Management Science

Chapter 1

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Chapter Topics

 The Management Science Approach to Problem

Solving
 Model Building: Break-Even Analysis
 Computer Solution
 Management Science Modeling Techniques
 Business Usage of Management Science Techniques
 Management Science Models in Decision Support
Systems

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The Management Science Approach

 Management science uses a scientific approach to

solving management problems.
 It is used in a variety of organizations to solve many
different types of problems.
 It encompasses a logical mathematical approach to
problem solving.
 Management science, also known as operations
research, quantitative methods, etc., involves a
philosophy of problem solving in a logical manner.

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The Management Science Process

Figure 1.1

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Steps in the Management Science Process

 Observation - Identification of a problem that exists (or may occur

soon) in a system or organization.
 Definition of the Problem - problem must be clearly and
consistently defined, showing its boundaries and interactions with
the objectives of the organization.
 Model Construction - Development of the functional mathematical
relationships that describe the decision variables, objective function
and constraints of the problem.
 Model Solution - Models solved using management science
techniques.
 Model Implementation - Actual use of the model or its solution.

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Example of Model Construction (1 of 4)

Information and Data:

 Business firm makes and sells a steel product
 Product costs $5 to produce
 Product sells for $20
 Product requires 4 pounds of steel to make
 Firm has 100 pounds of steel
Business Problem:
 Determine the number of units to produce to make the
most profit, given the limited amount of steel available.
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Example of Model Construction (2 of 4)

A variable is a symbol used to represent an item that

can take on any value.
Parameters are known, constant values that are often
coefficients of variables in equations.
Data are pieces of information from the problem
environment.
A model is a functional relationship that includes
variables, parameters, and equations.

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Example of Model Construction (3 of 4)

Variables: X = # units to produce (decision variable)

Z = total profit (in $)
Model: Z = $20X - $5X (objective function)
4X = 100 lb of steel (resource constraint)
Parameters: $20, $5, 4 lbs, 100 lbs (known
values)
Formal Specification of Model:
maximize Z = $20X - $5X
subject to 4X = 100 1-8
 Example of Model Construction (4 of 4)

Model Solution:
Solve the constraint equation:
4x = 100
(4x)/4 = (100)/4
x = 25 units

Substitute this value into the profit function:

Z = $20x - $5x
= (20)(25) – (5)(25)
= $375
(Produce 25 units, to yield a profit of $375)
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Model Building:
Break-Even Analysis (1 of 9)

■ Used to determine the number of units of a product to

sell or produce that will equate total revenue with total
cost.

■ The volume at which total revenue equals total cost is

called the break-even point.

■ Profit at break-even point is zero.

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Model Building:
Break-Even Analysis (2 of 9)
Model Components
 Fixed Cost (cf) - costs that remain constant regardless of

number of units produced.

 Variable Cost (cv) - unit production cost of product.

 Volume (v) – the number of units produced or sold

 Total variable cost (vcv) - function of volume (v) and unit

variable cost.
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Model Building:
Break-Even Analysis (3 of 9)
Model Components
 Total Cost (TC) = total fixed cost plus total variable
cost.
TC  c f  vcv

 Profit (Z) = difference between total revenue vp (p =

unit price) and total
Z cost,
 vpi.e.
- c - vc f v

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Model Building:
Break-Even Analysis (4 of 9)
Computing the Break-Even Point
The break-even point is that volume at which total
revenue equals total cost and profit is zero:
vp  c f  vcv  0
v( p  cv )  c f

cf
The break-even v
point p  cv
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Model Building:
Break-Even Analysis (5 of 9)

Example: Western Clothing Company

Fixed Costs: cf = $10000

Variable Costs: cv = $8 per pair
Price : p = $23 per pair

The Break-Even Point is:

v = (10,000)/(23 -8)
= 666.7 pairs
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 Break-Even Analysis: Computer solution Excel

Western Clothing Company Example

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Model Building:
Break-Even Analysis (6 of 9)

Figure 1.2

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Break-Even Analysis: An increase in price
(7 of 9)

Figure 1.3

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Break-Even Analysis: An increase in
variable cost (8 of 9)

Figure 1.4

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 Break-Even Analysis: an increase in fixed
cost (9 of 9)

Figure 1.5

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 Exercise1
The Willow Furniture Company produces tables. The fixed monthly
cost of production is $8,000, and the variable cost per table is $65.
The tables sell for $180 apiece.
a.For a monthly volume of 300 tables, determine the total cost, total
revenue, and profit.

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 Exercise1
The Willow Furniture Company produces tables. The fixed monthly
cost of production is $8,000, and the variable cost per table is $65.
The tables sell for $180 apiece.
a.For a monthly volume of 300 tables, determine the total cost, total
revenue, and profit.
Answer:
Fixed cost (cf) = $8,000

Total variable cost (vcv ) = (300)*(65) = $19,500

Total cost = $8,000 + $19,500 = $27,500
Total revenue (vp) = (300)*(180) = $54,000

Profit = $54,000 - $27,500 = $26,500

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 Exercise1
b. Determine the monthly break-even volume for the
Willow Furniture Company.

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 Exercise1
b. Determine the monthly break-even volume for the Willow
Furniture Company.
Answer:
To break even cf
v
p  cv
8,000

180  65
8,000

115
 69.57
The company needs to produce almost 70 tables per month to
break even

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 Exercise2
Evergreen Fertilizer Company produces fertilizer. The
company's fixed monthly cost is $25,000, and its variable
cost per pound of fertilizer is $0.15. Evergreen sells the
fertilizer for $0.40 per pound. Determine the monthly
break-even volume for the company.

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 Exercise2
Evergreen Fertilizer Company produces fertilizer. The
company's fixed monthly cost is $25,000, and its variable
cost per pound of fertilizer is $0.15. Evergreen sells the
fertilizer for $0.40 per pound. Determine the monthly
break-even volume for the company. cf
v
p  cv
25,000

0.40  0.15
25,000

0.25
 100,000

Evergreen must produce 100,000 lb per month to break

even
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 Exercise3
Graphically illustrate the break-even volume for the
Evergreen Fertilizer Company determined in Exercise2

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 Exercise3
Graphically illustrate the break-even volume for the
Evergreen Fertilizer Company determined in Exercise2

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 Exercise4
 Students are organizing a contest. They know that at
least 100 students will attend. The rental fee for the hall
is $150 and the winning student will receive $500. In
order to guarantee that they break even, how much
should they charge for each ticket?

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 Exercise4
 Fixed cost (cf) = $150 + $500 = $650
 Total variable cost (vcv ) = none
 Volume (p) = 100 students
 Total revenue (vp) = 100p

To break even
vp = cf + vcv
100p = 650
P= $6.50
Therefore they should charge $6.50 for each ticket

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Classification of Management Science Techniques

Figure 1.6 Modeling Techniques

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Characteristics of Modeling Techniques

 Linear Mathematical Programming - clear objective;

restrictions on resources and requirements; parameters
known with certainty. (Chap 2-6, 9)
 Probabilistic Techniques - results contain uncertainty.
(Chap 11-13)
 Network Techniques - model often formulated as
diagram; deterministic or probabilistic. (Chap 7-8)
 Other Techniques - variety of deterministic and
probabilistic methods for specific types of problems
including forecasting, inventory, simulation,
multicriteria, etc. (Chap 10, 14-16)
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Business Use of Management Science

 Some application areas:

- Project Planning
- Capital Budgeting
- Inventory Analysis
- Production Planning
- Scheduling
 Interfaces - Applications journal published by
Institute for Operations Research and Management
Sciences (INFORMS)
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Management science is an
art.

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