THE UNIVERSITY OF DODOMA SCHOOL OF SOCIAL SCIENCES MS 200: QUANTITATIVE TECHNIQUES FOR BUSINESS DECISIOS SUGGESTED SOLUTIONS FOR

EXERCISE 3 Question 1 Machange buys grapes to sell at his outlet at Msasani fruits market. He purchases grapes in the morning of each day and makes sure that he sells the entire supply by the end of the day because Msasani people would not buy yesterdays supply. In the past 300 days, Machange has experienced the following sales pattern of grapes at the outlet. Quantities Sold Number of days (kg) demanded 20 30 30 90 40 120 50 60 Total 300 Machange buys grapes at Tshs 250 per kg and sales them at Tshs 500 per kg. In case demand is not met, he incurs a loss of Tshs 150 per kg of grapes to cover loss of goodwill and future sales. Required: a) Generate the pay off table of profit. b) Decide on the quantity that should be stocked every day so as to maximize expected profit.

c) Determine the expected lost opportunity from the optimal supply level if Machange decides to stock 20 kg each day. d) Determine the value of the perfect information. Solution From the information, we can list the following: Profit per unit = Tshs. 250. Loss in case of excessive supply = Tshs. 250 per unit Loss due to not meeting the demand = Tshs. 150 per unit. Then, the probability distribution of the demand level is as follows below: Quantities Sold Probability (Demand) kg 20 0.10 30 0.30 40 0.40 50 0.20

a)

The pay off table of profit will be: Supply Level (Decision) 20 30 40 50 Quantities Sold (Demand) 30 (0.30) 40 (0.40) 50 (0.20) 3,500 7,500 5,000 2,500 2,000 6,000 10,000 7,500 500 4,500 8,500 12,500
2

20 (0.10) 5,000 2,500 0 -2500

b) The quantity to be stocked every day in order to maximize expected profit is obtained from the following analysis. Supply Quantities Sold (Demand) Level 20 30 40 50 (Decision) (0.10) (0.30) (0.40) (0.20) 20 5,000 3,500 2,000 500 30 2,500 7,500 6,000 4,500 40 0 5,000 10,000 8,500 50 -2500 2,500 7,500 12,500 EMV

2,450 5,800 7,200 6,000

Highest EMV appears at the supply level of 40 kg. This is therefore, the optimal level to supply. c) Expected lost opportunity from the optimal supply level if Machange decides to stock 20 kg each day will be: 7,200 - 2,450 = Tshs. 4,750. e) Value of the perfect information (EVPI) is given by Minimum EOL. The table below shows computation of regret values and the EOL for each supply level. Supply Quantities Sold (Demand) Level 20 30 40 50 (Decision) (0.10) (0.30) (0.40) (0.20) 20 0 4,000 8,000 12,000 30 2,500 7,500 4,000 8,000 40 5,000 2,500 0 4,000 50 7,500 5,000 2,500 0 EOL

6,800 5,700 2,050 3,250

3

Since minimum EOL = 2,050, then EVPI = Tshs. 2,050. Question 2 a) Outline the procedure required to undertake a decision using Expected Opportunity Loss approach. b) ABC Company trades in a perishable product. The Marketing Department of ABC has produced the following sales forecasts, covering the next three months.

Units 200 300 400 500 Demanded Probability 0.10 0.40 0.30 0.20 The Company makes Tshs 9,000 for a unit of the product sold. If that unit is not sold, the Company loses Tshs 4,000. Also, if the Company cannot meet demand, it will lose Tshs 1,000 per unit for the demand not met, to cover loss of good-will and future sales. Required: (i) Set up a pay off matrix for this problem. (ii) Use the EOL decision approach to decide on the number of units that ABC Company should supply so as to cover this three months period. Solution for part (b) (i) Pay off table is given by: Supply Level (Decision) Demand Level (States of nature) 200 300 400(0.30 500(0.20) (0.10) (0.40) )

200 300 400 500

1,800,0 00 1,400,0 00 1,000,0 00 600,000

1,700,00 0 2,700,00 0 2,300,00 0 1,900,00 0

1,600,00 0 2,600,00 0 3,600,00 0 3,200,00 0

1,500,00 0 2,500,00 0 3,500,00 0 4,500,00 0

(ii) From the above pay off table, we can obtain a regret matrix as shown below: Supply Level (Decision) 200 300 400 500 Demand Level (States of nature) 200 300 400(0.30 500(0.20) (0.10) (0.40) ) 0 1,000,00 2,000,00 3,000,00 0 0 0 400,000 0 1,000,00 2,000,00 0 0 8,00,00 400,000 0 1,000,00 0 0 1,200,0 800,000 400,000 0 00

The EMV for each supply level is provided below: EOL(200) = 1,600,000 EOL(300) = 740,000 EOL(400) = 1,160,000. EOL(500) = 560,000

Since minimum EOL corresponds to the supply level of 500 units, ABC Company should order 500 units to cover the three months period.

Question 3 Suppose a decision-maker, faced with four different alternatives and four states of nature develops the following pay off table (Tshs). Decision s S1 D1 14,00 0 D2 11,00 0 D3 9,000 D4 States of Nature S2 S3 9,000 10,00 0 10,00 8,000 0 10,00 10,00 0 0 8,000 10,00 11,00 0 0

S4 5,000 7,000 11,00 0 13,00 0

Suppose the decision-maker obtains information that enables the following probability estimates: P(S1) = 0.5; P(S2) = 0.2; P(S3) = 0.2; P(S4) = 0.1. Required: a) Determine the optimal decision under the EMV criterion. b) Determine the value of perfect information (EVPI). Solution a) EMV calculations is shown in the table below: Decisions States of Nature EMV S1(0.50 S2(0.20) S3(0.20) S4(0.10) ) 14,000 9,000 10,000 5,000 11,300
7

D1

D2 D3 D4

11,000 9,000 8,000

10,000 10,000 10,000

8,000 10,000 11,000

7,000 11,000 13,000

9,800 9,600 9,500

Maximum expected monetary value is Tshs. 11,300 that corresponds to decision D1. Thus, optimal decision under the EMV criterion is to go for D1. b) To determine the value of perfect information (EVPI), first we need to generate a regret matrix. The following table provides regret values with EOL computations. Decisions States of Nature S1(0.50 S2(0.20) S3(0.20) S4(0.10) ) 0 1,000 1,000 8,000 3,000 0 2,000 6,000 5,000 0 1,000 2,000 6,000 0 0 0 EOL

D1 D2 D3 D4

1,200 2,500 2,900 3,000

Therefore, EPVI is Tshs. 1,200 Question 4 XYZ Company Ltd. is contemplating on four different methods it can use to process red beans at its plant at Morogoro. These beans are sold at Tshs 1,000/= per kg after being processed. The possible markets for the processed beans are Dar es Salaam, Mwanza, Dodoma and Arusha. The variable costs of processing 200,000kg of the red beans using the four methods and then transporting them to the potential markets are provided in the table below:

Variable costs of processing 200,000 kg of red beans (Tshs. 000) Decision States of Nature s Dar Mwan Dodo Arusha za ma Method 140,0 90,00 100,0 50,000 1 00 0 00 Method 110,0 100,0 80,00 75,000 2 00 00 0 Method 90,00 95,00 100,0 115,00 3 0 0 00 0 Method 80,00 100,0 110,0 125,00 4 0 00 00 0 Required: a) Which method would you recommend to XYZ Company Ltd. using Maximin approach? b) Which method would you recommend to XYZ Company Ltd. using Maximax approach? c) Suppose that you wished to use EMV decision approach to reach the optimal decision, which method would you have recommended? d) In connection to part (c) above, suppose all the 200,000 kg of red beans are sold, what should be the expected contribution? Solution a) The table below provides the Maximin analysis. Tshs. 000 Decision Minimum pay off Method 1 140,000 Method 2 110,000

Method 3 Method 4

115,000 125,000

Maximum pay off is Tshs. 110,000 that corresponds to Method 2. Thus, XYZ Company should go for Method 2 using Maximin approach b) The table below provides the Maximax analysis. Tshs. 000 Decision Maximum pay off Method 1 50,000 Method 2 75,000 Method 3 90,000 Method 4 80,000 Maximum pay off is Tshs. 50,000 that corresponds to Method 1. Thus, XYZ Company should go for Method 1 using Maximax approach. Since we are required to use EMV criterion but we do not have probabilities, we apply rationale approach. That is we assign equal probabilities and then compute EMVs. The table below provides the EMV computations. Tshs. 000 Decision EMV Method 1 95,000 Method 2 91,250 Method 3 100,000
10

Method 4

103,750

Highest EMV is 91,250,000 that correspond to Method 2. This is therefore the decision to take using EMV approach.
c)

If all the 200,000 kg of red beans are sold, expected revenues will be 200,000 1,000 = 200,000,000. Thus, expected contribution will be 200,000,000 91,250,000. This will amount to Tshs. 108,750,000.

Question 5 Solartronics is considering marketing a do it yourself solar hot water heating unit. The board of directors must decide whether or not to commit $1 million to develop a kit that even a child can assemble. Based on results of the survey reported by the head of marketing, they decided to pursue further development. If the results of the development effort are favourable (p = 0.80), they will market the product. They must then decide on whether to market at a high level, medium level or low level. If they market at a high level and demand is high (p = 0.60), they will earn $8 million. If the demand is low (p = 0.40), a loss of $1.5 will be sustained. If they market at a medium level and demand is high, they will earn $5 million. I demand is low they will earn $1 million. If marketed at low level and demand is high, they will earn $1 million. However, if the demand is low, a loss of $0.5 million will be sustained. Required: Conduct a decision tree analysis of this situation (Hint: before drawing the decision tree, explain sequentially the decision situations and the outcomes).

11

Solution Steps are: 1) Make a decision on whether to develop the product of not. 2) After making that decision, there will be a situation of outcomes, which are to anticipate favourable or unfavourable development. 3) In case of favourable development, then another decision regarding the level of marketing is required. The alternative decisions, which are open to the decision-maker, are to decide on whether to market at a high level, medium level or low level. 4) Finally, whatever the decision that is taken, there will be demand situations that may intervene the decisions, these are; to have high demand level or low demand level. The tree diagram is shown below:
US $ 8mill
$ m .5 -1

ill

High demand

0.6

US

Low demand High demand 0.4

m $5 US

ill

0.6

E(HLM) = 4.2
High level marketing

Low deman d
Medium level marketing
E(MLM) = 3.4

$ US

ill 1m
ill

0.4
and High dem

1m S$ U

Low level marketing

Favourable outcome

0.6 Lo w de 0.4

0.8

E(LLM) = 0.4 Unfavourable outcome

-1 mill 0.2 US$

m an

d
-0.5 US$

E(D) = 3.16
p e lo ev D

US$

Do n ot de v

elop

12

Computations of expected monetary values are provided below as follows:

arketing 1 E(M Hedium levelarketing ) =) ,000 000 ,000 .0.6 + ,000 ,0000.4 .4 4,200 ,000 . . igh level m m 8= 5, ,000 0 6 1,500 ,000 0 = = 3,400 ,000

Other expected monetary values are:

E(L ow level m arketing ) =1,000 ,000 0.6 500 ,000 0.4 =400 ,000

E ( D ve p ) = 4,2 0 ,0 0 .8 ,0 0 ,0 0 .2 =3,1 0 ,0 0 e lo 0 0 0 1 0 0 0 6 0 a d E ( D n t d e p ) =0. n o o ev lo

13

Question 7 Karibu Textile Mills at Mbagala is currently facing a problem on its packaging machine at the plant. Regarding the specific problem, there are 48 hours of manufacturing time to go before a scheduled shutdown for repairs. One of the machines major parts has developed visible defects, which have not yet had any effect on production. However, it may suddenly fail at anytime in the next 48 hours of production operations and, therefore, force an emergency shutdown. Based on these conditions, the production foreman can take one of the two alternatives. He can shutdown the plant now and repair the machine on a planned basis, which will take four hours since servicemen are available. Alternatively, he can continue with production operations but run the risk of a sudden breakdown, which will require eight hours due to the need to call in the mechanics, make repairs and restart the machine. In both cases, production time is evaluated to be worth Tshs 100,000. Any lost time can be calculated by this hourly rate. Experience with this packaging machine indicates that there are 8 chances in 10 in making it through the 48 hours of normal operation without a breakdown. On the other hand, there is a 0.99 probability of the machine holding up during the 48 hours after a shutdown for repairs now. Required: a) Draw a decision tree for this statistical decision problem. b) Advise the foreman on the decision to take so as to maximise expected returns to the plant on the optimal use of machine time. Solution a) Decision tree for the problem is provided below:

14

Tshs 3,600,000

Breakdown

0.01
Tshs 4,400,000

No breakdown
E(SP) = 4,392,000

Shut plant

0.99
Tshs 4,000,000

Continue production
E(CP) = 4,640,000

0.2

Breakdown

No breakdown 0.8
Tshs 4,800,000

15

Computations are: Shut the plant option: If there happens breakdown within shut down, total number of lost hours will be 4 + 8 = 12. Thus pay off will be 100,000 (48 12) = 3,600,000. If there is no breakdown within the 48 hours of shutting down the machine, total number of lost hours will be 4. Pay off for this case will be 100,000 (48 4) = 4,400,000. Continue production option: If there happens breakdown, total number of lost hours will be 8. This will make the pay off to amount to 100,000 (48 8) = 4,000,000. Alternatively, if there is no breakdown, pay off will be 48 100,000 = 4,800,000. Computations of expected monetary values are also provided below:
E(S hut plant ) = 3,600 ,0 0.8 +4,4 ,000 0.2 = 4,3 ,000 . 00 00 92 ) = 4,000 ,000 0.01 +4,800 ,000 0.99 = 4,640 ,000 E (C ont . P oduction r

b) The foreman should continue with normal operation, the option that will provide highest expected monetary value of Tshs. 4,640,000.

16