OM-Decision Making

Mahr Irfan Ahmad Tahir

B.Sc., ACFMA(Pak), MIPA(Aus), AFA(UK)
 Break-Even Analysis
Break-even quantity is the volume at which total
revenues equal total cost.
Use of this technique is called Break-even analysis
(use to find break even quantity.
Can also be used to compare processes by finding the
volume at which two different processes have equal
costs.
BEA based on assumption that cost can be divided
into two categories a) variable costs-c b) fixed costs-F
 Break-Even Analysis
Variable Cost-portion of total cost that varies directly with
volume of output (material, labor, faction of overheads).
Fixed cost-portion of total cost that remains constant
regardless of changes in output( depreciation, interest,
taxes, insurance).
If, Q is the volume, then
Total cost=F+cQ
Total revenue= pQ p is unit price
For break even pQ=F+cQ
Q=F/(p-c)
 Break-Even Analysis-Problem
A hospital is considering new procedure to be offered
at $200 per patient. The fixed cost would be $100,000
per year. Variable cost is $100 per patient. What is the
break-even quantity for this service?

Page 52
 Break-Even Analysis-Decision point
BEA cannot tell a manager whether to pursue a new
service or product idea or drop an existing line. This
technique is likely to show happenings of various
forecast of cost and sales volume.
To answer “what-if”, approach called “sensitivity
analysis” is used.
 Sensitivity Analysis
A technique for systematically changing parameters in
a model to determines the effects of such changes.
We asses sensitivity of total profits to different pricing
strategies , sales volume forecasts, cost estimates.
Make or buy option
Let Fb and Cb are fixed and variable cost for buying.
Let Fm and Cm are fixed and variable cost for making.
Q is the breakeven quantity
Fb+ QCb= Fm+ QCm
Q=(Fm-Fb)/(Cb-Cm)
 Preference matrix
A table that allows to rate an alternative according to
several performance criteria.
Example
 Decision Theory
Decision theory is a general approach to decision making when
outcomes associated with alternatives are often in doubt. It helps
operation managers with decision on process, capacity, location
and inventory because such decisions are about uncertain future.
With decision theory, a manager makes choices using the
following process;
List of feasible alternatives (alternatives are finite) i.e. for a new
retail store, theoretically may every corner of the city, but, in fact,
manager must narrow the choices to a reasonable numbers.
List of events (chance events or states of nature) having impact on
the outcome, beyond the controls of manager. i.e. demand may be
high or low depending on the location convenient to the customers
etc
 Decision Theory
Calculate payoff for each alternate in each event(total
profit or total cost). These payoffs may be entered into a
payoff table, shows amount of each alternative if each
possible even occurs. For 3 alternative and 4 events,
12(3x4) payoffs.
Estimate the likelihood of each event (using past data,
executive opinion or other forecasting methods)
Select a decision rule to evaluate the
alternatives( choosing alternative with lower expected
cost)
Using this process, examine decisions under three
different situations; certainty, uncertainty and risk
 Decision Theory
Certainty (when manager knows which event will occur). Rule is to
pick the alternative with the best payoff for the know event (in case
of profit, highest payoff. For cost with lowest payoff).
Uncertainty (can list possible events but cannot estimate their
probabilities). One of four rule may used;
Maximin (choose “best of the worst”). For pessimists, who anticipate
the “worst case in each alternative.
Maximax (choose “best of the best”). For optmist who has high
expectations and prefer to “go for broke”.
Laplace (best weighted payoff). Give equal importance/ probability. If
“n” events, probability of each is 1/n.
Minimax regret (best “worst regret”). A regret is the difference
between a given payoff and the best payoff.
 Decision Theory-Problem
To decide build a large facility or small facility;

Possible future demand

Alternative Low high
Small facility 200 270
Large facility 160 800
Do nothing 0 0

What is the best choice?