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MANAGEMENT ADVISORY SERVICES OCTOBER 2022 BATCH

WEEK 12

TOPIC 16 - Quantitative Techniques

(Study Notes)

Quantitative Techniques
ü Also called Management Science
ü Discipline devoted to studying and developing procedures to help the process of making
decision and uses the scientific method for decision making.

Linear Programming
• It is a technique used in planning by using linear relationships of variables involved.
• It made use of certain mathematical techniques to get the best possible solution (maximum
profit or minimum costs) to a problem involving limited resources.

Properties of a Linear Programming Problem

1. The objective of the decision-maker must be either to maximize or to minimize
2. The actions of the decision-maker must be constrained and the decision variables must not
violate the limitations or the constraints.
3. All variables have a value greater than or equal to zero.
4. The relationships of variables could be expressed in terms of equation or inequalities.

Parts of a Linear Program

1. Objective Function
a. Algebraic expressions introduced by the word maximize or minimize.
b. It is an expression of the relationship between the variables (item) that the decision
maker wishes to optimize and the level of operation of the decision variables in the
problem.
2. Constraints
a. Introduced by the phrase subject to
b. These are the limitations placed on the decision maker.
c. Types of Constraints
i. Explicit Constraint – apparent limitations as expressed in the problem
ii. Implicit Constraint – implied limitations or more commonly known as the non-
negativity constraint (the variables are not supposed to be a negative value
because we cannot produce a negative number of units)

Ways to Solve a Linear Programming Problem

1. Graphical Method – can be used when there are only two variables.
2. Simplex Method – is a computational procedure for solving linear programming problems.
a. Usage of slack (less than) and surplus (more than) variable
b. Simplex table
c. Different approach between maximization and minimization problem.

The Decision Theory and Probability Analysis

ü This is a matter of selecting a single act among all the alternatives.
ü Using quantitative information in analyzing alternatives helps in minimizing mistakes.

Elements of a Decision Making Situation

1. Decision Alternative – the courses of action available to the decision maker. (To issue an
unqualified, qualified, adverse opinion)
2. States of Nature – future events which are normally not under the control of the decision
maker. (Low, Moderate, and High Risk)
3. Optimal Decision – best decision alternative
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Stepsin the Decision Theory Approach

1. List all the decision alternatives that must be considered.
2. List all the possible state of nature
3. Determine the pay-off associated with each decision alternative and state of nature
combination.
4. Estimate (if possible) the probability of occurrence of each state of nature.
5. Construct a pay-off or decision tree for the decision situation

Method of Structuring a Decision Situation

1. Pay-off Tables
a. Shows the payoff (profit, cost or any other measure of output) which would result
from each possible combination of decision alternative and state of nature.
2. Decision Trees
a. A graphical representation of a decision making situation.
b. The different alternatives and states of nature in the decision situation are represented
by the branches. – drawn from left to right.
c. Circles – nodes for state of nature
d. Square – nodes for decision alternative

Types of Decision Making Situations

1. Decision making under certainty
a. Expected Value
i. Also called as Mathematical Expectation
ii. Depends on two factors – probability of an event will occur and the amount to
be receive in relation to such event.
1. Concept of Probability
a. It is a measure of certainty.
b. The value ranges from 0 to 1 – If an event is certain to happen
the probability is 1 or 100% versus if an event is impossible to
happen the probability is zero.
iii. Computation of the Expected Value
1. EV = P(X) wherein P is the probability value and X is the amount of
money.
2. Decision making under uncertainty
a. Criteria for Decision Making
i. Maximin Criterion (Maximum of all Minimum)
1. A very pessimistic or conservative approach (assuming the worst will
happen)
ii. Maximax or Manimin Criterion (Maximum of all Maximum)
1. A very optimistic approach
2. Concentrates the attmpt to obtain the biggest payoff possible and it
completely neglects possible losses or low returns.
iii. Minimax Regret Criterion (Minimum of all Maximum Opportunity Loss)
1. Regret or Opportunity Loss
a. The relative loss resulting from the choice of an alternative given
that a particular state of nature has occurred, compared with the
best alternative under that state.
b. Highest Pay-off less other pay-off for each states of nature.
2. Look for the maximum regret for each of the decision alternative.
3. Select the minimum of all the maximum opportunity loss selected for
each decision alternative.
3. Decision making under risk
a. Expected Pay-off Criterion
i. Sometimes called as the expected monetary value
ii. The sum of weighted pay-offs for the alternative
iii. Choose the alternative with the maximum expected pay-off.
b. Expected Opportunity Loss Criterion
i. Weighted mean of the regret values associated with the alternative.
ii. Choosing the alternative with the minimum expected opportunity loss.
Value of the Perfect Information – the expected value of perfect information is the difference
between the expected value without perfect information and the return if the best action is taken
given perfect information.

Decision Tree
ü A decision tree is a planning and decision making tools which map the possible outcome and
probability of a particular scenario. It can be used by managers to determine which of a
range of possible scenarios should be chosen.
ü Procedures in drawing a decision tree
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1. The tree is to be drawn from left to right

2. A square represents a decision while a circle represents an outcome.
3. At a decision square, a branch from it represents a potential event or option attaching
the probability of such event or option happening.
4. Use the expected values at all outcome points to make decisions.
ü Evaluating the Tree
1. In evaluating a decision tree, it will be done from right to left (opposite of drawing it)
2. Calculate the expected value of each event or options indicated in each outcome circle
3. Choose the best option at each decision square
4. Recommend the option with the highest expected value.
ü Benefits of Decision Trees
1. It forces managers to consider a range of options and events than relying on emotion
or hunches
2. It allows comparisons between different options based on numerical data
3. It helps in assessing the risk involved in making a particular decision especially in
choosing a particular option.
ü Limitations of Decision Trees
1. Probabilities and outcomes are usually just estimated figures and may not be reliable
at all times.
2. Subsequent external factors may affect the likelihood of an outcome from happening
3. Decision trees do not take into consideration qualitative factors that affects a scenario
or event or the organization as a whole.

Learning Curve
ü This theory stipulates that every time the cumulative quantity of units produced is doubled,
the cumulative average time per unit is reduced by a given percentage.
ü Assumptions:
1. The time required to perform a given task becomes progressively shorter.
2. This technique is only applicable to the early stages of production or of any new task.
3. Ordinarily, the curve is expressed in a percentage of reduced time to complete a task
for each doubling of cumulative production.
ü Applications
1. Setting of prices based on estimates of expected costs
2. Scheduling labor requirements
3. Capital budgeting decisions
4. Setting incentive wage rates.
ü Computing the 3rd, 5th, 6th or those in between the doubled unit:

Where: Y – cumulative average time per unit

X – Cumulative number of units produced
a – Time required to produced the first unit
b – Factor used to calculate cumulative average time to produce units
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Quantitative Techniques (Practice Problems)

Problem 1 (Linear Programming): A furniture company produces tables and chairs and can sell
all it can produce. Each table contributes P230 to profit of the firm, and each chair contributes P125.
Production of each table requires 100 minutes in the company’s assembly center and 200 minutes in
the company’s finishing center. Production of each chair requires 140 minutes in the assembly and
120 minutes in the finishing center. The company’s assembly center is available only for 2,000
minutes a day and its finishing center is available only for 1,680 minutes a day.

Required: Construct the linear programming objective and constraints.

Problem 2 (Linear Programming): A small generator burns two types of fuel: Low sulfur and
high sulfur to produce electricity. For one hour, each gallon of low sulfur emits 2 units of sulfur
dioxide, generates 4 kilowatts electricity and costs P160. Each gallon of high sulfur emits 5 units of
sulfur dioxide, generates 4 kilowatts and costs P150. The environmental protection agency insists
that the maximum amount of sulfur dioxide that can be emitted per hour is 15 units. Suppose that
at least 16 kilowatts must be generated per hour.

Required: Construct the linear programming objective and constraints.

Problem 3 (Expected Value): A man buying a raffle ticket can win a first prize of P15,000 or a
second prize of P12,000 with probabilities of .002% and .0015%, respectively.

Required: Determine the fair price to pay for the ticket. (The fair price is equivalent to the EV)

Problem 4 (Expected Value): Pio and Sons Incorporated spends P30,000 to prepare a bid on a
construction project. If the contract is awarded, the estimated revenue will be P300,000. If the
contract is not awarded, the company has a penalty of P40,000. There is a 40% chance that the
company will be awarded the contract.
Required: Determine the expected value.

Problem 5 (Decision Theory and Decision Trees): Rex Computers is in the stage of determining
the size of computer system to be used in its computer shops. The pay-off table with the
corresponding decision alternative and state of nature follows:
Low Moderate High
Consumer Consumer Consumer
Acceptance Acceptance Acceptance
Put up a small system 500,000 700,000 1,200,000
Put up a medium-sized
300,000 1,000,000 1,600,000
system
Put up a large system (200,000) (50,000) 2,500,000
Rex Computers’ management believes that there is a 20% chance that consumer acceptance of their
computer services will be low; a 50% chance that it will be moderate, and a 30% chance it will be
high.

Required:
1. Show the decision recommendation under each of the following criteria:
a. Maximax
b. Maximin
c. Minimax Regret
2. What is the decision recommended under the expected payoff criterion? Under the expected
opportunity loss criterion?
3. What is the expected value of perfect information?
4. Draw a Decision Tree based on the table presented.

Problem 6 (Decision Theory and Decision Trees): A dealer in luxury yachts may order 1, 2 or 3
yachts for this season’s inventory but no more or less. There is P50,000 cost of carrying each excess
yacht and a P200,000 gain for each yacht sold.

Required:
1. Construct the decision pay-off table.
2. Show the decision recommendation under each of the following criteria:
a. Maximax
b. Maximin
c. Minimax Regret
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3. What is the decision recommended under the expected payoff criterion if management
estimates that there is a 20% probability that it will be able to sell 1 yacht, 50% probability
of selling 2 yacht and a 30% probability that 3 yacht will be sold? Under the expected
opportunity loss criterion?
4. What is the expected value of perfect information?
5. Draw a Decision Tree based on the table presented.

Problem 7: (Learning Curve) A particular manufacturing job is subjected to an estimated 75%

learning curve. The first unit required 50 labor hours to complete.

Required:
1. What is the cumulative average time per unit after four units are completed?
2. What is the total time required to produce 2 units?
3. How many hours are required to produce the second unit?

Problem 8 (Learning Curve): Bulacan Corporation plans to begin production of a new product on
July 1, 2019. An 80% learning curve is applicable to Bulacan’s manufacturing operations.

Required: If it is expected to take 1,000 direct labor hours to produce the first unit, how many
direct labor hours should it take to produce a total of eight units?

/mbg