A – 1 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall. Decision Making A For Operations Management, 9e by Krajewski/Ritzman/Malhotra © 2010 Pearson Education Homework: Workshop #1, #2, 5, 14, 15abc

A – 2 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall. Learning Objectives About the best alternative under various outcome scenarios. Break Even Analysis Preference Matrix Certainty Uncertainty Risk Expected Value Decision Trees

A – 3 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall. Break-Even Analysis Evaluating Services or Products  Is the 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?

A – 4 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall. 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 – 5 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall. Break-Even Analysis By setting revenue equal to total cost pQ = F + cQ Q = F p - c So Total cost = F + cQ Total revenue = pQ

A – 6 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall. 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.

A – 7 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall. Finding the Break-Even Quantity Total annual costs Fixed costs Break-even quantity Profits Loss Patients (Q) Dollars (in thousands) 400 – 300 – 200 – 100 – 0 – |||| (2000, 300) Total annual revenues The two lines intersect at 1,000 patients, the break-even quantity FIGURE A.1 – Graphic Approach to Break-Even Analysis (2000, 400)

A – 8 Break-Even Analysis CommunityFixed Costs (F)c A$150,000$62 B$300,000$38 C$500,000$24 D$600,000$30

A – 9 Break-Even Analysis Q (thousands of units) A best B bestC best Break-even point A D B C (20, 1390) (20, 1200) (20, 1060) (20, 980) Annual cost (thousands of dollars) Break-even point

A – 10 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall. 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 – 11 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall. 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? Evaluating an Alternative Performance CriterionWeight (A)Score (B) Weighted Score (A  B) Market potential Unit profit margin Operations compatibility Competitive advantage Investment requirements10220 Project risk5420 Weighted score =750

A – 12 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall. Preference Matrix Example North Total patient miles per month 254 Facility utilization 20 3 Average time per emergency trip203 Expressway accessibility154 Land and construction costs101 Employee preference105

A – 13 Decisions Under Certainty Example: New product introduction. Build a large or small facility? Possible Future Demand LowHigh Build Small Build Large A manager knows with certainty which event or outcome will occur. Pick the alternative with the best payoff for the known outcome.

A – 14 Decision Making Under Uncertainty Maximin Maximax Laplace Possible Future Demand LowHigh Build Small Build Large160800

A – 15 Decisions Under Risk Similar to Laplace technique, but we use estimated probabilities (not equal) for the outcomes. Possible Future Demand LowHigh Build Small Build Large160800

A – 16 Expected Value Concept (Used in Decision Trees)

A – 17 Decision Trees Model of alternatives along with potential consequences. Square Nodes – decision points. Circular Nodes – chances/probabilities that must sum to one. Branches – represent alternatives or different possibilities. Payoffs EV

A – 18 Analyzing a Decision Tree $200 $223 $270 $40 $800 $20 $220 Don’t expand Expand Low demand [0.4] High demand [0.6] 2 Low demand [0.4] High demand [0.6] 3 Do nothing Advertise Modest response [0.3] Sizable response [0.7] Small facility Large facility 1

A – 19 Workshop #1 A firm must decide whether to construct a small, medium, or large stamping plant. A consultant’s report indicates a.20 probability that demand will be low and a.80 probability that demand will be high. If the firm builds a small facility and demand turns out to be low, the net present value will be $42 (million). If demand turns out to be high, the firm can either subcontract and realize a NPV of $42 or expand greatly for an NPV of $48. The firm could build a medium size facility as a hedge: If demand turns out to be low, its NPV is estimated at $22; if demand turns out to be high, the firm could do nothing and realize a NPV of $46, or it could expand and realize a NPV of $50. If the firm builds a large facility and demand is low, the NPV will be -$20, whereas high demand will result in a NPV of $72. Analyze this issue using a decision tree. What would be the maximin alternative?

A – 20 Workshop #2 Refer to Problem #15 in the textbook. Suppose after a certain amount of discussion, management is able to assess the probabilities of demand as follows: P(low)=.40 P(moderate)=.40 P(high)=.20 Determine the expected profit of each alternative. Which alternative is best?

A – 21 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall.

A – 22 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall.