Supplement

Decision Making

PROBLEMS 1. Williams Products a. Break-even quantity (Q) = Fixed costs (Unit price Unit variable costs) = $60,000 ($18 $6) = 5,000 units The graphic approach is shown on the following illustration, using Break-Even Analysis Solver of OM Explorer.
$200,000 $180,000 $160,000 $140,000 $120,000 $100,000 $80,000 $60,000 $40,000 $20,000 $0 0 2000 4000 6000 Quantity (Q) 8000 10000 12000 Break-even quantity (10,000, 120,000) - -Revenues Costs (10,000, 180,000)

Two lines must be drawn: Revenue: = 18Q Total cost: = 60,000 + 6Q b. Profit = Revenue Total cost = pQ ( F + cQ) = ($14.00)10,000 $60,000 + ($6)10,000 = $140,000 $120,000 = $20,000 c. Profit = Revenue Total cost = pQ ( F + cQ) = ($12.50)15,000 $60,000 + ($6)15,000 = $187,500 $150,000 = $37,500

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Therefore, the strategy of using a price of $12.50 will result in a greater contribution to profits. d. Williams must also consider how this product fits within her existing product line from the perspective of required technologies and distribution channels. Other marketing, operations, and financial criteria must also be considered. 2. Jennings Company a. Break-even quantity ( Q ) = Fixed costs ( Unit price Unit variable costs ) = $80, 000 ( $22 $18 ) = 20, 000 units The graphic approach is shown on the following graph created by the BreakEven Analysis Solver.
$1,000,000 $900,000 $800,000 $700,000 $600,000 $500,000 $400,000 $300,000 $200,000 $100,000 $0 0 5000 10000 15000 20000 25000 30000 35000 40000 45000 Quantity (Q) Break-even quantity (40,000, 880,000) (40,000, 800,000) Costs - -Revenues

Two lines are: Revenue: = $22Q Total cost: = $80,000 + 18Q b. Alternative 1: Sales increase by 30 percent, to 22,750 units. Profit = pQ ( F + cQ) = ($22)22,750 $80,000 + ($18)22,750 = $11,000

Decision Making

SUPPLEMENT A

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Alternative 2: Cost reduction to 85 percent results in $15.30 unit cost. Profit = pQ ( F + cQ) = ($22)17,500 $80,000 + ($15.30)17,500 = $37,250 Therefore the cost reduction leads to higher profits in this example. c. Initial unit profit is ($22 $18) = $4.00 Alternative 1: ($22 $18) = $4.00 The percentage change in profit margin is zero. Alternative 2: ($22 $15.30) = $6.70 The percentage change is ($6.70 $4) $4 = 67.5 percent increase. 3. Interactive television service F = ( p c)Q = ($15 $10)15,000 = $75,000 4. Brook Trout Q = F ( p c) p = ( F Q) + c = $10, 600 800 + $6.70 = $19.95 5. Gabriel Manufacturing a. Total cost = Fixed cost + Variable cost TC = F + cQ TC ( second process ) = $120, 000 + $900Q At the break-even quantity, $300,000 + $600Q = $120,000 + $900Q TC ( first process ) = $300, 000 + $600Q

$300Q = $180,000 Q = 600 units Beyond 600 units the first process becomes more attractive. b. At Q = 800 units TC ( first process ) = $300, 000 + $600 ( 800 ) = $780, 000 The difference in total cost = $840, 000 $780, 000 = $60, 000

TC ( second process ) = $120, 000 + $900 ( 800 ) = $840, 000

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6. News clipping service Fm Fa $400,000 $1,300,000 = = 227,848 clippings a. Q = ca cm $2.25 $6.20 b. Profit = Total Revenue Total Cost Current (manual) situation: = (225,000 $8.00) $400,000 + (225,000 $6.20) Profit = $5,000 Modernization: = (900,000 $4.00) $1,300,000 + (900,000 $2.25) Profit = $275,000 the clipping service should be modernized.
c.

Q=

F $1,300, 000 = = 742,857 clippings p c $4.00 $2.25

7. a.

Hahn Manufacturing Total cost of buying 750 units from the supplier: TCb = ($1,500 unit )( 750 units) = $1,125,000 Total cost of making 750 units in-house: TCm = ($1,100 unit +$300 unit )( 750 units) + $40,000 = $1,090,000 Therefore Hahn should make the components in-house, saving $35,000 per year. At the break-even quantity, the total cost of the two alternatives will be equal: $1,500Q = $40,000 + $1,400Q 100Q = $40,000 Q = 400 units c. If the decision is to buy, Hahn may get a quantity discount from the supplier (we would be ordering 750 per year instead of the current 150 per year). Just a $50 per unit quantity discount would make the buy alternative more attractive than the make alternative. Because the component is a key item, Hahn should check the reliability of the supplier and of their own processes. Reliability may argue for the make decision. 8. Current Profit = ( Price Variable cost )(Annual Volume) Annual Fixed Costs = ($10.00 $5.00)(30,000) ($140,000)
a. b.

b.

= $10,000 Profit with new equipment = ($10.00 $6.00)(50,000 ) ($200,000) = $0 Because the profit decreases, Techno should not buy the new equipment. Profit with new equipment = ($11.00 $6.00)( 45,000 ) ($200,000) = $25,000 Because the profit increases, Techno should buy the new equipment if they also raise the selling price.

Decision Making

SUPPLEMENT A

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9.

This problem is a thinly disguised portrayal of an actual situation faced by Tri-State G&T Association, Inc. of Thornton, Colorado, and which is common to many other REA Utilities. However the costs, prices, and demands stated in the problem are fictional. F a. Q = pc p= F $82,500,000 +c = + $25 = $107.5 per MWH Q 1,000,000

b. Profit (or loss) = Total Revenue Total Cost = (1,000,000 95%)($107.5) $82,500,000 + (1,000,000 95%)($25) = $102,125,000 $106,250,000 Loss = $4,125,000 In order to break even, the price would have to be raised to $4,125, 000 $107.5 + 950, 000 = $111.842 , assuming even more conservation would not occur at this higher price.
Tri-County G&T: 140 120 100 80 60 40 20 0.25 0.50 0.75 1.00 Volume, ( Q , in thousands of MWH) 1.25 Total Revenue Total Costs Problem 9 Problem 11

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10. Earthquake ... Build or Buy. This problem is related to problem 9. Build: F + Qc1 = $10,000,000 + (150,000MWH $35) = $15,250,000 1 Buy: F2 + Qc2 = $0 + (150,000MWH $75) = $11,250,000 It would be less costly for Boulder to buy power from Tri-County. Note that Boulder enjoys a lower price ($75) than Tri-County charges its own REA customers ($107.50). 11. Tri-County G&T continued. This problem builds on problems 9 and 10 to show that Tri-Countys REA customers also benefit from the bargain arrangement with Boulder. Contribution from sales to Boulder = Q( p c) = 150,000($75 $25) = $7,500,000 Remaining fixed costs to cover = $82,500,000 $7,500,000 = $75,000,000 F Q= pc F $75,000,000 +c = + $25 = $100 per MWH Q 1,000,000 Note that selling power to Boulder at a reduced price also reduces the price to the REA customers. However, it may be difficult to persuade REAs that selling electricity to city slickers below cost also benefits rural customers. p= 12. Forsite Company a. Say that each criterion (arbitrarily) receives 20 points: Product A B C Calculation 20( 0.6) + 20( 0.7) + 20( 0.4 ) + 20(1.0 ) + 20( 0.2 ) 20( 0.8) + 20( 0.3) + 20( 0.7) + 20( 0.4) + 20(1.0 ) 20( 0.3) + 20( 0.9) + 20( 0.5) + 20( 0.6) + 20( 0.5) Total Score = 58 = 64 = 56

The best alternative is service B and the worst is service C. This relationship holds as long as any arbitrary weight is equally applied to all performance criteria. b. x = point allocation to criteria 1, 3, 4, and 5 2 x = point allocation to criteria 2 ( ROI ) x + 2 x + x + x + x = 100 points 6 x = 100 points x = 16.7 points Let

Decision Making

SUPPLEMENT A

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Product Calculation Total Score 16.7( 0.6) + 33.3( 0.7) + 16.7( 0.4 ) + 16.7(1.0 ) + 16.7( 0.2 ) A = 60.0 B embed Equation.3 = 58.4 16.7( 0.8) + 33.3( 0.3) + 16.7( 0.7) + 16.7( 0.4 ) + 16.7(1.0 ) C 16.7( 0.3 + 33.3 0.9 + 16.7 0.5 +( ) 0.6 16.7) 0.5 = 61.7 16.7 ) ( ) ( ) (+ The rank order of the services has changed to C, A, B. 13. Five new products a. Let

x = point allocation to criteria 2 and 3 4 x = point allocation to criterion 1 4 x = point allocation to criterion 4

4 x + x + x + 4 x = 100 points 10 x = 100 points x = 10 points Product A B C D E

b.

Calculation 40(8) + 10(3) + 10(9) + 40( 7) embed Equation.3 embed Equation.3 40( 7) + 10(8) + 10(5) + 40(6) embed Equation.3 embed Equation.3 40(3) + 10( 4 ) + 10( 7) + 40( 9) embed Equation.3 embed Equation.3 40(6) + 10( 7) + 10(6) + 40( 2 ) embed Equation.3 embed Equation.3 40( 9) + 10( 7) + 10(5) + 40( 7)

Total Score = 720 = 650 = 590 = 450 = 760

The threshold is 0.7 10( 40 + 10 + 10 + 40 ) = 700

c. Because Product A and Product E score greater than 700, they should be considered for introduction. 14. Accel-Express Inc. a. The weighted score for Location A: (10 )(8) + (10 )( 7) + (10 )( 4 ) + (20 )( 7) + ( 20 )( 4 ) + (30 )( 7) = 620 The weighted score for Location B: (10 )(5) + (10 )( 7) + (10 )( 7) + (20 )( 4 ) + (20 )(8) + (30 )(6 ) = 610 Location A must be chosen. b. If equal weights are placed on the criteria, the two locations will be tied because the sum of the scores is 37 for both A and B. 15. Build-Rite Construction a. Maximin CriterionBest Decision: Subcontract ... Payoff: $100,000 b. Maximax CriterionBest Decision: Hire ... Payoff: $625,000

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Using Operations to Compete

c. Laplace CriterionBest Decision: Subcontract ... Weighted Payoff: $221,667

Alternative Hire Subcontract Do nothing

Weighted Payoff $250,000 + 100,000 + $625,000 3 = $158,333 $100,000 + 150,000 + $415,000 3 = $221,667 $50,000 + 80,000 + $300,000 3 = $143,333

d. Minimax Regret CriterionSubcontract ... Minimum Maximum Regret $210,000 Regrets ($000) Demand for Home Improvements Alternative Low Moderate High Maximum 100 ( 250) = 350 150 100 = 50 625 625 = 0 Hire 350 100 100 = 0 150 150 = 0 625 415 = 210 Subcontract 210 100 50 = 50 150 80 = 70 625 300 = 325 Hire 325 16. Decision Tree Choose Alternative 2, expected value = $24.00. Problem 16, Decision Tree
4 (0.5) (0.5) (0.4) (0.3) (0.3) $15 $30 $20 $18 $24 $25 $20 $30 $26 $20

$22.50 Alternative 1 $22.50 1 Alternative 2 $24.00 (0.2)

2 $20.60 5

6 $24

(0.6) (0.4) (0.5) (0.3)

Working from right to left, the expected value of Event 7 [0.6 ($20) + 0.4 ($30)] = $24.00 Decision 3 prunes Event 7 from the tree because the upper branch has a higher expected value ($25 versus $24). Event 5 [0.4 ($20) + 0.3 ($18) + 0.3 ($24)] = $20.60 Event 4 [0.5 ($15) + 0.5 ($30)] = $22.50

Decision Making

SUPPLEMENT A

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Decision 2 prunes Event E from the tree because the upper branch has a higher expected value ($22.50 versus $20.60). Event C [0.2 ($25) + 0.5 ($26) + 0.3 ($20)] = $24.00 Decision 1 prunes the upper branch because the lower branch has a higher expected value ($24.00 versus $22.50). The indicated decision is to follow the lower branch, Alternative 2, from Decision 1. If the top branch of Event C occurs (a 20% probability), then Decision 3 will follow the upper branch. 17. One machine or two. The decision tree is shown following. Decision Tree
Subcontract High demand (0.80) D Do nothing Buy second Low demand (0.20) $120,000 $160,000 $120,000 $140,000

$152,000 B One A Two $162,000

C High demand (0.80) $180,000 Low demand (0.20) $90,000

b. Working from right to left: Decision D is to subcontract because the upper branch has the highest expected value. Event B [0.80 ($160,000) + 0.20 ($120,000)] = $152,000 Event C [0.80 ($180,000) + 0.20 ($90,000)] = $162,000 Decision A prunes Event B from the tree because the lower branch has a higher expected value. The indicated decision is to purchase two machines now. 18. Small, medium, or large facility. The decision tree is shown following. b. Working from right to left: Decisions E, F, and G are pruned according to highest payoff. Then the expected values are: Event B [0.35 ($220,000) + 0.40 ($125,000) 0.25 ($60,000)] = $112,000 Event C [0.35 ($150,000) + 0.40 ($140,000) 0.25 ($25,000)] = $102,250 Event D [0.35 ($125,000) + 0.40 ($ 75,000) + 0.25 ($18,000)] = $ 78,250 Decision A prunes Events C and D from the tree because the upper branch has the highest expected value. The indicated decision is to build the large facility now, with an expected payoff of $162,000

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Using Operations to Compete

High demand (0.35) B Average demand (0.40) Low demand (0.25) $112,000 Large Medium $102,250 Expand Lrg High demand (0.35) E Do nothing C Average demand (0.40) Low demand (0.25) Expand Lrg High demand (0.35) F Expand avg Do nothing D Average demand (0.40)G Expand avg Do nothing Low demand (0.25)

$220,000 $125,000 ($60,000) $145,000 $150,000 $140,000 ($25,000) $125,000 $60,000 $75,000 $60,000 $75,000 $18,000

Small $78,250

19. Small or large plant. The decision tree is shown following. a. Payoffs are in millions of dollars.

High demand (0.70) $12.2 million Small A Large $14.1 million High demand (0.70) C Low demand (0.30) B Low demand (0.30)

Expand D Do nothing

$14 $10 $8

$18 $5

b. Working from right to left: Decision D is pruned according to highest payoff. Then the expected values are: Event B [0.70 ($14,000,000) + 0.30 ($8,000,000)] = $12,200,000 Event C [0.70 ($18,000,000) + 0.30 ($5,000,000)] = $14,100,000 Build LARGE plant. 20. Expected payoff for the BUILD decision:

Decision Making

SUPPLEMENT A

21

0.4 ($20,000,000) + 0.6 ($10,000,000) = $2,000,000. Expected payoff for the DO NOT BUILD decision: $0.