Quantitative Decision Models I

73220
Lecture 02
 Agenda
● Review of last class
– Course outline, introduction to QDM
● Break-even analysis
– Graphical, algebraic, and Excel
● Next class
Example: Ponderosa Development
Corp.

Ponderosa Development Corporation

(PDC) is a small real estate developer that builds
only one style house. The selling price of the house is
$115,000.
Land for each house costs $55,000 and lumber,
supplies, and other materials run another $28,000 per
house. Total labor costs are approximately $20,000 per
house.
Example: Ponderosa Development
Corp.
Ponderosa leases office space for $2,000
per month. The cost of supplies, utilities, and
leased equipment runs another $3,000 per month.
The one salesperson of PDC is paid a commission
of $2,000 on the sale of each house. PDC has seven
permanent office employees whose monthly salaries
are given on the next slide.
Example: Ponderosa Development
Corp.

Employee Monthly Salary

President $10,000
VP, Development 6,000
VP, Marketing 4,500
Project Manager 5,500
Controller 4,000
Office Manager 3,000
Receptionist 2,000
 Example: Ponderosa Development
Corp.
● Question:
Identify all costs and denote the marginal cost and
marginal revenue for each house.
● Answer:
The monthly salaries total $35,000 and monthly office
lease and supply costs total another $5,000. This $40,000
is a monthly fixed cost.
The total cost of land, material, labor, and sales
commission per house, $105,000, is the marginal cost for a
house.
The selling price of $115,000 is the marginal revenue
per house.
 Example: Ponderosa Development
Corp.
● Question:
Write the monthly cost function c (x), revenue
function r (x), and profit function p (x).
● Answer:
c (x) = variable cost + fixed cost = 105,000x +
40,000
r (x) = 115,000x
p (x) = r (x) - c (x) = 10,000x - 40,000
Example: Ponderosa Development
Corp.
● Question:
What is the breakeven point for monthly sales
of the houses?
● Answer:
r (x ) = c (x )
115,000x = 105,000x + 40,000
Solving, x = 4.
 Example: Ponderosa Development
Corp.

● Question:
What is the monthly profit if 12 houses
per
month are built and sold?
● Answer:

p (12) = 10,000(12) - 40,000 = $80,000

monthly profit
 Example: Ponderosa Development
Corp.
1200
Total Revenue =
Thousands of Dollars

1000
115,000x
800
600
Total Cost =
400
40,000 +
200 105,000x
Break-Even Point = 4 Houses
0
0 1 2 3 4 5 6 7 8 9 10
Number of Houses Sold (x)

1
 Using Excel for Breakeven Analysis

■ A spreadsheet software package such as Microsoft

Excel can be used to perform a quantitative analysis of
Ponderosa Development Corporation.
■ We will enter the problem data in the top portion of
the spreadsheet.
■ The bottom of the spreadsheet will be used for model
development.

1
Example: Ponderosa Development
Corp.
● Formula Spreadsheet
A B
1 PROBLEM DATA
2 Fixed Cost $40,000
3 Variable Cost Per Unit $105,000
4 Selling Price Per Unit $115,000
5 MODEL
6 Sales Volume
7 Total Revenue =B4*B6
8 Total Cost =B2+B3*B6
9 Total Profit (Loss) =B7-B8

1
Example: Ponderosa Development
Corp.
● Question
What is the monthly profit if 12 houses
per month are built and sold?

1
Example: Ponderosa
Development Corp.
● Spreadsheet Solution
A B
1 PROBLEM DATA
2 Fixed Cost $40,000
3 Variable Cost Per Unit $105,000
4 Selling Price Per Unit $115,000
5 MODEL
6 Sales Volume 12
7 Total Revenue $1,380,000
8 Total Cost $1,300,000
9 Total Profit (Loss) $80,000

1
 Example: Ponderosa Development
Corp.
● Question:
What is the breakeven point for monthly sales of the
houses?
● Spreadsheet Solution:
– One way to determine the break-even point using a
spreadsheet is to use the Goal Seek tool.
– Microsoft Excel’s Goal Seek tool allows the user to
determine the value for an input cell that will cause the
output cell to equal some specified value.
– In our case, the goal is to set Total Profit to zero (i.e.,
breakeven point) by seeking an appropriate value for
Sales Volume.

1
 Example: Ponderosa Development
Corp.
● Spreadsheet Solution: Goal Seek Approach

Using Excel ’s Goal Seek Tool

Step 1: Select the Tools pull-down menu
Step 2: Choose the Goal Seek option
Step 3: When the Goal Seek dialog box appears:
Enter B9 in the Set cell box
Enter 0 in the To value box
Enter B6 in the By changing cell box
Select OK

1
Example: Ponderosa Development
Corp.
● Spreadsheet Solution: Goal Seek Approach
Completed Goal Seek Dialog Box

1
Example: Ponderosa Development
Corp.
● Spreadsheet Solution: Goal Seek Approach
A B
1 PROBLEM DATA
2 Fixed Cost $40,000
3 Variable Cost Per Unit $105,000
4 Selling Price Per Unit $115,000
5 MODEL
6 Sales Volume 4
7 Total Revenue $460,000
8 Total Cost $460,000
9 Total Profit (Loss) $0

1
Range Name for Spreadsheet Model

● Define names for cells and use range names in the

formulae.
● Insert  Name  Define…
● Shortcut to define a name: click on the name box
(to the left of formula bar above the spreadsheet)
and directly input a name.
● To replace cell labels (row and column reference)
with range names, go to Insert  Name  Apply.
● To paste all range names used in the current
workbook, go to Insert  Name  Paste

1
Special Products Break-Even
Analysis
● The Special Products Company produces expensive and
unusual gifts.
● The latest new-product proposal is a limited edition
grandfather clock.
● Data:
– If they go ahead with this product, a fixed cost of $50,000 is
incurred.
– The variable cost is $400 per clock produced.
– Each clock sold would generate $900 in revenue.
– A sales forecast will be obtained.

Question: Should they produce the clocks, and if

so, how many?

2
Mathematical Model of the Problem

● Decision variable:
– Q = Number of grandfather clocks to produce
● Costs:
– Fixed Cost = $50,000 (if Q > 0)
– Variable Cost = $400 Q
– Total Cost =
» 0, if Q = 0
» $50,000 + $400 Q, if Q > 0
● Profit:
– Profit = Total revenue – Total cost
» Profit = 0, if Q = 0
» Profit = $900Q – ($50,000 + $400Q) = –$50,000 + $500Q, if Q > 0

2
 
Graphical Analysis
$

$200,000

$160,000
Revenue = $900 x
Profit

$120,000

Fixed cost Cost = $50,000 + $400 x
$80,000

Loss
$40,000

0 40 80 120 160 200 x

Break­even point = 100 units

2
 Spreadsheet Model
Data Results
Unit Revenue $900 Total Revenue $270,000 Range Name Cell
Fixed Cost $50,000 Total Fixed Cost $50,000
FixedCost C5
Marginal Cost $400 Total Variable Cost $120,000
Sales Forecast 300 Profit (Loss) $100,000 MarginalCost C6
ProductionQuantity
C9
Production Quantity 300 Profit F7
SalesForecast C7
Results TotalFixedCost F5
Total Revenue =UnitRevenue*MIN(SalesForecast,ProductionQuantity) TotalRevenue F4
Total Fixed Cost =IF(ProductionQuantity>0,FixedCost,0)
Total Variable Cost =MarginalCost*ProductionQuantity TotalVariableCostF6
Profit (Loss) =TotalRevenue-(TotalFixedCost+TotalVariableCost) UnitRevenue C4

2
Useful Excel Functions
● MIN (range or numerical values) gives the
minimum of several numerical values.
● MAX (range or numerical values) gives the
maximum of several numerical values.
● IF(a, b, c): a is a logical statement. If a is true, it
returns a value of b; otherwise, it returns a value
of c.
● Use Tools  Goal Seek to find break-even point.
Note: Be cautious to analyze the solution to make
sure it makes sense. You may try your initial
production quantity of 300 to see what happens.

2
 Next Class
● Do some break-even analysis problems in
Chapter 1.
● Read Chapter 2 – Linear Programming
● Bring to class
– Notes for next class

YOU LEARN DECISION ANALYSIS BY

DOING DECISION ANALYSIS!!