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# Chapter 2 Deterministic

Modeling

MGS3100
Julie Liggett De Jong

Deterministic Deterministic
models models

Use influence
U i fl Use influence
U i fl
diagrams to diagrams to
translate black translate black
box relation- box relation-
ships ships

Model
documentation

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Deterministic Deterministic
models models

## Rules of good Rules of good

model design model design
and layout and layout

Excell tips
E ti &
techniques

## •Selling Price (SP) •Cost

Basic Profit Model  Sales Volume  Sunk Cost
 Production  Fixed Cost (FC)
Volume  Variable Cost (VC)
 Total Cost (TC)

## •Demand (D) •Contribution margin

•Revenue •Breakeven point
•Profit •Crossover point.

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Basic Profit Model Basic Profit Model
Profit = Revenue – Total Cost

Example:
FC=\$150K; SP=\$400; VC=\$250
What Q will produce profit of \$300k?

## Breakeven Point Breakeven Point

Find breakeven quantity:
Set Profit = 0 and solve for Q Example, if:
FC = 150,000
VC = 250
SP = 400

## How much do we need to sell to breakeven?

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Crossover Point Crossover Point
Verizon Cellular:
Cross-over Point a/k/a Indifference Point
ProfitA=CMA*QA – FCA SetProfitA=ProfitB Pl
Plan Mi
Minutes R
ProfitB=CMB*QB – FCB Solve for Q
cost/min
A 600 \$75 .35
B 900 \$100 .25
If we know we will use at least 600 minutes
but no more than 900 minutes, at what
quantity of minutes are we indifferent
between the two plans?

## Crossover Point Class Exercise

Verizon Wireless Plans
Plan A Plan B Plan C
\$120 00
\$120.00
FC 150 000
150,000 450 000
450,000 2 850 000
2,850,000
\$110.00
VC 250 150 100
\$100.00
SP 400 400 400
Cost

\$90.00

\$80.00
\$ Calculate
600 minutes
\$70.00 900 minutes • Contribution Margin for each plan
\$60.00 • Breakeven Point for each plan
• Indifference Points between A & B; B & C;
0

0
60

61

62

63

64

65

66

67

68

69

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## M inutes Used A&C

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Simon Pies 1.Study the environment & frame
Ingredients:
the situation
Filling Decision statement:
Frozen dough
What pie price will maximize profit?

Decision Variable:
Pie Price

## 2.Model Formulation 2.Model Formulation

Performance
Decision Measure / Parameters:
V i bl
Variable Obj ti
Objective
Unit processing cost
What pie price will maximize profit? Unit ingredients cost
Fixed costs

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2.Model Formulation 3.Construct the Model

## Conceptually formulate model: Profit = Revenue – Total Cost

Pie Price
Revenue = Pie Price * Pies Demanded
Unit Cost, Filling
Unit Cost, Dough Model
Unit Pie Processing Cost
Profit Total Cost = Processing Cost + Ingredients Cost + Fixed
Fixed Cost Costs
Exogenous variables Endogenous variables

Cost

## Ingredients Cost = Pies Demanded * (Unit Filling Cost +

Unit Dough Cost)

Simon’s initial model input values Simon’s Pie Weekly Profit Model

Pie Price \$8 00
\$8.00
Pies Demanded and sold 16
Unit Pie Processing Cost \$2.05

g \$3.48

## Fixed Cost (\$000’s per week) \$12

Figure 3, p36

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Present clearly labeled input
variables together.

and Layout

Figure 3, p36

appropriate.

## Figure 3, p36 Figure 3, p36

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Store input variables in separate Format the spreadsheet to simplify
cells & refer to addresses in interpretation.
formulas.

## Separate physical results from

financial results.

## Refine the Model

Figure 3, p36

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The model treats Pie Price & Pies Demanded The model treats Pie Price & Pies Demanded
as if they are independent of each other. as if they are independent of each other.

• When price is
Pie Demand 50 \$12, demand 50

## & Pie Price 40 is 0 40

P ie D e m a n d

P ie D e m a n d
share an 30 30

inverse 20
• For each \$1 20

10 10
mathematical reduction in
0 0
relationship. 0 2 4 6
Pie Price 8 10 12 price, an 0 2 4 6
Pie Price 8 10 12

4000 pies sold

## What is our dependent variable? Demand = y-intercept + slope * (Price)

What “drives”
drives demand?
Pies Demanded = 48 – 4 * Pie Price
(\$0 < price < \$12)

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Modify the spreadsheet to include Separate physical results from
this relationship. financial results.

## Capstone Computers assembles and sells

personal computers.
computers Sales volume depends on
the sales price. At \$1,000/each, 5,000 computers
will be sold; every increase (or decrease) of \$100,
sales will decrease (or increase, respectively) by
1,000 units.

E
Exercise:
i Capstone
C t C
Computer
t z Compute the slope
z Compute the y-intercept
z What is the linear equation that describes the
relationship between demand and price?

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Computer Demand Computer Demand

15,000 15,000
14,000 14,000
13,000 13,000
12,000 12,000
11,000 11,000
10,000 10,000
9,000 9,000
Demand

Demand
8,000 8,000
7,000 7,000
6,000 6,000
5,000 5,000
4,000 4,000
3,000 3,000
2,000 2,000
1,000 1,000
0 0
\$- \$100 \$200 \$300 \$400 \$500 \$600 \$700 \$800 \$900 \$1,000 \$1,100 \$1,200 \$1,300 \$1,400 \$1,500 \$- \$100 \$200 \$300 \$400 \$500 \$600 \$700 \$800 \$900 \$1,000 \$1,100 \$1,200 \$1,300 \$1,400 \$1,500

Price Price

## Demand & Price have an inverse Computers Demanded =

mathematical relationship. 15,000 – \$10 * Sales Price.

Ground to Cover
z What-if & Sensitivity Analysis
z Charts & Graphs
z Calculating % change from
base (demand, revenue, etc.)
z Time Intervals What if / Sensitivity Analysis
z Model validation
z Excel
z Functions: SUM
z Trendline

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What if Analysis More What If Analysis
Another view . . .
What if we change the
values of two parameters?

## How will this effect

Total Cost and Profit?

## Graph It! Sensitivity Analysis

What effect does a percentage change
in Pie Price have on Profit?

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Model We assumed a
Validation \$2.05 per pie
processing cost
in our model
&
When we review
Simon Pies actual data, we
see that this is
Revisited
only accurate for
base case of 12
thousand Pies
Demanded

We validate the
model by
comparing actual
Processing Cost
data for different
levels of pie
production to our
projected costs.

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Excel’s Trendline
feature allows us
to fit a trend
equation to the
actual cost data.

## 1. Plot historical data

and model data
formulas
3. Conduct “What if”
and Sensitivity
Analysis.

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What if Analysis: Sensitivity Analysis:

## How does the new What happens to

processing cost profit when Price &
equation affect Demand change?
profit?

## Sensitivity Analysis Graphed

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Time Intervals
Ground to Cover
z Expanding a product line
z More Charts & Graphs
z Excel
z Functions: IF
z Data Table 1
z Data Table 2
z G
Goal Seek
S

## Simon’s Pies Simon’s Pies Expands

Expanding the
Product Line Each shares same basic model as Apple Pie

## Pie Prices are somewhat different:

Lemon
Strawberry • Lemon: \$1.00 less than Apple
• Strawberry: \$0.25 more than Apple
Cherry • Cherry: same price as Apple

No historical data

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Simon’s initial model input values

## Pie Price \$9.32 (\$1.00) \$ .25 Same

Unit Cost, Fruit Filling (\$ per pie) \$3.48 \$2.20 \$3.90 \$3.10
Unit Cost, Dough (\$ per pie) \$0.30 \$0.28 \$0.35 \$0.33
Fixed Cost (\$000’s per week) \$33
Pie Demand Intercept 48 43 50 49
Pie Demand Slope -4 -4.4 -4.3 -4.5
Processing Cost Intercept -14.34 -11.66 -13.28 -12.30
Processing Cost Slope 3.38 4.45 3.62 3.25

Figure 2_18

## Stacked Column Chart

Simon can produce 25 thousand pies a
Weekly Pie Revenue, Costs & Contribution
100% week
90%
80%
70%
60% Contribution Producing more than 25 thousand pies a
50% Ingredients Cost
Processing Cost
week requires a second shift.
40%
30% Revenue
20%
10%
0% A second shift incurs overtime costs of
Apple Lemon Strawbry Cherry \$0.80 for each pie produced
Figure 2_19

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Normal Pie Processing Capacity and Overtime Processing Processing Cost has been broken up into Normal Processing
Cost parameters have been added. Cost and Overtime Processing Cost.
Figure 2_20 Figure 2_20

## Can overtime costs be reduced by raising Systematically batch processes “What

What if
if”
pie prices, and thus reducing pie demand? analysis

g
Tabulates results into rectangular array
y of
If Simon
Si can raise
i the
th Normal
N lP
Production
d ti cells (a table)
Capacity above the 25 thousand limit, how
much would profit increase?

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Excel’s Data Table Option Excel’s Data Table Option

## Data Table 1 Data Table 2

Manipulates one exogenous (input) variable Manipulates two exogenous (input) variables
and calculates the results of several parameters and reports the results for a single endogenous
and / or endogenous (output / performance (output/ performance) variable.
variables).
variables)

## Sensitivity Analysis Excel’s Data Table 2

Can the overtime cost be reduced by Decision Variable: Apple Pie Price
raising pie prices,
prices and thus reducing pie Parameter: Normal Processing Capacity
demand? Performance Variable: Total Profit

If Simon
Si can raise
i the
th Normal
N lP
Production
d ti
Capacity above the 25 thousand limit, how Our model facilitates this type of analysis:
much would profit increase ?
If we change the Apple pie price the other pie
prices will also change. Figure 2_23

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We can easily chart our results!
Excel’s Data Table 2

1. Define value ranges for 2 exogenous variables. Profit vs Pie Price & Capacity

\$84.00
2 Enter cell reference for single performance
2.
\$83.00
measure in upper left hand corner. 25
\$82.00 26
\$81.00

P rofit
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3. Select all cells in the rectangular range, I3:016. 28
\$80.00
\$79.00 29
4. Run Excel’s Data Table command: \$78 00
\$78.00 30

\$77.00
For Excel 2003: For Excel 2007:
\$9.20 \$9.30 \$9.40 \$9.50 \$9.60 \$9.70 \$9.80 \$9.90 \$10.00
Select Data > Table Select Data > What-if Analysis > Data Table
Apple Pie Price

5. Specify the Row and Column input cells; click OK. Figure 2_25

## If we only change pie price,

price what happens Data Table 1
to demand, revenue, overtime cost, and
profit? Manipulates one exogenous (input) variable
and calculates the results of several parameters
and / or endogenous (output / performance
variables).
variables)

Figure 2_28

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Excel’s Data Table 1
1. Specify values of input variable in an empty row
or column on worksheet.
2 Place labels for endogenous variables in separate
2.
rows.
3. Input cell references for parameter values that will END OF CHAPTER 2
be recalculated.
4. Select all cells in the rectangular range, I22:S26
5. Run Excel’s Data Table command:
For Excel 2003: For Excel 2007:
Select Data > Table Select Data > What-if Analysis > Data Table

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