for, and correctly assigned to either the fixed cost category or the variable cost category.
Copyright 2007 The McGraw-Hill Companies. All rights reserved. McGraw-Hill/Irwin 120

Figure 13

Total Revenue Increases Linearly as Volume Increases

Copyright 2007 The McGraw-Hill Companies. All rights reserved.

McGraw-Hill/Irwin 121

Figure 14

Fixed Costs

Copyright 2007 The McGraw-Hill Companies. All rights reserved.

McGraw-Hill/Irwin 122

Figure 15

Total Variable Cost

Copyright 2007 The McGraw-Hill Companies. All rights reserved.

McGraw-Hill/Irwin 123

Figure 16

Total Cost

Copyright 2007 The McGraw-Hill Companies. All rights reserved.

McGraw-Hill/Irwin 124

Figure 17

Profit and the Break-Even Point

Profit

Copyright 2007 The McGraw-Hill Companies. All rights reserved.

McGraw-Hill/Irwin 125

Example 11

Copyright 2007 The McGraw-Hill Companies. All rights reserved.

McGraw-Hill/Irwin 126

Exhibit 14

Break-Even Analysis

Copyright 2007 The McGraw-Hill Companies. All rights reserved.

McGraw-Hill/Irwin 127

Exhibit 15

Goal Seek Input Screen

Exhibit 16

Goal Seek Output Screen

Copyright 2007 The McGraw-Hill Companies. All rights reserved.

McGraw-Hill/Irwin 128