DEPARTMENT OF ACCOUNTANCY

REFRESHER COURSE

QUANTITATIVE TECHNIQUES Management Advisory

Services
QUANTITATIVE TECHNIQUES – refer to the application of mathematics in actual business operations. It is also
known as quantitative methods.

OPERATIONS RESEARCH refers to the discipline of applying quantitative methods in organizational planning
and control.

NETWORK MODELS
NETWORK MODELS involve project scheduling techniques that are designed to aid the planning and control of large-scale
projects having many interrelated activities. These models aid management in predicting and controlling costs that pertain to
certain projects or business activities.
COMMON PROJECT SCHEDULING TECHNIQUES (Network Models)
1. Gantt or bar chart
2. Program Evaluation and Review Technique (PERT)
3. Critical Path Method (CPM)

GANTT OR BAR CHARTS

The project is divided into different sub-projects called activities or tasks. The starting and completion time of activity is
estimated and a bar chart is prepared showing each activity as a horizontal bar along a time scale.

B
TASK
C

APR MAY JUN JUL

a. Which task is the longest in completion time? b. All tasks are being perform in what month?

PROGRAM EVALUATION AND REVIEW TECHNIQUE (PERT) – CRITICAL PATH METHOD (CPM)
PERT is developed to aid managers in controlling large-scale, complex problems.
 PERT diagram is a probabilistic diagram of the interrelationship of a complex series of activities; it is a free-form
network showing each activity as line between events.
 EVENTS – discrete moment in time representing the start or finish of an activity; they consume no resources.
 ACTIVITES – tasks to be accomplished; they consume resources (including time)
The following are the common type of activities:
o Series – an activity cannot be performed unless another activity is undertaken
o Parallel – can be performed simultaneously
CPM, like PERT, is a network technique, but unlike PERT, it uses deterministic time and cost estimates; its advantages
include cost estimates plus the concept of crash efforts and costs.
 CRITICAL PATH – is longest path through the PERT network.
 EXPECTED TIME – is the average time an activity would require if it were repeated several times.

te = (to + 4 tm + tp) / 6
Where to –optimistic time; tm – most likely time; tp – pessimistic
 SLACK TIME – the amount of time that can be added to an activity without increasing the total time required on
the critical path; the length of time an activity can be delayed without forcing a delay for the entire project.
 CRASH TIME – the amount of time to complete an activity assuming that, under rush or urgent condition, all
available resources were devoted tot eh task (e.g., overtime, extra labor, etc.); any crash time spent in an activity
normally would incur crash cost.

i. Contratista, Inc. is considering a three-phase research project. The time estimates for completion of Phase 2 of the project are:
Pessimistic 24 weeks
Most likely 20 weeks
Optimistic 10 weeks
Using the program evaluation and review technique (PERT), the expected time for completion of Phase 2 should be
A. 20 weeks C. 18 weeks
B. 19 weeks D. 24 weeks

PROBABILITY ANALYSIS
PROBABILITY ANALYSIS is important to decision-making because of the unpredictability of future events.
Decision-making involves:
 RISK – this occurs when the probability distribution of the possible future state of nature is known.
 UNCERTAINTY – this occurs when the probability distribution of possible future state of nature is not known
and must be subjectively determined.
 The probability of an event varies from 0 to 1 (0% to 100%). 100% or probability of 1.0 means that event is certain to
occur while zero probability means the event cannot occur under any circumstances.
THE CONCEPT OF EXPECTED VALUE
The expected value of an action is found by multiplying the probability of each outcome by its pay-off and summing
up the products. A decision tree diagram is normally devised to show the several decisions or acts and the possible
consequences (outcome or events) of each act.
 Objective probabilities – calculated from either logic or actual experience.
 Subjective probabilities – estimates, based on judgment, of the likelihood of future events.
 Two events are said to be mutually exclusive if they cannot occur simultaneously.
 Two events are said to be independent if occurrence of one has no effect on probability of another.
 The joint probability of two events is the probability that both will occur.
 The conditional probability of two events is the probability that one will occur given that the other has already occurred.

EXERCISES: PROBABILITY ANALYSIS

ii. Dough Distributors has decided to increase its daily muffin purchases by 100 boxes. A box of muffins costs P2 and sells for P3 through
regular stores. Any boxes not sold through regular stores are sold through Dough’s thrift store for P1. Dough assigns the following
probabilities to selling additional boxes:
Additional sales Probability
60 0.6
100 0.4
What is the expected value of Dough’s decision to buy 100 additional boxes of muffins?
A. P28 C. P52
B. P40 D. P68

iii. Karen Company has three sales departments. Department A processes about 50 percent of sales, Department B about 30 percent,
and Department C about 20 percent. In the past, Departments A, B, and C had error rates of about 2 percent, 5 percent, and 2.5
percent, respectively. A random audit of the sales records yields a recording error of sufficient magnitude to distort the company’s
results. The probability that Department A is responsible for this error is
A. 0.50 C. 0.20
B. 0.33 D. 0.25

iv. A beverage stand can sell either softdrinks or coffee on any given day. If the stand sells softdrinks and the weather is hot, it will Commented [MC1]: The expected payoff calculation
make P2,500; if the weather is cold, the profit will be P1,000. If the stand sells coffee and the weather is hot, it will make P1,900; for coffee is:
if the weather is cold, the profit will be P2,000. The probability of cold weather on a given day at this time is 60%. The expected .4($1,900) + .6($2,000) = $1,960.
payoff if the vendor has perfect information is The vendor would like to sell coffee on cold days
A. P3,900 C. P2,200 ($2,000) and soft drinks on hot days ($2,500). Hot days
B. P1,360 D. P1,960 are expected 40% of the time. Hence, the probability
is 40% of making $2,500 by selling soft drinks. The
LEARNING CURVES chance of making $2,000 by selling coffee is 60%. The
payoff equation is:
LEARNING CURVES describes the effeciecies arising from experience, because with experience comes increased
.4($2,500) + .6($2,000) = $2,200.
productivity. This productivity increases with production size, but at decreasing rate as diagrammed below:

The time required to perform a given task becomes progressively

shorter, but this is applicable only to the early stages of production
Units or any new stages
produced
per day The curve is expressed as a percentage of reduced time (usually
between 60% and 80%) to complete a task of each doubling of
cumulative production. Hence, the time required is reduced by
20% to 40% each time cumulative production is doubled.

Cumulative Production
 The cumulative average time per unit is reduced by a certain percentage each time production doubles
 Incremental unit time (time to produced the last unit) is reduced when production

EXERCISES : LEARNING CURVE THEORY

v. Wind Company expects an 85% learning curve. The first batch of a new product required 500 hours. The first four batches should
take an average of
A. 361.25 hours C. 500.0 hours
B. 425.0 hours D. 322.4 hours

vi. A learning curve of 80% assumes that production unit costs are reduced by 20% for each doubling of output. What is the cost of
the sixteenth unit produced as an approximate percent of the first unit produced?
A. 30 percent C. 41 percent
B. 51 percent D. 64 percent
vii. Soft Inc. has a target total labor cost of P3,600 for the first four batches of a product. Labor is paid P10 an hour. If Soft expects
an 80% learning curve, how many hours should the first batch take?
A. 360 hours C. 57.6 hours
B. 140.63 hours D. 230.4 hours

viii. Havenot has estimated the first batch of product will take 40 hours to complete. A 90% learning curve is expected. If labor is paid
P15 per hour, the target labor cost for four batches of product is
A. P600 C. P1,944
B. P2,160 D. P2,400

ix. Hanip Co. used 30 hours to produce the first batch of units. The second batch took an additional 18 hours. How many total hours will
the first four batches require?
A. 76.8 hours C. 120.0 hours
B. 96.2 hours D. 48.0 hours

INVENTORY MODELS
INVENTORY MODELS are usually devised to minimize the cost associated with inventory while maintaining certain level of
inventories needed to sustain smooth operations.
COMPONENT OF INVENTORY COST
The total inventory costs are comprised of:
 CARRYING COSTS: This cost increases with order size or quantity of inventory on hand
Example: Storage cost, insurance on inventory, normal spoilage, record keeping cost, etc.
 ORDERING COSTS: This cost decreases with order size or quantity of inventory on hand
Example: Delivery costs, administrative costs – inspection, purchasing and receiving

THE CONCEPT OF ECONOMIC ORDER QUANTITY (EOQ)

EOQ is the quantity to be ordered that minimizes the sum of ordering cost and carrying cost. EOQ tries to answer the question
“How many units should be ordered (and when to order) to minimize inventory costs?”
2 Do Where: o = Cost of placing one order (ordering cost)
EOQ =
k D = Annual demand in units
K = Annual cost of carrying one unit for one year
At EOQ, a firm incurs the minimum total inventory costs computed as follows:

EOQ D
TC  (k )  (o )
2 EOQ
Average inventory is computed as follows:
 No safety stock: EOQ/2
 With safety stock: EOQ/2 + safety stock
 If EOQ is not available: (beginning inventory + Ending Inventory)/2
Assumptions of EOQ models:
 Annul determinable demand for inventory is spread evenly throughout the year.
 Lead time does not vary and each order is delivered in a single delivery.
 The unit costs of the time ordered are constant; thus, there can be no quantity discounts.

When applied to production operations, the EOQ formula is used to compute the Economic Lot Size (ELS)
Where: o = Set-up cost
2 Do D = Annual production requirement
ELS = K = Annual cost of carrying one unit for one year
k

EOQ-RELATED TERMINOLOGIES
 LEAD TIME is period between the time the order is placed and received
 NORMAL TIME USAGE is derived by multiplying normal lead time with average usage
 SAFETY STOCK = (maximum lead time – normal lead time) x average usage or demand
 ORDER (Reorder) POINT is the inventory level that automatically calls for a new order
When to order is a stock-out problem; the objective is to order at a point in time so as not to run out of stock before receiving
the inventory ordered but not so early that an unnecessary quantity of safety stock is maintained. When order point is
computed, there may be stock-out situation if:
 Demand is greater than expected during the lead time, or
 The order time exceeds the lead time
 RE-ORDER POINT (without safety stock) = Normal lead time usage
 RE-ORDER POINT (with safety stock) = Normal lead time usage + safety stock
= Maximum lead time x average usage

EXERCISES : INVENTORY MODELS

KMU Company uses a small casting in one of its finished products. The castings are purchased from a foundry located in another Asian
country. In total, KMU Company purchases 54,000 castings per year at a cost of P8 per casting.
The castings are used evenly throughout the year in the production process on a 360-day-per-year basis. The company estimates that it
costs P90 to place a single purchase order and about P3 to carry one casting in inventory for a year. The high carrying costs result from
the need to keep the castings in carefully controlled temperature and humidity conditions, and from the high cost of insurance.
Delivery from the foundry generally takes 6 days, but it can take as much as 10 days. The days of delivery time and the percentage of
their occurrence are shown in the following tabulation:

Delivery Time (days) Percentage of Occurrence

6 75
7 10
8 5
9 5
10 5
100

x. What is the economic order quantity for the company.

A. 1,800 C. 2,545
B. 1273 D. 2,700

xi. Assuming that the company will not provide any safety stock units, how much would the annual inventory costs?
A. P2,700 C. P5,400
B. P8,100 D. P6,000

xii. Assuming that the company is willing to assume a 15% risk of being out of stock, what would be the number of safety stock?
A. 0 C. 300
B. 150 D. 450

xiii. Assuming that the company is willing to assume only a 5% risk of being out of stock, what would be the reorder point?
A. 450 C. 1,200
B. 1,050 D. 1,350

xiv. Assuming a 5% stock-out risk, what would be the total cost of ordering and carrying inventory for one year?
A. 5,850 C. 6,075
B. 6,300 D. 6,750

xv. Assuming that the cost of stock out is P80 per occurrence, which safety stock level is necessary in reducing the cost?
A. 0 C. 300
B. 150 D. 450

LINEAR PROGRAMMING
LINEAR PROGRAMMING is a mathematical technique that helps managers to determine the volume of various products to
produce when resources are limited or scarce in order to maximize net income. It is a technique used to optimize an objective
function (maximize revenue of profit function, or minimize a cost of function), subject to constraints (such as scarce resources,
minimum/maximum levels of production, performance, etc.)
Maximize revenue
OBJECTIVE Maximize net profit
Minimize costs and expenses

Limited resources must be allocated to the company’s most profitable products so that net income is maximized. Linear
programming models are extremely helpful in the analysis and solution of resource allocation problems.

Simplex method is a more complex linear programming technique especially useful if there are more than two variables in a
linear programming problem.

EXERCISES : LINEAR PROGRAMMING

The Kinis Company produces a cosmetic product in 60 gallon batches. The basic ingredients used are material X, costing P70 per
gallon, and material Y, costing P170 per gallon. No more than 18 gallons of X can be used, and at least 15 gallons of Y must be used.

8. How would the objective function (minimization of product cost) be expressed?

A. 70X + 170Y C. 170X + 70Y
B. 18X + 15Y D. 18X + 42Y

9. Which of the following is not a constraint of the Kinis Company?

A. X ≤ 18 C. Y ≥ 15
B. X + Y ≤ 60 D. X ≥ 0

Use the following data to answer Question Nos. 10 through 12:

Sun, Inc. manufactures product X and product Y, which are processed as follows:
 Type A machine Type B machine
Product X 6 hours 4 hours
Product Y 9 hours 5 hours

The contribution margin is P12 for product X and P7 for product Y. The available time daily for processing the two products is 120 hours
for machine Type A and 80 hours for machine Type B.

10. How would the constraint for machine Type A be expressed?

A. 4X + 5Y C. 4X + 5Y ≤ 80
B. 6X + 9Y ≤ 120 D. 12X + 7Y

11. How would the constraint for machine Type B be expressed?

A. 4X + 5Y C. 4X + 5Y ≤ 80
B. 6X + 9Y ≤ 120 D. 12X + 7Y

12. How would the objective function be expressed?

A. 4X + 5Y C. 4X + 5Y ≤ 80
B. 6X + 9Y ≤ 120 D. 12X + 7Y

i. Answer: B
Formula: (Pessimistic + 4Most likely + Optimistic) / 6
[24 + (20 x 4) +10] ÷ 6 = 19 weeks

ii
. Answer: C
Sales Conditional Profit (Loss)
60 (60 x P3) + (40 x P1) – P200 = P 20
100 (100 x P3) – P200 = 100
Expected Value: (P20 x 0.6) + (P100 x 0.4) = P52

iii. Answer: B
Dept. Error Weight Probability
A 0.02 0.010 .01/.03 = 33.00%
B 0.05 0.015 .015/03= 50.00%
C 0.025 0.05 .005/03= 16.67%
0.03

iv. Answer: C
Expected payoff:
Sale of coffee during cold weather 2,000 x 0.6 1,200
Sale of soft drinks during hot weather 2,500 x 0.4 1,000
Total 2,200

v. Answer: A
Units Cumulative Average Time Computation
1 500.00
2 425.00 (0.85 x 500.00)
4 361.25 (0.85 x 425.00)

vi. Answer: C
Units Cumulative Average Time Computation
1 1.00
2 0.80 (0.8 x 1.00)
4 0.64 (0.8 x 0.80)
8 0.51 (0.8 x 0.64)
16 0.41 (0.8 x 0.51)
Percentage: 0.41 ÷1.00 = 41.0%

vii. Answer: B
Average hours after 4th batch P3,600 ÷ 10 ÷ 4 units 90
Hours used by 1st batch: 90 ÷ 0.80 ÷ 0.80 140.63

viii. Answer: C
Units Cumulative Average Time Computation
1 40.00
 2 36.00 (0.9 x 40.00)
4 32.40 (0.9 x 36.00)
Total number of hours used by 4 units: 4 x 32.4 129.6
Total labor cost used by 4 units: 129.6 x P15 P1,944

ix. Answer: A
Learning curve (30 + 18) ÷ 2 ÷ 30 = 80.0%
Cumulative average time after 4 batches: 30 x 0.8 x 0.8 19.2
Total number of hours used by first 4 batches: 4 x 19.2 76.8

x. Answer: A
EOQ = the square root of 2 x annual units required x ordering cost ÷ carrying cost per unit
EOQ = the square root of 2 x 54,000 x 90 ÷ 3 = 1,800

xi. Answer: C
Annual ordering cost: 54,000/1800 x 90 2,700
Annual carrying cost: 1,800/2 x 3 2,700
Total cost 5,400

xii. Answer: B
A 15% risk of out-of-stock means a 85% assurance that order will be received on time. Without having a safety stock, the company
will use a lead time of 6 days (75%). Therefore, 7-day lead time has 85% assurance or a 15% risk of stockout. The safety stock level
is for 1 day (7 – 6) or 150 units.
Daily requirements: 54,000/360 = 150

xiii. Answer: D
A 5% risk of out-of-stock means a 95% assurance that order will be received on time. This is estimated to have a lead time of 9 days
(the total of probability for 9 days is 95%).
Reorder point without safety stock 6 days x 150 900
Safety stock (9 – 6) 150 450
Reorder point 1,350

xiv. Answer: D
Ordering cost (unchanged) 2,700
Carrying cost
Average inventory (1800/2) + 450 = 1,350
1,350 x 3 4,050
Total 6,750

xv. Answer: A
Safety units Stock out cost Carrying Cost Total
0 0.25 x 2,400 = 600 0 600
150 0.15 x 2,400 = 360 150 x 3 = 450 810
300 0.10 x 2,400 = 240 300 x 3 = 900 1,140
450 0.05 x 2,400 = 120 450 x 3 = 1,350 1,470
Annual stockout cost (100% probability) based 30 orders (54,000/1800):
30 x 80 = 2,400
The probability of stockout is the inverse of assurance, say at zero safety stock, 6 days, its 75% probable that ordered goods will
arrive, therefore, its 25% probable that it won’t.