B.3. Forecasting Techniques

The regression equation is Y = a + bX. Which of the following is true?
CalculatorTime Value Tables

A. b represents the amount of Y when X = 0
B. X represents the dependent variable
C. b represents fixed cost per unit
D. a represents the amount of Y when X = 0
Explanation
Choice "D" is correct. In the regression formula (Y = a + bX), Y represents the

dependent variable, X represents the independent variable, b is the variable cost per
unit, and a represents the amount of Y when X = 0.
Choice "A" is incorrect. In the regression equation Y = a + bX, b does not represent the
amount of Y when X = 0.
Choice "B" is incorrect. In the regression equation Y = a + bX, X does not represent the
dependent variable.
Choice "C" is incorrect. In the regression equation Y = a + bX, b does not represent
fixed costs per unit.
A regression equation:

A. Estimates the dependent variables.
B. Is based on objective and constraint functions.
C. Estimates the independent variable.
D. Ignores the coefficient of determination.
Explanation
Choice "A" is correct. Regression analysis is a technique for estimating the relationship
between two variables: a dependent variable and an independent variable.
In a simple linear regression of the form Y = a + bX, X is the independent variable and Y
is the dependent variable. The equation estimates the dependent variable Y for
a projected value of X.
Choice "B" is incorrect. This is a distractor. Objective and constraint functions are used
in linear programming, not in regression analysis.
Choice "C" is incorrect. An independent variable is assumed (not estimated) in

regression analysis and is based on activity.
Choice "D" is incorrect. The coefficient of determination (denoted by R2) is used to

analyse the result of regression analysis. It is interpreted as the proportion of the
variance in the dependent variable that is predictable from the independent variable.
ABC Company has run a regression analysis and determined that sales are related to
marketing costs. The regression formula the analysts have calculated is Y = $5,000,000
+ $125(x), where Y = sales and x = marketing costs. Use the regression formula to
determine what the annual sales will be if marketing expenditures are $1,000,000.

A. $6,000,000
B. $5,000,000
C. $130,000,000
D. $125,000,000
Explanation
Choice "C" is correct. The regression formula states that:
Y = $5,000,000 + $125X
where Y = sales and X = marketing costs
Y = $5,000,000 + $125($1,000,000)
Y = $5,000,000 + $125,000,000
Y = $130,000,000
Choice "A" is incorrect. This answer was calculated by adding $5,000,000 and
$1,000,000. However, this answer does not consider that $1 in marketing expenditures
results in $125 of sales.
Choice "B" is incorrect. This answer represents the portion of sales that take place
regardless of the amount of marketing expenditures. However, this answer does not
consider the portion of sales that result from the marketing expenditures.
Choice "D" is incorrect. This answer was calculated by multiplying $125 by $1,000,000.
However, this answer does not consider the portion of sales that take place regardless
of the amount of marketing expenditures.
A company has accumulated data for the last 24 months in order to determine if there is
an independent variable that could be used to estimate shipping costs. Three possible
independent variables with a theoretical basis are being considered: packages shipped,
miles shipped, and pounds shipped. The quantitative technique that should be used to
determine whether any of these independent variables might provide a good estimate
for shipping costs is:

A. Flexible budgeting.
B. Linear programming.
C. Linear regression.
D. Variable costing.
Explanation
Choice "C" is correct. Regression analysis is focused on discovering relationships or

effects surrounding one dependent variable. The researcher develops a theoretical
basis: a reason to believe that one or more other variables affect the dependent
variable. The dependent variable depends on those other independent variables. The
other variables cannot depend on the dependent variable or each other; they must be
independent.
Linear regression is a type of regression analysis where the relationship between the
independent variables and the dependent variable is presumed to be linear (i.e., a one-
unit change in an independent variable results in a proportional change of the
dependent variable, regardless of the actual value of either variable).
Choice "A" is incorrect. A flexible budget changes with volume or activity. The budget
"flexes" for changes in volume and/or activity, because the company is trying to
determine the activities to which the changing budget is most sensitive.
Choice "B" is incorrect. Linear programming is a mathematical modeling technique to

optimize a function comprised of linear relationships. Optimizing costs may be an
eventual goal of management but would require an understanding of the relationships
among packages, miles, and pounds shipped to shipping costs, none of which are
currently known.
Choice "D" is incorrect. Variable costing is a reporting methodology that only assigns
variable product costs to inventory. It is not as useful in estimating costs as the
relationships between cost drivers would be. Product units produced is not the same as
product units shipped, and all the dependent and independent variables are related to
shipping.
High Concept Fashion is planning its next advertising campaign to coincide with its
store expansion in the following months. Using information from the past few years, the
company was able to perform a regression analysis with the following results:
Sales revenue = $200,000 + 15(Advertising budget)
R 2 = 0.85
The company's advertising budget over the last few years usually fell between the range
of $10,000 and $15,000 a year. The company plans to spend $50,000 this year as a
result of its expansion. Given its new advertising budget, High Concept Fashion should
expect:

A. Unable to make any prediction because the new budget lies outside the range of the sample
used to estimate the regression equation.
B. $950,000 in sales revenue.
C. $200,000 in sales revenue.
D. $750,000 in sales revenue.
Explanation
Choice "A" is correct. Since the regression equation is estimated using advertising
budgets that fell between the range of $10,000 and $15,000 a year, the equation is best
used to predict sales revenue using advertising budgets that fall within that range. When
the firm uses an advertising budget that falls outside $10,000 to $15,000 a year to
predict sales revenue, the result can no longer be reliable.
Choice "B" is incorrect. This answer was calculated as follows: $200,000 + (15 ×
$50,000). Although the regression equation can be considered for this calculation,
realistically, the regression equation cannot be used here because the advertising
spending plan is so much higher than the range previously used to derive the
regression equation.
Choice "C" is incorrect. This answer represents the amount of sales revenue that occurs
regardless of the advertising budget. However, this answer does not consider how the
higher advertising spending affects the amount of sales.
Choice "D" is incorrect. This answer was calculated by multiplying 15 by $50,000 and
represents the amount of sales revenue that occurs because of the advertising budget.
However, this answer does not consider the amount of sales revenue that occurs
regardless of the advertising budget. It also does not consider if the regression equation
can be used for this calculation.
In order to determine how its in-house training program is affecting its employees'
performance rating, Maxis Tech performed a regression analysis with the following
results:
Performance rating = 0.2 + 0.05 hours of training
R2 = 0.1
Given the above information, Maxis Tech can conclude that:

A. An employee's performance rating will be 0.35 if the employee receives only one hour of
training.
B. The number of training hours received has a significant impact on an employee's performance
rating.
C. There are factors other than number of training hours received that can better explain an
employee's performance rating.
D. For every hour of training received, an employee's performance rating will decrease by 0.05.
Explanation
Choice "C" is correct. The R2 of 0.1 means that the number of training hours received
can explain only 10 percent of the variation in an employee's performance rating
(according to the regression analysis). Other factors can explain the remaining 90
percent of the variation in an employee's performance rating. As a result, the firm should
have performed a multiple regression analysis (with multiple independent variables)
rather than a simple regression analysis (with just one independent variable).
Choice "A" is incorrect. Based on the regression equation given, an employee's

performance rating will be 0.25 if the employee receives only one hour of training, not
0.35.
Choice "B" is incorrect. The number of training hours received does not have a
significant impact on an employee's performance rating as the relationship between
performance rating and hours of training is represented by an R2 of 0.1.
Choice "D" is incorrect. Based on the regression equation given, for every hour of
training received, an employee's performance rating will increase by 0.05, not decrease.
Automite Co. is an automobile replacement parts dealer in a large metropolitan
community. Automite is preparing its sales forecast for the coming year. Data regarding
both Automite's and industry sales of replacement parts as well as both the used and
new automobile sales in the community for the last 10 years have been accumulated.
If Automite wants to determine if its sales of replacement parts are patterned after the
industry sales of replacement parts or to the sales of used and new automobiles, the
company would employ:

A. Correlation and regression analysis.
B. Time series analysis.
C. Simulation techniques.
D. Statistical sampling.
Explanation
Choice "A" is correct. The purpose of correlation and regression analysis is to determine
the relationship between a dependent variable and one or more independent variables.
Regression analysis determines the best linear, unbiased estimate between a
dependent variable and one or more independent variables.
Choice "B" is incorrect. If Automite wants to determine if its sales of replacement parts
are patterned after the industry sales of replacement parts or to the sales of used and
new automobiles, the company would not employ time series analysis.
Choice "C" is incorrect. If Automite wants to determine if its sales of replacement parts
new automobiles, the company would not employ simulation techniques.
Choice "D" is incorrect. If Automite wants to determine if its sales of replacement parts
new automobiles, the company would not employ statistical sampling.
The primary difference between simple linear regression and multiple linear regression
is:

A. Multiple linear regression analysis involves more than one independent variable while simple
linear regression only considers one independent variable.
B. Multiple linear regression analysis considers the impact of one independent variable on
multiple dependent variables while simple linear regression analysis only considers one
dependent variable.
C. Multiple linear regression analysis considers the impact of multiple independent variables on
multiple dependent variables while simple linear regression analysis only considers one
independent and one dependent variable.
D. Multiple linear regression analysis considers codependent variables while simple linear
regression analysis only considers mutually exclusive variables.
Explanation
Choice "A" is correct.
Simple linear regression involves only one independent variable. Multiple linear
regression analysis involve more than one independent variable.
Choice "B" is incorrect. Multiple linear regression analysis analyzes the impact of
multiple independent variables (income, competitors, etc.) on a single dependent
variable (revenue) not vice versa.
Choice "C" is incorrect. While non-linear multiple regression analysis may consider the
dynamic relationships associated with multiple independent and dependent variables,
multiple linear regression only considers the impact of multiple independent variables on
a single dependent variable.
Choice "D" is incorrect. This is a distracter. Codependence has more to do with

psychoanalysis than regression analysis.
An international not-for-profit organization finances medical research. The majority of its
revenue and support comes from fundraising activities, investments, and specific grants
from an initial sponsoring corporation. The organization has been in operation for over
15 years and has just finished a major fundraising event that raised $500 million for the
current fiscal period. The following are selected data from recent financial statements (in
millions of dollars).
Current Year Past Year

Revenue $500 $425
Investments (average balances) 210 185
Investment income 16 20
Administrative expense 10 8
A financial analyst wants to determine whether the change in investment income during
the current year was due to changes in investment strategy, changes in portfolio mix, or
other factors. Which one of the following techniques should be used?

A. Ratio analysis that compares changes in the investment portfolio monthly.
B. Multiple regression analysis that includes independent variables associated with the nature of
the investment portfolio and market conditions.
C. Best-practice analysis that compares the investment income as a percentage of total assets
with a competitorʹs investment income as a percentage of total assets.
D. Simple linear regression that compares investment income changes over the past five years to
determine the nature of the changes.
Explanation
Choice "B" is correct. A critical component of financial analysis is examining results over
time to see where changes have occurred, and then develop an understanding of the
drivers behind those changes. Merely looking at the numbers rarely tells the story;
therefore, a more detailed analysis is needed to provide context to the numbers and to
help others understand the underlying drivers of change.
Multiple linear regression is a statistical method used to model the relationship between
one dependent (or response) variable and two or more independent (or explanatory)
variables by developing a linear equation based on observed data. The purpose of
doing so is to understand what independent factors are impacting the performance of
the dependent variable. Applying a multiple regression analysis here should allow the
analyst to ascertain if the investment strategy, portfolio mix, or some other factor is the
primary contributor to the change in investment income.
An analyst has developed a multiple regression model to forecast the selling price for a
piece of equipment three years from now. Which of the following independent variables
is least likely to be included in the regression equation?

A. Hours logged on the machine
B. The useful life of the machine
C. The color of the machine
D. The number of nonroutine repairs needed to date
Explanation
Choice "C" is correct. Multiple regression is a predictive method used to study the
relationship between a dependent variable and two or more independent variables. A
regression equation should only include independent variables that have a direct effect
on the outcome of the dependent variable.
Although hours logged, the useful life, and the number of repair visits may drive
equipment value, the color of the machine is least likely to have a significant effect on
value; therefore, color is unlikely to be included in the regression equation.
Choice "A" is incorrect. Hours logged on the machine will have a direct effect on the
value the company will receive when the machine is sold three years from now.
Choice "B" is incorrect. The useful life of the machine serves as the time period for
recognizing the depreciation (or allocation of cost) of an asset. The life of an asset is
directly correlated with the expected value of that asset in the future.
Choice "D" is incorrect. Nonroutine repair may indicate issues with the equipment; the
more repairs needed, the lower the value of the asset.
Maxis Tech is trying to determine how an employee's performance rating could be
explained by his or her level of education (EDU), the length of employment (EMP) with
the company, and the number of training (TRN) hours received.
Using data from 100 of its employees, Maxis Tech performs a regression analysis with
the following results:
Performance rating = 0.2 + 0.32 EDU + 0.15 EMP + 0.07 TRN
R2 = 0.72
t for EDU = 0.013
t for EMP = 3.276
t for TRN = 4.121
The value of these terms in the parentheses (EDU, EMP, and TRN) represent the t‐
statistics of the regression coefficient. Which of the following statements best describes
the statistical significance of the impact of the three factors on employee performance
ratings?

A. The impact of all three is statistically significant because the R2 is relatively high.
B. None of the factors has a statistically significant impact.
C. Only the impact of number of training hours received is statistically significant because it has
the highest t-statistics.
D. Both length of employment with the company and number of training hours received have a
statistically significant impact because the absolute values of their t-statistics are higher than
the most extreme cutoff point.
Explanation
Choice "D" is correct. Both length of employment with the company and number of
training hours received have a statistically significant impact because the absolute
values of their t-statistics are higher than the most extreme cutoff point.
To determine if an independent variable is statistically significant, we need to look at its

t-statistics. If its t-statistics are greater than a certain cutoff point (which is determined
by the level of significance), it is considered to be statistically significant.
Although no level of significance is provided in this scenario, the absolute values of the
t-statistics of EMP and TRN are so high that they will be considered statistically
significant even with the smallest level of significance.
In order to analyze sales as a function of advertising expenses, the sales manager of
Smith Company developed a simple regression model. The model included the
following equation, which was based on 32 monthly observations of sales and
advertising expenses with a related coefficient of determination of 0.90.
S = $10,000 + $2.50A
S = Sales
A = Advertising expenses
If Smith Company’s advertising expenses in one month amounted to $1,000, the related
point estimate of sales would be:

A. $2,500.
B. $11,250.
C. $12,250.
D. $12,500.
Explanation
Choice "D" is correct. The results of a successful regression analysis is a model (i.e.,
equation) specifying the relationship between the dependent variable and the
independent variable(s). In this case, the equation shows a linear relationship where
each one unit increase in advertising expense results in 2.5 units increase in sales and
a baseline of $10,000 in sales if no advertising dollars were spent.
The "coefficient of determination" is the amount of variation in the dependent variable

that is explained by the independent variable based on the regression equation. The
regression formula developed from the model in question is simple algebra: Sales =
$10,000 + (2.5 × Advertising expenses).
Choice "A" is incorrect. This value would result from multiplying advertising expenses by
its regression coefficient but forgetting to add the baseline sales.
Choice "B" is incorrect. This value would result from following the correct "Sales =
$10,000 + (2.5 × Advertising expenses)" formula, then multiplying by the coefficient of
determination. The coefficient of determination has no role in this calculation.
Choice "C" is incorrect. This value would result from adjusting the formula to Sales =
$10,000 + [(2.5 × Advertising expenses) × Coefficient of determination]. The coefficient
of determination has no role in this calculation.
Which of the following are the shortcomings of regression analysis?
I. Regression analysis requires the collection of numerous data points to be accurate.
II. The user must evaluate whether the relationship between the dependent and
independent variables is reasonable.
III. Regression analysis is limited to the use of one independent variable.
IV. Regression analysis can be strongly influenced by outlying data points.

A. II and IV only
B. I, II, III, and IV
C. I only
D. I, II, and IV only
Explanation
Choice "D" is correct. Regression analysis requires the collection of multiple,

representative data points. Multiple regression will incorporate more than one
independent variable.
Choice "A" is incorrect. One or more of the statements not selected in this answer is a
shortcoming of regression analysis.
Choice "B" is incorrect. One or more of the statements selected in this answer is not a
Choice "C" is incorrect. One or more of the statements not selected in this answer is a
A corporation has determined that when the quantity produced in units doubles from x
to 2x, the average time per unit for 2x units is 90 percent of the average time per unit for
x units. The decline in time per unit as production doubles is an example of:

A. Incremental unit-time learning model.
B. Cumulative average-time learning model.
C. High-low cost estimation model.
D. Simple regression cost estimation model.
Explanation
Choice "B" is correct. As companies and production employees gain experience, they
naturally become faster and more productive. The majority of these efficiencies occur
early on as production employees gain experience with the production process.
Companies can significantly reduce their costs through the discovery of these
efficiencies, and as a result allocate resources more effectively.
The cumulative average-time learning model, or learning curve, is a mathematical

expression of the phenomenon that incremental unit costs to produce decrease as
management and labor gain experience from practice and as better methods are
developed. The calculation begins with the first unit/batch. As cumulative production
doubles (from one unit to two units, to four units, to eight units, etc.), cumulative
average time per unit falls to a fixed percentage of the previous average time.
Choice "A" is incorrect. The incremental unit-time learning model is another form of the
learning curve. This model represents the fact that the time required to produce the last
unit decreases by a constant percentage as the cumulative quantity of units produced
doubles. The information in the fact pattern relates to average production time per unit
when production increases from x units to 2x units; this question is not addressing the
incremental time between x units and 2x units.
Choice "C" is incorrect. The high-low method is used to determine a cost formula using
the highest and lowest values of the cost driver within the relevant range to determine
the fixed and variable cost per unit associated with production.
Choice "D" is incorrect. A simple regression cost estimation model uses one
independent variable to estimate the value for a dependent variable. This question is
related to decreases in production times as production quantities double.
Dynamicsub Inc. has developed a new product for spacecraft, which includes the
manufacturing of a complex part. The manufacturing of this part requires a high degree
of technical skill. Management believes that there is a good opportunity for its technical
force to learn and improve as it becomes accustomed to the production process. The
production of the first unit requires 10,000 direct labor hours. If an 80 percent learning
curve is used, the cumulative direct labor hours required for producing a total of eight
units would be:

A. 51,200 hours.
B. 40,960 hours.
C. 64,000 hours.
D. 80,000 hours.
Explanation
Choice "B" is correct. Using a cumulative average-time learning curve, as the

cumulative output doubles, the cumulative average direct labor hours per unit becomes
the learning curve percentage times the previous cumulative average direct labor hours
per unit. So, if the direct labor hours for the first unit are 10,000 and an 80
percent learning curve is used, then the cumulative average direct labor hours for 2
units would be calculated as follows:
Cumulative average direct labor hours for 2 units = 0.8(10,000 direct labor hours) =
8,000 direct labor hours
When output doubles to 4 units, the cumulative average direct labor hours would be
calculated as follows:
Cumulative average direct labor hours for 4 units = 0.8(8,000 direct labor hours) = 6,400
direct labor hours
When output doubles again, this time to 8 units, the cumulative average direct labor
hours would be calculated as follows:
Cumulative average direct labor hours for 8 units = 0.8(6,400 direct labor hours) = 5,120
direct labor hours
Therefore, the cumulative direct labor hours for 8 units = (5,120 direct labor hours)(8
units) = 40,960 direct labor hours.
Choice "A" is incorrect. This answer was calculated by multiplying 10,000 direct labor
hours by 80 percent to get 8,000, the cumulative average direct labor hours for 2 units,
and then by 80 percent again to get 6,400, the cumulative average direct labor hours for
4 units. 6,400 was multiplied by 8 units to get 51,200 direct labor hours. However, this
Reeves Inc. has developed a new production process to manufacture its product. The
new process is complex and requires a high degree of technical skill. However,
management believes that there is a good opportunity for the employees to improve as
they become more familiar with the production process. The production of the first unit
requires 100 direct labor hours. If a 70 percent learning curve is used, using the
cumulative average time model, the cumulative direct labor hours required to produce a
total of eight units would be:

A. 560 hours.
B. 274 hours.
C. 196 hours.
D. 392 hours.
Explanation
Choice "B" is correct. The cumulative direct labor hours required to produce a total of
8 units is approximately 274 hours. The following table shows how this number is
derived:
X Cumulative Average Time per Unit Cumulative Total Time

1 100 100 (100 × 1)
2 70 (100 × 0.7) 140 (70 × 2)
4 49 (70 × 0.7) 196 (4 × 49)
8 34.3 (49 × 0.7 274.4 (34.3 × 8)
Choice "A" is incorrect. This answer was calculated by multiplying 800 direct labor hours
(8 units × Direct labor hours) by the 70 percent learning curve. However, this answer
does not consider the entire impact of the learning curve.
Choice "C" is incorrect. This answer represents the cumulative direct labor hours to
produce 4 units, not 8 units.
Choice "D" is incorrect. This answer was calculated by multiplying 8 units by 49, the
cumulative average direct labor hours per unit for 4 units. However, the cumulative
average direct labor hours per unit for 8 units must be calculated and used to find the
correct cumulative direct labor hours for 8 units.
Huron Co. plans to bid on a special project that calls for a total of 24,000 units. The
units will be produced in lots with the first lot consisting of 750 units. Based on prior
experience, the direct labor time needed per unit of product will be progressively smaller
by a constant percentage rate as experience is gained in the manufacturing process.
The quantitative method that would best estimate Huron's total cost for the project is:

A. Learning curve techniques.
B. Differential calculus.
C. Linear programming.
D. Cost‐volume‐profit analysis.
Explanation
Choice "A" is correct. Learning curve analysis is a systematic method for estimating
costs when a learning process is involved. Calculations for the analysis are based on a
learning rate. The learning rate is the rate at which the cumulative average time per lot
produced decreases as cumulative output doubles.
Choice "B" is incorrect. Differential calculus is not the quantitative method that would
best estimate Huron's total cost when the direct labor time needed per unit of product
will be progressively smaller by a constant percentage rate as experience is gained.
Choice "C" is incorrect. Linear programming is not the quantitative method that would
best estimate Huron's total cost when the direct labor time needed per unit of product
will be progressively smaller by a constant percentage rate as experience is gained.
Choice "D" is incorrect. Cost‐volume‐profit analysis is not the quantitative method that
would best estimate Huron's total cost when the direct labor time needed per unit of
product will be progressively smaller by a constant percentage rate as experience is
gained.
The Ogee Co. needs 40 hours to produce the first unit of its product and 60 hours to
produce its first two units. The controller states that the learning curve rate is 67
percent. Is this statement correct?

A. Yes, because the learning curve rate is equal to 40 hours divided by 60 hours.
B. Yes, because the second unit only requires two thirds as much time as the first unit.
C. No, because the learning curve rate of 50 percent is equal to 20 hours divided by 40 hours.
D. No, because the learning curve rate of 75 percent is calculated by dividing 60 hours by 80
hours.
Explanation
Choice "D" is correct. Learning curve analysis is based on the premise that as workers
become more familiar with a specific task, the per-unit labor hours will decline as
experience is gained and production becomes more efficient. Quantifying the learning
curve is accomplished by calculating the learning curve rate, which represents the
increase in speed as production levels double. Efficiencies gained are strongest early
on and tend to level off (produce a flatter curve) as production increases.
The correct calculation for the learning curve rate is to take the total time needed to
produce two units (60 hours) and divide it by the number of hours it would have taken to
produce the first two units had the pace of producing the first unit continued (40 hours
× 2 units = 80 hours). 60 ÷ 80 = 75 percent.
Choice "A" is incorrect. The learning curve rate is not calculated by dividing the first
unit's production time by the first two units' cumulative production time.
Choice "B" is incorrect. The second unit requires 20 hours to produce, which is one-half
of the time needed to produce the first unit (40 hours).
Choice "C" is incorrect. This is not the correct way to calculate the learning curve rate.
Refer to the table below. One new worker can produce a garment in 20 hours. Due to
increased learning, the second garment can be produced in 16 hours. The same worker
can produce his or her fourth garment in 12.8 hours. Using the cumulative average‐time
learning model, what is the individual time for producing the fourth garment?

A. 12.8 hours
B. 9.08 hours
C. 9.6 hours
D. 16 hours
Explanation
Choice "B" is correct. Using the cumulative average‐time learning model, the individual
unit time for the Xth unit is calculated based on cumulative total time, which is in turn
derived by multiplying the cumulative average hours for the latest unit times the number
of units. The chart below shows the cumulative total hours in the third column. The
individual unit time for the Xth unit is the increase in cumulative total hours above the
previous. The individual unit times are shown in the fourth column.
Choice "A" is incorrect. This answer represents the cumulative average time per unit
after producing the fourth garment, not the individual time for producing the fourth
garment.
Choice "C" is incorrect. This answer represents the difference between the cumulative
total hours for producing 2 garments (32) and producing 4 garments (51.2) or 19.2
divided by 2. This is not the individual time for producing the fourth garment.
Seacraft Inc. received a request for a competitive bid for the sale of one of its unique
boating products with a desired modification. Seacraft is now in the process of
manufacturing this product but with a slightly different modification for another customer.
These unique products are labor intensive and both will have long production runs.
Which one of the following methods should Seacraft use to estimate the cost of the new
competitive bid?

A. Expected value analysis
B. Learning curve analysis
C. Regression analysis
D. Continuous probability simulation
Explanation
Choice "B" is correct. Learning curve analysis is used to determine the reduction in cost
due to an increase in efficiency and experience over a period of time. Learning curve
analysis shows that if a task is performed over and over by workforce/labor, less time
would be required for the task, leading to a reduction in cost.
The company has received a request for products that are labor intensive and have long
production runs. The company has experience in producing similar products. Learning
curve analysis will help the company determine costs after considering the effect of
efficiency/experience and can be used to estimate the cost of the new competitive bid.
Choice "A" is incorrect. Expected value is the value arrived at by multiplying the
probability of each outcome by its payoff and then summing the results. It can be used
when multiple outcomes are possible. It is not an appropriate method in the given case.
Choice "C" is incorrect. Regression analysis can be used to estimate the relationship
between a dependent variable and an independent variable. Regression analysis can
be used to estimate the costs based on past data. However, this does not factor the
efficiency resulting out of experience.
Choice "D" is incorrect. Simulation is the process of changing variables to arrive at the
change in the outcome. Continuous probability simulation uses probability to simulate
outcomes. This is not the best method to determine cost in the given case.
A manufacturing firm plans to bid on a special order of 80 units that will be
manufactured in lots of 10 units each. The production manager estimates that
the direct labor hours per unit will decline by a constant percentage each time
the cumulative quantity of units produced doubles. The quantitative technique
used to capture this phenomenon and estimate the direct labor hours required
for the special order is:

A. Cost-profit-volume analysis.
B. The Markov process.
C. Linear programming analysis.
D. Learning curve analysis.
Explanation
Choice "D" is correct. Learning curve analysis utilizes the cumulative average-time
learning model. The cumulative average time per unit declines by a constant
percentage each time the cumulative quantity of units produced doubles.
The question stem highlights the key elements of the cumulative average-time
learning model such as the direct labor hours per unit will "decline by a constant
percentage" each time the quantity of units produced "doubles".
Choice "A" is incorrect. Cost-profit-volume analysis is an analysis of the

relationship of cost and revenue. It determines the volume at which there is neither
profit nor loss for a product or group of products.
Choice "B" is incorrect. Markov process is a "random" process whose future

probabilities are determined by its most recent values.
Choice "C" is incorrect. Linear programming is a mathematical tool used to

optimize an objective function subject to various constraints, all of which are linear.
It is often used to find the combination of products that will maximize profits or
minimize costs.
Propeller Incorporation plans to manufacture a newly designed high-technology
propeller for airplanes. Propeller forecasts that as workers gain experience, they will
need less time to complete the job. Based on prior experience, Propeller estimates a 70
percent cumulative learning curve and has projected the following costs:
Manufacturing Projections
Cumulative Number
of Units Produced Average Cost Per Unit Total Costs
1 $20,000 $20,000
2 14,000 28,000
If Propeller manufactures eight propellers, the total manufacturing cost would be:

A. $50,660.
B. $54,880.
C. $62,643.
D. $112,000.
Explanation
Choice "B" is correct. A learning curve model in which the cumulative average time per
unit declines by a constant percentage each time the cumulative quantity of units
produced is doubled.
Unit 4 $9,800 average cost per unit ($14,000 × 0.70)

Unit 8 $6,860 average cost per unit ($9,800 × 0.70)
Total cost = 8 units × $6,860 cost per unit
= $54,880
Choice "A" is incorrect. Choice "A" incorrectly sums up the running cumulative average
hours per unit ($20,000 for unit 1 + $14,000 for unit 2 + $9,800 for unit 4 + $6,860 for
unit 8).
Choice "C" is incorrect. There is no likely combination of choices that will result in this
combination of numbers.
Choice "D" is incorrect. Choice "D" incorrectly applies the learning rate of 70 percent to
the total hours required to produce eight units all together for the first time (70% × 8
units × 20,000 cost per unit = $112,000).
In competing as a subcontractor on a military contract, Aerosub Incorporation has
developed a new product for spacecraft that includes the manufacturing of a complex
part. Management believes there is a good opportunity for its technical force to learn
and improve as they become accustomed to the production process. Accordingly,
management estimates an 80 percent learning curve would apply to this unit. The
overall contract will call for supplying eight units. Production of the first unit requires
10,000 direct labor hours. The estimated total direct labor hours required to produce the
seven additional units would be:

A. 30,960 hours.
B. 40,960 hours.
C. 56,000 hours.
D. 70,000 hours.
Explanation
Choice "A" is correct. A learning curve model in which the cumulative average time per
Total hours for next seven units = 8 unit total hours – First unit hours
= (8 × 5,120*) – 10,000
= 40,960 – 10,000
= 30,960 hours
* Unit 1: 10,000 hours
Unit 2: 8,000 hours (10,000 × 0.80)
Unit 4: 6,400 hours (8,000 × 0.80)
Unit 8: 5,120 hours (6,400 × 0.80)
Choice "B" is incorrect. This choice represents the total hours used to produce all eight
units (8 × 5,120 hours per unit = 40,960 hours).
Choice "C" is incorrect. This choice incorrectly applies the learning rate of 80 percent to
the total hours required to produce eight units for the first time (80% × 8 units × 10,000
hours per unit = 56,000 hours).
Choice "D" is incorrect. This choice implies there is no learning curve (10,000 hours × 8
units – First unit of 10,000 hours = 70,000 hours).
A manufacturing company required 800 direct labor hours to produce the first lot of four
units of a new motor. Management believes that a 90 percent learning curve will be
experienced over the next four lots of production. How many direct labor hours will be
required to manufacture the next 12 units?

A. 1,792
B. 1,944
C. 2,016
D. 2,160
Explanation
Choice "A" is correct. A learning curve model in which the cumulative average time per
= =
800 ÷ 200
Lot 4 per
1 units unit
=
(800 =
× 0.9) 180
Lot ÷ 4 per
2 units unit
=
(1,440 =
× 0.9) 162
Lot ÷ 8 per
4 units unit
Hours for next 12 units = (16 × 162) – 800 for first four units
= 2,592 – 800
= 1,792 hours
As the cumulative quantity doubles, the cumulative average time is reduced by 10

percent.
Cumulative Cumulative
Cumulative Average Production
Lot Units Per Unit Hours
1 4 200 800
2 8 180 1,440
Lake Corp. manufactures specialty components for the electronics industry in a highly
labor-intensive environment. Arc Electronics has asked Lake to bid on a component that
Lake made for Arc last month. The previous order was for 80 units and required 120
hours of direct labor to manufacture. Arc would now like 240 additional components.
Lake experiences an 80 percent learning curve on all of its jobs. The number of direct
labor hours needed for Lake to complete the 240 additional components is:

A. 307.2
B. 384
C. 288
D. 187.2
Explanation
Unit Cumulative Average Direct Labor Hours per Total Direct Labor
X s Batch Hours
1 batch 80 120 120 (120 × 1 batch)
2
batches 160 96 (120 × 0.8) 192 (96 × 2 batches)
4
batches 320 76.8 (96 × 0.8) 307.2 (76.8 × 4 batches)
Choice "D" is correct. As illustrated in the above table, an 80 percent cumulative

average‐time learning model states that as cumulative output doubles, the cumulative
average time per batch becomes 80 percent of the previous cumulative average time.
The average time for the first batch of 80 units was 120 direct labor hours. The
cumulative average time per batch for 2 batches (160 units) would be 96 direct labor
hours (0.80 × 120).
For 4 batches (320 units), the cumulative average time per batch would be 76.8 direct
labor hours (0.80 × 96).
Therefore, the total time for 4 batches (320 units) would be 307.2 direct labor hours (4 ×
76.8).
The time for the 240 additional units would be 187.2 direct labor hours (the 307.2 for the
320 units less the 120 for the first 80 units).
Choice "A" is incorrect. This answer was calculated by multiplying 120 by 80 percent,
resulting in the cumulative average direct labor hours required for 160 units or 2
batches, then multiplying that amount (96) by 80 percent, resulting in 76.8, the
cumulative average direct labor hours required for 320 units or 4 batches. Finally, 76.8
Which of the following are the shortcomings of learning curve analysis?
I. Only new employees will improve at their tasks.
II. The learning curve approach is not as effective when robotics perform repetitive
tasks.
III. The learning rate is assumed to be constant, but actual learning rate and declines in
production times are not constant.
IV. Data that show improvements in productivity may be mistakenly assumed to be due
to learning when they are in fact due to other factors.

A. I, II, III, and IV
B. I and III only
C. II, III, and IV only
D. II and IV only
Explanation
Choice "C" is correct. Virtually all people new to a task can learn and improve
performance, regardless of IQ and education levels.
Choice "A" is incorrect. One or more of the statements selected in this answer is not a
shortcoming of learning curve analysis.
Choice "B" is incorrect. One or both of the statements selected in this answer is not a
shortcoming of learning curve analysis. Additionally, one or both of the statements not
selected in this answer is a shortcoming of learning curve analysis.
Choice "D" is incorrect. One or more of the statements not selected in this answer is a
shortcoming of learning curve analysis.
A company is developing its budget for the upcoming month. The financial planning
department has developed the following range of sales activity and the associated
probabilities for each level of budgeted sales.
Sales Estimate Probability

$120,000 25%
170,000 40%
200,000 35%
The companyʹs cost of goods sold averages 80 percent of sales, and the relationship is
expected to remain consistent in the next fiscal year. What is the expected value of the
companyʹs budgeted cost of goods sold?

A. $134,400
B. $136,000
C. $168,000
D. $170,000
Explanation
Choice "A" is correct. Expected value is the weighted average of the outcomes of an
action in which the values of the possible outcomes are weighted by their probabilities.
When multiple potential outcomes exist, each one has a value along with an associated
probability that must be from 0 to 100 percent, with the sum of all probabilities totaling
100 percent.
Estimated Sales Probability

$120,000 25% $30,000
$170,000 40% 68,000
$200,000 35% 70,000
Total expected value $168,000
COGS as a % of sales 80%
Estimated COGS $134,400
Choice "B" is incorrect. This answer choice did not calculate the expected value of
revenue to calculate the expected cost of goods sold. The $136,000 is calculated as 80
The table below shows the estimated probabilities of the percentage of defective units
resulting from a production run.
The expected percent defective is:

A. 1.9%
B. 3.65%
C. 2%
D. 2.95%
Explanation
Choice "D" is correct. Expected value (the mathematical expectation of mean) of a

discrete random variable is calculated by taking the sum of the probability of each
possible outcome and multiplying it by the outcome.
Mathematically, E(x) = P(x 1 ) times x 1 + P(x 2 ) times x 2 + … + P(x n ) times x n, where:
E(x) = Total expected value
x = Variable representing a possible outcome
p = Probability factor of each possible outcome
n = The number of possible outcomes
In this case, the expected percent defective is 0.15(0.01) + 0.2(0.02) + 0.3(0.03) +

0.25(0.04) + 0.1(0.05) = 0.0015 + 0.004 + 0.009 + 0.01 + 0.005 = 0.0295, or 2.95%.
Choice "A" is incorrect. 1.9% does not represent the expected percent defective
calculated by taking the sum of the probability of each possible outcome and multiplying
it by the outcome.
Choice "B" is incorrect. 3.65% does not represent the expected percent defective
calculated by taking the sum of the probability of each possible outcome and multiplying
it by the outcome.
Stock X has the following probability distribution of expected future returns:
Probability Expected Return

0.1 -20%
0.2 5%
0.4 15%
0.2 20%
0.1 30%
The expected rate of return on stock X would be:

A. 10%.
B. 12%.
C. 16%.
D. 19%.
Explanation
Choice "B" is correct. To find expected value, multiply each outcome by its probability,
then sum all the results. Make sure that every outcome is accounted for and the
probabilities sum to 1.
Substituting and expanding the formula yields:
= 0.1 × (-0.20) + 0.2 × (0.05) + 0.4 × (0.15) + 0.2 × (0.2) + 0.1 × (0.3)
= -0.2 + 0.01 + 0.06 + 0.04 + 0.03

= 0.12 (or 12%)
Choice "A" is incorrect. This value is a simple average of the expected returns,
unweighted by probabilities.
Choices "C" and "D" are incorrect. This value is a distractor and cannot be derived by
the proper method detailed above.
The Lions Club is planning to sell pretzels at a local football game and has estimated
sales demand as follows:
Sales demand 8,000 10,000 12,000 15,000

Probability 10% 40% 30% 20%
The cost of the pretzels varies with the quantity purchased, as follows:
Purchase quantity 8,000 10,000 12,000 15,000

Cost per unit $1.25 $1.20 $1.15 $1.10
Any unsold pretzels would be donated to the local food bank. The calculated profits at
the various sales demand levels and purchase quantities are as follows:
Expected Profits at Various Purchase Quantity Levels

Sales Demand 8,000 10,000 12,000 15,000
8,000 $6,000 $4,000 $2,200 ($500)
10,000 $6,000 $8,000 $6,200 $3,500
12,000 $6,000 $8,000 $10,200 $7,500
15,000 $6,000 $8,000 $10,200 $13,500
Which of the following purchase quantities would you recommend to the Lions Club?

A. 8,000
B. 10,000
C. 12,000
D. 15,000
Explanation
Choice "C" is correct. The problem requires a three-step process.
Step 1: Find the expected value for sales demand. The method to find expected value is
to multiply each outcome by its probability of occurring and sum all of the results,
making sure that every outcome is accounted for, and the probabilities sum to 1.
The probabilities shown in the table below represent the estimate of sales for a new
product.
What is the probability of the company selling between 101 and 300 units of the new
product?

A. 45%
B. 20%
C. 70%
D. 25%
Explanation
Choice "C" is correct. The probability of selling between 101 and 300 units is calculated
by taking the probability of selling 101 to 200 units (0.45) plus the probability of selling
201 to 300 units (0.25) = (0.45 + 0.25) = 0.70, or 70%.
Choice "A" is incorrect. This answer represents the probability of selling between 101
and 200 units, not selling between 101 and 300 units.
Choice "B" is incorrect. This answer was calculated by subtracting the probability of
selling between 201 and 300 units (0.25) from the probability of selling between 101 and
200 units (0.45), which does not represent the probability of selling between 101 and
300 units.
Choice "D" is incorrect. This answer represents the probability of selling between 201
and 300 units, not selling between 101 and 300 units.
A company has three potential scenarios for October investment portfolio returns. The
first scenario is a 30 percent likelihood of a 5.0 percent return. The second scenario is a
30 percent likelihood of a 4.0 percent return. The third scenario is a 40 percent
likelihood of a 7.0 percent return. Given these scenarios, the expected return for the
portfolio in October is equal to:

A. 5.0 percent.
B. 5.5 percent.
C. 6.0 percent.
D. 7.0 percent.
Explanation
Choice "B" is correct. Expected value is the weighted average of the outcomes of an
action in which the values of the possible outcomes are weighted by their probabilities
and summed to produce a total expected value. When calculating expected value, make
sure that all probabilities are from 0 to 100 percent and sum to 100 percent. Also, the
final output should be logical given the values themselves. For example, a portfolio with
two investments returning 3 percent and 5 percent, respectively, would not produce an
expected value below 3 percent or above 5 percent no matter what probabilities are
assigned to each value.
Using the table below, the expected value for this portfolio of 5.5 percent is calculated
as follows:
Portfolio Return: Expected Value

Expected Value Probability Return (Probability × Return)
Scenario 1 30% 4.0% 1.2%
Scenario 2 30% 5.0% 1.5%
Scenario 3 40% 7.0% 2.8%
Total 100% 5.5%
Choice "A" is incorrect. Five percent is the value for the first scenario, not the overall
expected return.
Choice "C" is incorrect. Six percent is within the range of 4.0 percent to 7.0 percent
returns, which makes it a possible expected return. Given the weightings assigned to
each return, a 6.0 percent expected return would require a higher weighting toward 7.0
percent and a lower weighting toward the other outcomes.
According to recent focus sessions, Norton Corporation has a "can’t miss" consumer
product on its hands. Sales forecasts indicate either excellent or good results, with
Norton’s sales manager assigning a probability of 0.6 to a good results outcome. The
company is now studying various sales compensation plans for the product and has
determined the following contribution margin data:
Contribution Margin
If sales are excellent and
Plan 1 is adopted $300,000
Plan 2 is adopted 370,000
If sales are good and
On the basis of this information, which of the following statements is correct?

A. Plan 2 should be adopted because it is $10,000 more attractive than Plan 1.
B. Plan 1 should be adopted because it is $8,000 more attractive than Plan 2.
C. Plan 1 should be adopted because of the sales manager’s higher confidence in good results.
D. Either plan should be adopted, the decision being dependent on the probability of excellent
sales results.
Explanation
Choice "B" is correct. Expected value is the weighted average of the outcomes of an
Plan 1 expected value = ($300,000 × 0.4) + ($240,000 × 0.6) = $264,000

Plan 2 expected value = ($370,000 × 0.4) + ($180,000 × 0.6) = $256,000
Plan 1 is greater by $8,000
Choice "A" is incorrect. This choice ignores probabilities for both scenarios: Plan 1:
($300,000 + $240,000 = $540.000); Plan 2: ($370,000 + $180,000 = $550,000).
Choice "C" is incorrect. Expected value considers all outcomes of an action. As such,
excellent results should not be ignored in the expected value calculation to make
decisions.
Choice "D" is incorrect. Expected value considers all outcomes of an action. As such,
good results should not be ignored in the expected value calculation to make decisions.
Scarf Corporation’s controller has decided to use a decision model to cope with
uncertainty. With a particular proposal, currently under consideration, Scarf has two
possible actions: invest or not invest in a joint venture with an international firm. The
controller has determined the following:
Action 1: Invest in the Joint Venture

Events and probabilities:
Probability of success = 60%
Cost of investment = $9.5 million
Cash flow if investment is successful = $15.0 million
Cash flow if investment is unsuccessful = $2.0 million
Additional costs to be paid = $0
Costs incurred up to this point = $650,000
Action 2: Do Not Invest in the Joint Venture
Events:
Costs incurred up to this point = $650,000
Additional costs to be paid = $100,000
Which one of the following alternatives correctly reflects the respective expected
values of investing versus not investing?

A. 300,000 and $(750,000)
B. $(350,000) and $(100,000)
C. $300,000 and (100,000)
D. $(350,000) and $(750,000)
Explanation
Choice "C" is correct. Expected value is the weighted average of the outcomes of an
Expected value should consider only the relevant costs in the calculations. Relevant
cost is a cost that should be considered in choosing among alternatives. Only those
costs yet to be incurred (future costs) that differ among the alternatives (differential
costs) are relevant in decision making.
For both actions, the $650,000 is sunk cost and should not be considered.
The sales manager of Serito Doll Company has suggested that an expanded
advertising campaign costing $40,000 would increase the sales and profits of the
company. He has developed the following probability distribution for the effect of the
advertising campaign on company sales:
Sales Increase
(Units) Probability
15,000 0.10
30,000 0.35
45,000 0.10
60,000 0.25
75,000 0.20
The company sells the dolls at $5.20 each. The cost of each doll is $3.20. Serito’s
expected incremental profit, if the advertising campaign is adopted, would be:

A. $6,500.
B. $46,500.
C. $53,000.
D. $93,000.
Explanation
Choice "C" is correct. Expected value is the weighted average of the outcomes of an
Increased units sold = 0.1 (15,000) + 0.35 (30,000) + 0.1 (45,000) + 0.25 (60,000) + 0.2 (75,000)
= 1,500 + 10,500 + 4,500 + 15,000 + 15,000
= 46,500 units
Increased profit = [46,500 × ($5.20 – $3.20)] – $40,000
= $93,000 – $40,000
Choice "A" is incorrect. This choice incorrectly deducts the expected cost of the
advertising campaign from the expected increase in units sold instead of the
incremental profit from the units sold.
Choice "B" is incorrect. 46,500 represents the expected increase in units sold. This
choice does not consider the incremental profit nor the expected cost of the advertising
campaign.
Reshenie Inc. is analyzing the following decision: whether to start an R&D project or
purchase a license to produce new types of sensors, the company's major product. If
the decision to conduct R&D in‐house is made, the company will have two alternatives:
conduct a complex R&D project to create a new product or proceed with a low‐cost
project to improve the characteristics of existing products. Three levels of demand for
sensors are considered: high, medium, and low. Expected values of project results (EV)
are shown in $ millions.
Applying the decision tree analysis, select the best alternative.

A. Conduct R&D research, as its expected value is $0.65 million higher than the license purchase
alternative.
B. Conduct R&D research, as its expected value is $1.4 million higher than the license purchase
alternative.
C. Purchase a license, as its expected value is $0.25 million higher than the R&D alternative.
D. Purchase a license, as its expected value is $1.9 million higher than the R&D alternative.
Explanation
Choice "B" is correct. There are two alternatives available: do R&D research or buy the
license.
The expected value of the decision to buy the license = ($18 m × 0.7) + ($17 m × 0.1) +
($14 m × 0.2) = $17.1 m.
If R&D research is selected, there are two alternatives available: conduct complex R&D
or conduct low‐cost R&D.
A complex R&D expected value = ($20 m × 0.8) + ($16 m × 0.1) + ($9 m × 0.1) = $18.5
m.
Larry Clement is considering adding a new product line, which would involve
constructing a new plant. The options are to construct a large plant, to construct a small
plant, or to not add the new product line. Clement has determined that there is a 60
percent chance that the market will be favorable, resulting in high demand, and a 40
percent chance that the market will be unfavorable, resulting in low demand. Clement
has constructed the following decision tree and the payoffs under the different states of
nature.
Which one of the following alternatives should be recommended to Clement?

A. Construct a small plant, as the payoff is $32,000.
B. Do not expand, as the payoff is $0.
C. Construct a large plant, as the payoff is $28,000.
D. Construct a small plant, as the payoff is $40,000.
Explanation
Choice "A" is correct. The expected payoff for constructing either plant can be
calculated by taking the sum of the expected payoffs related to both the plant being
successful and not being successful.
Expected payoff for each alternative = (Expected payoff if the plant is successful) +
(Expected payoff if the plant is not successful)
Expected payoff, large plant = (0.6)($100,000) + (0.4)(−$80,000)

In decision making under conditions of uncertainty, expected value refers to the:

A. Present value of alternative actions.
B. Weighted average of probable outcomes of an action.
C. Potential effect of an alternative action.
D. Probability of a given outcome from a proposed action.
Explanation
Choice "B" is correct. Expected value (the mathematical expectation of mean) of a

discrete random variable is the sum of the probability of each possible outcome of the
trial multiplied by the outcome.
Mathematically, E(x) = P(x 1 ) times x 1 + P(x 2 ) times x 2 + ... + P(x n ) times x n, where:
E(x) = Total expected value
x = Variable representing a possible outcome
p = Probability factor of each possible outcome
n = The number of possible outcomes.
Choice "A" is incorrect. Expected value does not refer to the present value of alternative
actions.
Choice "C" is incorrect. Expected value does not refer to the potential effect of an
alternative action.
Choice "D" is incorrect. Expected value does not refer to the probability of a given
outcome from a proposed action.
Which of the following best describes sensitivity analysis?

A. Sensitivity analysis helps determine how changes in probabilities will change expected
outcomes.
B. Sensitivity analysis is a marketing tool that tests consumers' sensitivity to market conditions.
C. Sensitivity analysis measures consumers' sensitivity to changes in product weights.
D. Sensitivity analysis determines the value of the mean square error.
Explanation
Choice "A" is correct. Sensitivity analysis helps analysts determine how changes in the
probabilities for states of nature or changes in potential payoffs, which may be based on
subjective assessments, affect recommended decision alternatives.
Choice "B" is incorrect. Sensitivity analysis is not a marketing tool that tests consumers'
sensitivity to market conditions.
Choice "C" is incorrect. Sensitivity analysis does not measure consumers' sensitivity to
changes in product weights.
Choice "D" is incorrect. Sensitivity analysis does not determine the value of the mean
square error.
The probabilities shown in the table below represent the estimate of sales for a new
product.
The sales outcome presented in the table is defined as which one of the following kinds
of events?

A. Independent
B. Mutually exclusive
C. Conditional
D. Dependent
Explanation
Choice "B" is correct. Mutually exclusive events are those that cannot occur
simultaneously. They are mutually interdependent. The occurrence of one event
precludes the occurrence of the others.
Choice "A" is incorrect. The sales outcomes presented in the table would not be defined
as independent events.
Choice "C" is incorrect. The sales outcomes presented in the table would not be defined
as conditional events.
Choice "D" is incorrect. The sales outcomes presented in the table would not be defined
as dependent events.
A beverage stand can sell either soft drinks or coffee on any given day. If the stand sells
soft drinks and the weather is hot, it will make $2,500; if the weather is cold, the profit
will be $1,000. If the stand sells coffee and the weather is hot, it will make $1,900; if the
weather is cold, the profit will be $2,000. The probability of cold weather on a given day
at this time is 60 percent.
The expected payoff if the vendor has perfect information is:

A. $2,200.
B. $1,600.
C. $3,900.
D. $1,960.
Explanation
Choice "A" is correct. The expected payoff is the sum of the probability of each possible
payoff multiplied by the payoff. The expected payoff if the vendor has perfect
information is calculated by taking the highest expected payoff if the weather is hot and
adding it to the highest expected payoff if the weather is cold.
The expected payoff with perfect information = (Highest expected payoff for hot
weather) + (Highest expected payoff if weather is cold)
Expected payoff with perfect information = $2,500(0.4) + $2,000(0.6) = $1,000 + $1,200

= $2,200
Choice "B" is incorrect. This answer represents the expected payoff for soft drinks, but
does not consider if coffee has a higher expected payoff in certain weather.
Choice "C" is incorrect. This answer was calculated by adding coffee profit of $1,900
when the weather is hot and $2,000 when the weather is cold to get a total of $3,900.
However, this answer does not consider (1) the probability of weather on a given day or
(2) if soft drinks have a higher expected payoff in certain weather.
Choice "D" is incorrect. This answer represents the expected payoff for coffee, but does
not consider if soft drinks have a higher expected payoff in certain weather.
A beverage stand can sell either soft drinks or coffee on any given day. If the stand sells
soft drinks and the weather is hot, it will make $2,500; if the weather is cold, the profit
will be $1,000. If the stand sells coffee and the weather is hot, it will make $1,900; if the
weather is cold, the profit will be $2,000. The probability of cold weather on a given day
at this time is 60 percent.
The expected payoff for selling coffee is:

A. $2,000.
B. $3,900.
C. $1,960.
D. $1,900.
Explanation
Choice "C" is correct. The expected payoff is the sum of the probability of each possible
payoff multiplied by the payoff. The expected payoff for selling coffee is calculated by
taking the payoff given hot weather, multiplied by the probability of hot weather, then
adding the payoff given cold weather multiplied by the probability of cold weather.
Expected payoff for selling coffee = (Hot weather payoff × Probability of hot weather) +
(Cold weather payoff × Probability of cold weather)
Expected payoff for selling coffee = $1,900(0.4) +$2,000(0.6) = $760 + $1,200 =

$1,960.
Choice "A" is incorrect. This answer represents the coffee profit when the weather is
cold. However, even though the probability of cold weather is higher, that does not
mean the weather will be cold 100 percent of the time.
Choice "B" is incorrect. This answer was calculated by adding coffee profit of $1,900
when the weather is hot and $2,000 when the weather is cold to get a total of $3,900.
However, this answer does not consider the probability of weather on a given day.
Choice "D" is incorrect. This answer represents the coffee profit when the weather is
hot. However, this answer does not consider the probability of the weather being cold
and the resulting impact on profit.
Analysts at XYZ Company have run a decision tree analysis to determine whether to
purchase investment A or investment B and have selected investment B. However, they
have some concerns that investment B will not perform as expected if the economy
changes. What analysis method can they use to test whether their decision should
change if the economy does change?

A. Regression analysis
B. Sensitivity analysis
C. Queuing theory
D. PERT
Explanation
Choice "B" is correct. Sensitivity analysis helps analysts determine how changes in the
probabilities for states of nature or changes in the potential payoffs themselves, which
may be based on subjective assessments, will affect recommended decision
alternatives.
Choice "A" is incorrect. Regression analysis is not a good method to use to test whether
their decision should change if the economy does change.
Choice "C" is incorrect. Queuing theory is not a good method to use to test whether
their decision should change if the economy does change.
Choice "D" is incorrect. PERT is not a good method to use to test whether their decision
should change if the economy does change.
A company is trying to determine which of two new products it should introduce this
season. Based on market research conducted for product A, there is a 20
percent chance for sales of $800,000; a 50 percent chance for sales of $1.2 million; and
a 30 percent chance for sales of $1.5 million. The same market research indicates that
for product B, there is a 40 percent chance for sales of $900,000 and a 60
percent chance for sales of $2 million. Suppose it costs the company $500,000 to
launch product A and $650,000 to launch product B; which of the two products should
the company introduce?

A. It should introduce product B because it has an expected profit of $1.56 million.
B. It should introduce product B because it has an expected profit of $910,000.
C. It should introduce product A because it has an expected profit of $710,000.
D. It should introduce product A because it has an expected profit of $1.21 million.
Explanation
Choice "B" is correct. The expected revenue from sales of product A is $1,210,000
(800,000 × 0.2 + 1,200,000 × 0.5 + 1,500,000 × 0.3).
Since the cost of introducing this product is $500,000, the expected profit from sales of
product A is $710,000 (1,210,000 − 500,000).
However, the expected revenue from sales of product B is $1,560,000 (900,000 × 0.4 +
2,000,000 × 0.6).
Since the cost of introducing this product is $650,000, the expected profit from sales of
product B is $910,000 (1,560,000 − 650,000). The company should introduce product B
because it has a higher expected profit.
Choice "A" is incorrect. This answer is correct in that the company should introduce
product B because it has a higher expected profit than product A. Additionally, this
answer correctly calculates the expected revenue from sales of product B; however, it
does not consider the cost of introducing the product.
Choice "C" is incorrect. This answer correctly calculates the expected profit from sales
of product A; however, the company should not introduce product A because product B
has a higher expected profit.
Choice "D" is incorrect. This answer correctly calculates the expected revenue from
sales of product A; however, it does not consider the cost of introducing the product.
Carson Products sells sweatshirts and is preparing for a World Cup soccer match. The
cost per sweatshirt varies with the quantity purchased as follows:
Quantity Unit Cost

4,000 $14.00
5,000 $13.50
6,000 $13.00
7,000 $12.50
Carson must purchase the sweatshirts one month before the game and has analyzed
the market and estimated sales levels as follows.
Unit Sales 4,000 5,000 6,000 7,000

Probability 15% 20% 35% 30%
The estimated selling price is $25 for sales made before and at the game day. Any
sweatshirts remaining after game day can be sold at wholesale to a local discount store
for $10.
The expected profit if Carson purchased 6,000 sweatshirts is:

A. $72,000.
B. $67,500.
C. $69,000.
D. $64,500.
Explanation
Choice "D" is correct. In order to calculate the expected profit if Carson purchased
6,000 sweatshirts, the profit for each level of sales must be calculated and multiplied by
the probability. For example, 4,000 unit sales are multiplied by the $25 sales price to get
$100,000 total revenue. 6,000 sweatshirts were purchased (and this will be the same for
every level of sales) at $13.00, the cost when you order 6,000 sweatshirts, to get
$78,000. Because only 4,000 sweatshirts are sold before and at the game day, 2,000
have to be sold wholesale to a local discount store for $10, resulting in $20,000
wholesale revenue. Together $100,000 − $78,000 + $20,000 = $42,000. Multiply
$42,000 by the probability of having unit sales of 4,000 of 15 percent to get $6,300.
Repeat this same calculation for each level of sales. Remember that there will be
wholesale revenue for 5,000 sweatshirt sales, but not for 6,000 or 7,000. Also, consider
that at 7,000 sales, sales are still limited to the 6,000 sweatshirts purchased.
Novelty Inc. plans to spend $65,000 to launch its newest product. Its research indicates
that there is a 10 percent chance for revenue of $40,000, a 60 percent chance for
revenue of $80,000, and a 30 percent chance for revenue of $120,000.
However, the company has to revise its estimate after receiving the latest economic
forecast. Now it is estimated that there is 50 percent chance for revenue of $40,000, a
40 percent chance for revenue of $80,000, and a 10 percent chance for revenue of
$120,000. What would the company decide about introducing (or not introducing) the
new product before and after the revision of its estimate?

A. Before revision: introduce product; after revision: do not introduce product.
B. Before revision: do not introduce product; after revision: introduce product.
C. Before revision: do not introduce product; after revision: do not introduce product.
D. Before revision: introduce product; after revision: introduce product.
Explanation
Choice "A" is correct. Before the revision, the expected revenue of Novelty's newest
product is $88,000 ($40,000 × 0.1 + $80,000 × 0.6 + $120,000 × 0.3).
Since the cost of launching the product is $65,000, the expected profit from sales of the
newest product is $23,000 ($88,000 − $65,000).
After revising its estimate, the expected revenue from sales of the newest product is
$64,000 ($40,000 × 0.5 + $80,000 × 0.4 + $120,000 × 0.1).
Since the cost of introducing this product remains at $65,000, the expected profit is now
($1,000), ($64,000 − $65,000).
Based on the calculation, the company should introduce the newest product before the
revision (because it has a positive expected profit) and should not introduce the product
after the revision (because it has a negative expected profit).
Choice "B" is incorrect. Based on the calculation of the expected revenue before and
after revision, the decision not to introduce the product before revision and to introduce
the product after revision is incorrect.
Choice "C" is incorrect. Based on the calculation of the expected revenue before and
after revision, the decision not to introduce the product before revision and not to
introduce the product after revision is incorrect.
Choice "D" is incorrect. Based on the calculation of the expected revenue before and
after revision, the decision to introduce the product before revision and to introduce the
product after revision is incorrect.
Meow Meow Cat Food plans to spend $120,000 to launch its newest product. Its
research indicates that there is a 20 percent chance for revenue of $100,000, a 50
percent chance for revenue of $150,000, and a 30 percent chance for revenue of
$200,000. However, the company has to revise its probabilities after receiving the latest
economic forecast. Now it is estimated that there is a 40 percent chance for revenue of
$100,000, a 40 percent chance for revenue of $150,000, and a 20 percent chance for
revenue of $200,000. What would be the company's decision regarding the new product
before and after the revision of its estimate?

A. Before revision: introduce product; after revision: do not introduce product.
B. Before revision: do not introduce product; after revision: do not introduce product.
C. Before revision: introduce product; after revision: introduce product.
D. Before revision: do not introduce product; after revision: introduce product.
Explanation
Choice "C" is correct. Before the revision, the expected revenue of Meow Meow Cat
Food's newest product is $155,000 ($100,000 × 0.2 + $150,000 × 0.5 + $200,000 ×
0.3).
Since the cost of launching the product is $120,000, the expected profit of the newest
product is $35,000 ($155,000 − $120,000).
After revising its probabilities, the expected revenue of the newest product is now
$140,000 ($100,000 × 0.4 + $150,000 × 0.4 + $200,000 × 0.2).
Since the cost of launching this product remains at $120,000, the expected profit is now
$20,000 ($140,000 − $120,000).
Based on the calculation, the company could introduce the newest product before the
revision or after the revision (because both have a positive expected profit).
Choice "A" is incorrect. Based on the calculation of the expected revenue before and
after revision, the decision to introduce the product before revision and not to introduce
Choice "B" is incorrect. Based on the calculation of the expected revenue before and
after revision, the decision not to introduce the product before revision and not to
introduce the product after revision is incorrect.
Choice "D" is incorrect. Based on the calculation of the expected revenue before and
after revision, the decision not to introduce the product before revision and to introduce

B.3. Forecasting Techniques

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