Decision Making

A Decision Making
For Operations Management, 9e by

PowerPoint Slides
Krajewski/Ritzman/Malhotra
by Copyright
Jeff Heyl © 2010 Pearson Education, Inc. Publishing as Prentice Hall. © 2010 Pearson Education
A–1
Break-Even Analysis
 Evaluating Services or Products

 Isthe predicted sales volume of the service or
product sufficient to break even (neither
earning a profit nor sustaining a loss)?
 How low must the variable cost per unit be to
break even, based on current prices and sales
forecasts?
 How low must the fixed cost be to break even?
 How do price levels affect the break-even
quantity?
Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall.
A–2
Break-Even Analysis
 Break-even analysis is based on the assumption

that all costs related to the production of a
specific service or product can be divided into two
categories: variable costs and fixed costs
 Variable cost, c, is the portion of the total cost that
varies directly with volume of output
 If Q = the number of customers served or units
produced per year, total variable cost = cQ
 Fixed cost, F, is the portion of the total cost that
remains constant regardless of changes in levels
of output
A–3
Break-Even Analysis
 So
Total cost = F + cQ
Total revenue = pQ
 By setting revenue equal to total cost
pQ = F + cQ
F
Q=
p-c
A–4
Finding the Break-Even Quantity
EXAMPLE A.1
A hospital is considering a new procedure to be offered at $200
per patient. The fixed cost per year would be $100,000, with
total variable costs of $100 per patient. What is the break-even
quantity for this service? Use both algebraic and graphic
approaches to get the answer.
SOLUTION
The formula for the break-even quantity yields
F 100,000
Q= = = 1,000 patients
p-c 200 – 100
A–5
 To solve graphically we plot two lines: one for costs and one
for revenues
 Begin by calculating costs and revenues for two different
output levels
 The following table shows the results for Q = 0 and Q = 2,000
Quantity Total Annual Cost ($) Total Annual Revenue ($)

(patients) (Q) (100,000 + 100Q) (200Q)
0 100,000 0
2,000 300,000 400,000
 Draw the cost line through points (0, 100,000) and (2,000,
300,000)
 Draw the revenue line through (0, 0) and (2,000, 400,000)
A–6
400 – (2000, 400)
300 – Profits
Total annual revenues
Dollars (in thousands)
(2000, 300)
200 – Total annual costs
Break-even quantity  The two lines
intersect at
100 –
1,000 patients,
Loss Fixed costs
the break-even
0– quantity
| | | |
500 1000 1500 2000
Patients (Q)
FIGURE A.1 – Graphic Approach to Break-Even Analysis
A–7
Application A.1
The Denver Zoo must decide whether to move twin polar bears
to Sea World or build a special exhibit for them and the zoo.
The expected increase in attendance is 200,000 patrons. The
data are:
Revenues per Patron for Exhibit
Gate receipts $4
Concessions $5  Is the
Licensed apparel $15
predicted
increase in
Estimated Fixed Costs
attendance
Exhibit construction $2,400,000
sufficient to
Salaries $220,000
break even?
Food $30,000
Estimated Variable Costs per Person

Concessions $2
Licensed apparel $9
A–8
Application A.1
Where
Q TR = pQ TC = F + cQ p = 4 + 5 + 15 = $24
0 $0 $2,650,000 F = 2,400,000 + 220,000 + 30,000
250,000 $6,000,000 $5,400,000 = $2,650,000
c = 2 + 9 = $11
7–
6–
(millions of dollars)
5–
Cost and revenue
4– t
ta l Cos
To
3–
e
e nu
2– ev
t a lR
1– To
0–
| | | | | |
50 100 150 200 250
Q (thousands of patrons)
A–9
Application A.1
Where
Q TR = pQ TC = F + cQ p = 4 + 5 + 15 = $24
0 $0 $2,650,000 F = 2,400,000 + 220,000 + 30,000
250,000 $6,000,000 $5,400,000 = $2,650,000
c = 2 + 9 = $11
Algebraic solution of Denver Zoo problem

pQ = F + cQ
24Q = 2,650,000 + 11Q
13Q = 2,650,000
Q = 203,846
A – 10
Sensitivity Analysis
EXAMPLE A.2
If the most pessimistic sales forecast for the proposed service
in Figure A.1 were 1,500 patients, what would be the
procedure’s total contribution to profit and overhead per year?
SOLUTION
The graph shows that even the pessimistic forecast lies above
the break-even volume, which is encouraging. The product’s
total contribution, found by subtracting total costs from total
revenues, is
pQ – (F + cQ) = 200(1,500) – [100,000 +

100(1,500)]
= $50,000
A – 11
Evaluating Processes
 Choices must be made between two

processes or between an internal process
and buying services or materials on the
outside
 We assume that the decision does not

affect revenues
 The analyst finds the quantity for which the

total costs for two alternatives are equal
A – 12
Evaluating Processes
 Let Fb equal the fixed cost (per year) of the buy

option, Fm equal the fixed cost of the make option,
cb equal the variable cost (per unit) of the buy
option, and cm equal the variable cost of the make
option
 The total cost to buy is Fb + cbQ and the total cost
to make is Fm + cmQ
 To find the break-even quantity, we set the two
cost functions equal and solve for Q:
Fb + cbQ = Fm + cmQ
Fm – Fb
Q=
cb – cm
A – 13
Break-Even Analysis for
Make-or-Buy Decisions
EXAMPLE A.3
 A fast-food restaurant featuring hamburgers is adding
salads to the menu
 The price to the customer will be the same
 Fixed costs are estimated at $12,000 and variable costs
totaling $1.50 per salad
 Preassembled salads could be purchased from a local
supplier at $2.00 per salad
 Preassembled salads would require additional refrigeration
with an annual fixed cost of $2,400
 Expected demand is 25,000 salads per year
 What is the break-even quantity?
A – 14
SOLUTION
The formula for the break-even quantity yields the following:
Fm – Fb
Q=
cb – cm
12,000 – 2,400
= = 19,200 salads
2.0 – 1.5
Figure A.2 shows the solution from OM Explorer’s Break-

Even Analysis Solver. The break-even quantity is 19,200
salads. As the 25,000-salad sales forecast exceeds this
amount, the make option is preferred. Only if the restaurant
expected to sell fewer than 19,200 salads would the buy
option be better.
A – 15
FIGURE A.2 – Break-Even Analysis

Solver of OM Explorer for Example A.3 A – 16
Application A.2
At what volume should the Denver Zoo be indifferent

between buying special sweatshirts from a supplier or have
zoo employees make them?
Buy Make
Fixed costs $0 $300,000
Variable costs $9 $7
Fm – Fb $300,000 – $0
Q= = = 150,000
$9 – $7
cb –
cm
A – 17
Preference Matrix
 A Preference Matrix is a table that allows you to

rate an alternative according to several
performance criteria
 The criteria can be scored on any scale as long as
the same scale is applied to all the alternatives
being compared
 Each score is weighted according to its perceived
importance, with the total weights typically
equaling 100
 The total score is the sum of the weighted scores
(weight × score) for all the criteria and compared
against scores for alternatives
A – 18
Evaluating an Alternative
EXAMPLE A.4
The following table shows the performance criteria, weights,
and scores (1 = worst, 10 = best) for a new thermal storage air
conditioner. If management wants to introduce just one new
product and the highest total score of any of the other product
ideas is 800, should the firm pursue making the air conditioner?
Performance Criterion Weight (A) Score (B) Weighted Score (A  B)

Market potential 30 8 240
Unit profit margin 20 10 200
Operations compatibility 20 6 120
Competitive advantage 15 10 150
Investment requirements 10 2 20
Project risk 5 4 20
Weighted score = 750
A – 19
Evaluating an Alternative
SOLUTION
Because the sum of the weighted scores is 750, it falls short of
the score of 800 for another product. This result is confirmed
by the output from OM Explorer’s Preference Matrix Solver in
Figure A.3.
Total 750
FIGURE A.3 – Preference Matrix Solver for Example A.4

A – 20
Application A.3
Performance Criterion Weight Score Weighted Score

Market potential 10 5
Unit profit margin 30 8
Operations compatibility 20 10
Competitive advantage 25 7
Investment requirements 10 3
Project risk 5 4
Total weighted score =
A – 21
Application A.3
Performance Criterion Weight Score Weighted Score

Market potential 10 5 50
Unit profit margin 30 8 240
Operations compatibility 20 10 200
Competitive advantage 25 7 175
Investment requirements 10 3 30
Project risk 5 4 20
Total weighted score = 715
 Repeat this process for each alternative – pick the one

with the largest weighted score
A – 22
Criticisms
 Requires the manager to state criterion

weights before examining alternatives, but
they may not know in advance what is
important and what is not
 Allows one very low score to be overridden

by high scores on other factors
 May cause managers to ignore important

signals
A – 23
Decision Theory
 Decision theory is a general approach to decision

making when the outcomes associated with
alternatives are in doubt
 A manager makes choices using the following
process:
1. List a reasonable number of feasible alternatives

2. List the events (states of nature)
3. Calculate the payoff table showing the payoff for each
alternative in each event
4. Estimate the probability of occurrence for each event
5. Select the decision rule to evaluate the alternatives
A – 24
Decision Making Under Certainty
 The simplest solution is when the

manager knows which event will occur
 Here the decision rule is to pick the
alternative with the best payoff for the
known event
A – 25
Decisions Under Certainty
EXAMPLE A.5
 A manager is deciding whether to build a small or a large
facility
 Much depends on the future demand
 Demand may be small or large
 Payoffs for each alternative are known with certainty
 What is the best choice if future demand will be low?
Possible Future Demand

Alternative Low High
Small facility 200 270
Large facility 160 800
Do nothing 0 0
A – 26
Decisions Under Certainty
SOLUTION
 The best choice is the one with the highest payoff
 For low future demand, the company should build a small
facility and enjoy a payoff of $200,000
 Under these conditions, the larger facility has a payoff of
only $160,000
Possible Future Demand

Alternative Low High
Small facility 200 270
Do nothing 0 0
A – 27
Decision Making Under Uncertainty
 Can list the possible events but can not

estimate the probabilities
1. Maximin: The best of the worst, a pessimistic
approach
2. Maximax: The best of the best, an optimistic
approach
3. Laplace: The alternative with the best weighted
payoff assuming equal probabilities
4. Minimax Regret: Minimizing your regret (also
pessimistic)
A – 28
Decisions Under Uncertainty
EXAMPLE A.6
Reconsider the payoff matrix in Example A.5. What is the best
alternative for each decision rule?
SOLUTION
a. Maximin. An alternative’s worst payoff is the lowest
number in its row of the payoff matrix, because the payoffs
are profits. The worst payoffs ($000) are
Alternative Worst Payoff

Small facility 200
Large facility 160
The best of these worst numbers is $200,000, so the

pessimist would build a small facility
A – 29
b. Maximax. An alternative’s best payoff ($000) is the highest
number in its row of the payoff matrix, or
Alternative Best Payoff

Small facility 270
Large facility 800
The best of these best numbers is $800,000, so the optimist

would build a large facility
A – 30
c. Laplace. With two events, we assign each a probability of
0.5. Thus, the weighted payoffs ($000) are
Alternative Weighted Payoff

Small facility 0.5(200) + 0.5(270) = 235
Large facility 0.5(160) + 0.5(800) = 480
The best of these weighted payoffs is $480,000, so the

realist would build a large facility
A – 31
d. Minimax Regret. If demand turns out to be low, the best
alternative is a small facility and its regret is 0 (or 200 –
200). If a large facility is built when demand turns out to be
low, the regret is 40 (or 200 – 160).
Regret
Maximum
Alternative Low Demand High Demand Regret
Small facility 200 – 200 = 0 800 – 270 = 530 530
Large facility 200 – 160 = 40 800 – 800 = 0 40
The column on the right shows the worst regret for each
alternative. To minimize the maximum regret, pick a large
facility. The biggest regret is associated with having only a
small facility and high demand.
A – 32
Application A.4
Fletcher (a realist), Cooper (a pessimist), and Wainwright (an
optimist) are joint owners in a company. They must decide
whether to make Arrows, Barrels, or Wagons. The government
is about to issue a policy and recommendation on pioneer
travel that depends on whether certain treaties are obtained.
The policy is expected to affect demand for the products;
however it is impossible at this time to assess the probability of
these policy “events.” The following data are available:
Payoffs (Profits)
Land Routes Land Routes Sea Routes
Alternative
No treaty Treaty Only
Arrows $840,000 $440,000 $190,000
Barrels $370,000 $220,000 $670,000
Wagons $25,000 $1,150,000 ($25,000)
A – 33
Application A.4
Fletcher (a realist), Cooper (a pessimist), and Wainwright (an
optimist) are joint owners in a company. They must decide
whether to make Arrows, Barrels, or Wagons. The government
is about to issue a policy and recommendation on pioneer
travel that depends on whether certain treaties are obtained.
The policy is expected to affect demand for the products;
however it is impossible at this time to assess the probability of
these policy “events.” The following data are available:
Payoffs (Profits)
Alternative
Arrows $840,000 $440,000 $190,000
Barrels $370,000 $220,000 $670,000
Wagons $25,000 $1,150,000 ($25,000)
A – 34
Application A.4
 Which product would be favored by Fletcher (realist)?
 Which product would be favored by Cooper (pessimist)?
 Which product would be favored by Wainwright (optimist)?
 What is the minimax regret solution?
Payoffs (Profits)
Alternative
Arrows $840,000
$440,000 $190,000
 The short answers
Barrels $370,000
are: $220,000 $670,000
 Wagons
Fletcher (realist – Laplace) $25,000
would choose arrows
$1,150,000 ($25,000)
 Cooper (pessimist – Maximin) would choose barrels

 Wainwright (optimist – Maximax) would choose wagons
 The Minimax Regret solution is arrows
A – 35
Decisions Under Risk
 The manager can list the possible events

and estimate their probabilities
 The manager has less information than
decision making under certainty, but more
information than with decision making
under uncertainty
 The expected value rule is widely used
 This rule is similar to the Laplace decision
rule, except that the events are no longer
assumed to be equally likely
A – 36
Decisions Under Risk
EXAMPLE A.7
Reconsider the payoff matrix in Example A.5. For the expected
value decision rule, which is the best alternative if the
probability of small demand is estimated to be 0.4 and the
probability of large demand is estimated to be 0.6?
SOLUTION Possible Future

Demand
The expected value for each Alternative Small Large
alternative is as follows: Small facility 200 270
Alternative Expected Value
Small facility 0.4(200) + 0.6(270) = 242
Large facility 0.4(160) + 0.6(800) = 544
A – 37
Application A.5
For Fletcher, Cooper, and Wainwright, find the best decision
using the expected value rule. The probabilities for the events
are given below.
Payoffs (Profits)
What alternative has Land Routes Land Routes Sea Routes
Alternative
the best expected No treaty Treaty Only
results? Arrows $840,000

$440,000 $190,000
Barrels $370,000
$220,000 $670,000
Wagons $25,000
$1,150,000 ($25,000)
Land routes, Land Routes,
Sea routes, Expected
Alternative No Treaty Treaty Only
Only (0.20) Value
(0.50) (0.30)
Arrows (0.50)(840,000) + (0.30)(440,000) (0.20) = 590,000

+
(190,000)
Barrels (0.20)
(0.50)(370,000) + (0.30)(220,000) + = 385,000
(670,000)
Wagons (0.50)(25,000) + (0.30)(1,150,000) + (0.20)(-25,000) = 352,500
A – 38
Decision Trees
 Are schematic models of available

alternatives and possible consequences
 Are useful with probabilistic events and
sequential decisions
 Square nodes represent decisions
 Circular nodes represent events
 Events leaving a chance node are
collectively exhaustive
A – 39
Decision Trees
 Conditional payoffs for each possible

alternative-event combination shown at
the end of each combination
 Draw the decision tree from left to right
 Calculate expected payoff to solve the
decision tree from right to left
A – 40
Decision Trees
E1 & Probability
Payoff 1
E2 & Probability Payoff 2
1
e E3 & Probability
t iv Payoff 3
a
rn
lte
A Alternative 3
Payoff 1
Alternative 4
1 2 Payoff 2
y
A i li t Alternative 5
1st lte ab Possible
b Payoff 3
decision rn
at P ro 2nd decision
iv &
e E1
2
E2 & Probability
= Event node Payoff 1
E3 & Probability Payoff 2
= Decision node
Ei = Event i
FIGURE A.4 – A Decision Tree Model
P(Ei) = Probability of event i
A – 41
Decision Trees
 After drawing a decision tree, we solve it

by working from right to left, calculating
the expected payoff for each of its
possible paths
1. For an event node, we multiply the payoff of
each event branch by the event’s probability
and add these products to get the event
node’s expected payoff
2. For a decision node, we pick the alternative
that has the best expected payoff
A – 42
Decision Trees
 Various software is available for drawing

and/or analyzing decision trees, including
 PowerPoint can be used to draw decision
trees, but does not have the capability to
analyze the decision tree
 POM with Windows
 SmartDraw
 PrecisionTree decision analysis from Palisade
Corporation
 TreePlan
A – 43
Analyzing a Decision Tree
EXAMPLE A.8
 A retailer will build a small or a large facility at a new location
 Demand can be either small or large, with probabilities
estimated to be 0.4 and 0.6, respectively
 For a small facility and high demand, not expanding will have
a payoff of $223,000 and a payoff of $270,000 with expansion
 For a small facility and low demand the payoff is $200,000
 For a large facility and low demand, doing nothing has a
payoff of $40,000
 The response to advertising may be either modest or sizable,
with their probabilities estimated to be 0.3 and 0.7,
respectively
 For a modest response the payoff is $20,000 and $220,000 if
the response is sizable
 For a large facility and high demand the payoff is $800,000
A – 44
SOLUTION
The decision tree in Figure A.5 shows the event probability
and the payoff for each of the seven alternative-event
combinations. The first decision is whether to build a small or
a large facility. Its node is shown first, to the left, because it is
the decision the retailer must make now. The second decision
node is reached only if a small facility is built and demand
turns out to be high. Finally, the third decision point is
reached only if the retailer builds a large facility and demand
turns out to be low.
A – 45
Low demand [0.4]
$200
Hi
g h
y d
l it [0 em
a ci .6 an
lf ] d Don’t expand
al $223
Sm 2
Expand $270
1
Do nothing
La $40
r ge d Modest response [0.3]
fa an 3 $20
ci m
lit de 4] Advertise
y ow [0.
L Sizable response [0.7]
$220
High demand [0.6]

$800
FIGURE A.5 – Decision Tree for Retailer (in $000)
A – 46
Low demand [0.4]
$200
Hi
g h
y d
l it [0 em
a ci .6 an
al $223
Sm 2
Expand $270
1 0.3 x $20 = $6
Do nothing
La $40
fa an 3 $20
ci m
lit de 4] Advertise
y ow [0.
$6 + $154 = $160 $220
0.7 x $220 = $154

High demand [0.6]
$800
A – 47
Low demand [0.4]
$200
Hi
g h
y d
l it [0 em
a ci .6 an
al $223
Sm 2
Expand $270
1
Do nothing
La $40
fa an 3 $20
ci m
lit de 4] Advertise
y ow [0. $160
$160 $220
High demand [0.6]

$800
A – 48
Low demand [0.4]
$200
Hi
g h
y d
l it [0 em
a ci .6 an
al $223
Sm 2
Expand
$270 $270
1
Do nothing
La $40
fa an 3 $20
ci m
lit de 4] Advertise
y ow [0. $160
$160 $220
High demand [0.6]

$800
A – 49
Low demand [0.4]
$200 x 0.4 = $80
$80 + $162 = $242
Hi
g h
y d
l it [0 em
a ci .6 an
al $223
Sm 2
Expand x 0.6 = $162
$270 $270
1
Do nothing
La $40
fa an 3 $20
ci m
lit de 4] Advertise
y ow [0. $160
$160 $220
High demand [0.6]

$800
A – 50
Low demand [0.4]
$200
$242
Hi
g
h
y d
l it [0 em
a ci .6 an
al $223
Sm 2
Expand
$270 $270
1
Do nothing
La $40
fa an 3 $20
ci m
lit de 4] Advertise
y ow [0. $160
$160 $220
0.4 x $160 = $64
$544 High demand [0.6]

$800 x 0.6 = $480
A – 51
Low demand [0.4]
$200
$242
Hi
g
h
y d
l it [0 em
a ci .6 an
al $223
Sm 2
Expand
$270 $270
1
Do nothing
La $40
$544 r ge d Modest response [0.3]
fa an 3 $20
ci m
lit de 4] Advertise
y ow [0. $160
$160 $220

$800
A – 52
Low demand [0.4]
$200
$242
Hi
g
h
y d
l it [0 em
a ci .6 an
al $223
Sm 2
Expand
$270 $270
1
Do nothing
La $40
$544 r ge d Modest response [0.3]
fa an 3 $20
ci m
lit de 4] Advertise
y ow [0. $160
$160 $220

$800
A – 53
Application A.6
a. Draw the decision tree for the Fletcher, Cooper, and

Wainwright Application A.5 problem
b. What is the expected payoff for the best alternative in the
decision tree below?
Land routes, Land Routes,

Sea routes,
Alternative No Treaty Treaty Only
Only (0.20)
(0.50) (0.30)
Arrows 840,000 440,000 190,000
Barrels 370,000 220,000 670,000
Wagons 25,000 1,150,000 -25,000
A – 54
Application A.6
A – 55
Solved Problem 1
 A small manufacturing business has patented a new device
for washing dishes and cleaning dirty kitchen sinks
 The owner wants reasonable assurance of success
 Variable costs are estimated at $7 per unit produced and
sold
 Fixed costs are about $56,000 per year
a. If the selling price is set at $25, how many units must be

produced and sold to break even? Use both algebraic
and graphic approaches.
b. Forecasted sales for the first year are 10,000 units if the
price is reduced to $15. With this pricing strategy, what
would be the product’s total contribution to profits in the
first year?
A – 56
Solved Problem 1
SOLUTION
a. Beginning with the algebraic approach, we get
F 56,000
Q= =
p–c 25 – 7
= 3,111 units
Using the graphic approach, shown in Figure A.6, we first

draw two lines:
Total revenue = 25Q
Total cost = 56,000 + 7Q
The two lines intersect at Q = 3,111 units, the break-even

quantity
A – 57
Solved Problem 1
b. Total profit contribution = Total revenue – Total cost

= pQ – (F + cQ)
= 15(10,000) – [56,000 + 7(10,000)]
= $24,000
A – 58
Solved Problem 1
250 –
200 –
Dollars (in thousands)
Total revenues
150 –
Break-even
100 – quantity
$77.7
Total costs
50 – 3.1
| | | | | | | |
0–
1 2 3 4 5 6 7 8
FIGURE A.6 Units (in thousands)
A – 59
Solved Problem 2
Binford Tool Company is screening three new product idea: A,
B, and C. Resource constraints allow only one of them to be
commercialized. The performance criteria and ratings, on a
scale of 1 (worst) to 10 (best), are shown in the following table.
The Binford managers give equal weights to the performance
criteria. Which is the best alternative, as indicated by the
preference matrix method?
Rating
Performance Criteria Product A Product B Product C
1. Demand uncertainty and project risk 3 9 2
2. Similarity to present products 7 8 6
3. Expected return on investment (ROI) 10 4 8
4. Compatibility with current 4 7 6
manufacturing process
5. Competitive Strategy 4 6 5
A – 60
Solved Problem 2
Rating
SOLUTION Performance Criteria Product A Product B Product C
1. Uncertainty and risk 3 9 2
Each of the five criteria 2. Similarity 7 8 6
receives a weight of 1/5 3. ROI 10 4 8
or 0.20 4. Compatibility 4 7 6
5. Strategy 4 6 5
Product Calculation Total Score
A (0.20 × 3) + (0.20 × 7) + (0.20 × 10) + = 5.6

(0.20 × 4) + (0.20 × 4)
B (0.20 × 9) + (0.20 × 8) + (0.20 × 4) + = 6.8

(0.20 × 7) + (0.20 × 6)
C (0.20 × 2) + (0.20 × 6) + (0.20 × 8) +

(0.20 × 6) + (0.20 × 5) = 5.4
The best choice is product B as Products A and C are well

behind in terms of total weighted score
A – 61
Solved Problem 3
Adele Weiss manages the campus flower shop. Flowers must
be ordered three days in advance from her supplier in Mexico.
Although Valentine’s Day is fast approaching, sales are almost
entirely last-minute, impulse purchases. Advance sales are so
small that Weiss has no way to estimate the probability of low
(25 dozen), medium (60 dozen), or high (130 dozen) demand for
red roses on the big day. She buys roses for $15 per dozen and
sells them for $40 per dozen. Construct a payoff table. Which
decision is indicated by each of the following decision criteria?
a. Maximin
b. Maximax
c. Laplace
d. Minimax regret
A – 62
Solved Problem 3
SOLUTION
The payoff table for this problem is
Demand for Red Roses

Low Medium High
Alternative
(25 dozen) (60 dozen) (130 dozen)
Order 25 dozen $625 $625 $625
Order 60 dozen $100 $1,500 $1,500
Order 130 dozen ($950) $450 $3,250
Do nothing $0 $0 $0
A – 63
Solved Problem 3
a. Under the maximin criteria, Weiss should order 25 dozen,
because if demand is low, Weiss’s profits are $625, the best
of the worst payoffs.
b. Under the maximax criteria, Weiss should order 130 dozen.
The greatest possible payoff, $3,250, is associated with the
largest order.
c. Under the Laplace criteria, Weiss should order 60 dozen.
Equally weighted payoffs for ordering 25, 60, and 130 dozen
are about $625, $1,033, and $917, respectively.
d. Under the minimax regret criteria, Weiss should order 130
dozen. The maximum regret of ordering 25 dozen occurs if
demand is high: $3,250 – $625 = $2,625. The maximum regret
of ordering 60 dozen occurs if demand is high: $3,250 –
$1,500 = $1,750. The maximum regret of ordering 130 dozen
occurs if demand is low: $625 – (–$950) = $1,575.
A – 64
Solved Problem 4
White Valley Ski Resort is planning the ski lift operation for its
new ski resort and wants to determine if one or two lifts will be
necessary
Each lift can accommodate 250 people per day and skiing
occurs 7 days per week in the 14-week season and lift tickets
cost $20 per customer per day
The table below shows all the costs and probabilities for each
alternative and condition
Should the resort purchase one lift or two?
Alternatives Conditions Utilization Installation Operation

One lift Bad times (0.3) 0.9 $50,000 $200,000
Normal times (0.5) 1.0 $50,000 $200,000
Good times (0.2) 1.0 $50,000 $200,000
Two lifts Bad times (0.3) 0.9 $90,000 $200,000
Normal times (0.5) 1.0 $90,000 $400,000
Good times (0.2) 1.0 $90,000 $400,000
A – 65
Solved Problem 4
SOLUTION
The decision tree is shown in Figure A.7. The payoff ($000) for
each alternative-event branch is shown in the following table.
The total revenues from one lift operating at 100 percent
capacity are $490,000 (or 250 customers × 98 days ×
$20/customer-day).
Alternatives Economic Conditions Payoff Calculation (Revenue – Cost)
One lift Bad times 0.9(490) – (50 + 200) = 191
Normal times 1.0(490) – (50 + 200) = 240
Good times 1.0(490) – (50 + 200) = 240
Two lifts Bad times 0.9(490) – (90 + 200) = 151
Normal times 1.5(490) – (90 + 400) = 245
Good times 1.9(490) – (90 + 400) = 441
A – 66
Solved Problem 4
Bad times [0.3]

0.3(191) + 0.5(240) + $191
0.2(240) = 225.3
Normal times [0.5]
$240
One lift
$225.3
Good times [0.2]
$240
$256.0
Bad times [0.3]
$151
Two lifts Normal times [0.5]

$245
$256.0
Good times [0.2]
0.3(151) + 0.5(245) + $441
0.2(441) = 256.0
FIGURE A.7
A – 67
A – 68

Decision Making

Uploaded by

Document Information

Original Title

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

Decision Making

Uploaded by

Copyright:

Available Formats

A Decision Making

For Operations Management, 9e by

 Evaluating Services or Products

Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall.

 Break-even analysis is based on the assumption

Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall.

 By setting revenue equal to total cost

Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall.

Quantity Total Annual Cost ($) Total Annual Revenue ($)

2,000 300,000 400,000

400 – (2000, 400)

FIGURE A.1 – Graphic Approach to Break-Even Analysis

Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall.

Estimated Variable Costs per Person

Algebraic solution of Denver Zoo problem

Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall.

pQ – (F + cQ) = 200(1,500) – [100,000 +

Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall.

 Choices must be made between two

 We assume that the decision does not

 The analyst finds the quantity for which the

Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall.

 Let Fb equal the fixed cost (per year) of the buy

Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall.

Figure A.2 shows the solution from OM Explorer’s Break-

Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall.

FIGURE A.2 – Break-Even Analysis

At what volume should the Denver Zoo be indifferent

Fixed costs $0 $300,000

 A Preference Matrix is a table that allows you to

Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall.

Performance Criterion Weight (A) Score (B) Weighted Score (A  B)

Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall.

FIGURE A.3 – Preference Matrix Solver for Example A.4

Performance Criterion Weight Score Weighted Score

Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall.

Performance Criterion Weight Score Weighted Score

 Repeat this process for each alternative – pick the one

Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall.

 Requires the manager to state criterion

 Allows one very low score to be overridden

 May cause managers to ignore important

 Decision theory is a general approach to decision

1. List a reasonable number of feasible alternatives

Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall.

 The simplest solution is when the

Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall.

Possible Future Demand

Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall.

Possible Future Demand

Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall.

 Can list the possible events but can not

Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall.

Alternative Worst Payoff

The best of these worst numbers is $200,000, so the

Alternative Best Payoff

The best of these best numbers is $800,000, so the optimist

Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall.

Alternative Weighted Payoff

The best of these weighted payoffs is $480,000, so the

Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall.

Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall.

Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall.