Professor Dongwook Shin Fall 2021

ISOM2700 Operations Management

Practice Questions Set #6

1. (Forecasting) Historical demand for a product is

Demand
January 12
February 11
March 15
April 12
May 16
June 15

a. Using a weighted moving average with weights of 0.6, 0.3, and 0.1, find the July forecast.
FJuly = .60(15) + .30(16) + .10(12) = 15.0

b. Using a simple three-month moving average, find the July forecast.

FJuly = (15 + 16 + 12) / 3 = 14.3

c. Using an exponential smoothing with 𝛼 = 0.2 and a June forecast = 13, find the July forecast.
Make whatever assumptions you wish.
FJuly = FJune + α(AJune – FJune) = 13 + 0.2(15-13) = 13.4

d. Using simple linear regression analysis, calculate the regression equation for the preceding
demand data.

e. t y ty t2
1 12 12 1
2 11 22 4
3 15 45 9
4 12 48 16
5 16 80 25
6 15 90 36
Total 21 81 297 91
Average 3.5 13.5

t = 3.5
y = 13.5
b= åty - nt y = 0.77
åt - nt
2 2

a = y - bt = 10.8
 ISOM2700 Practice Questions Set 6

e. Using the regression equation in d, calculate the forecast for July.

Y7 = a + b*7 = 10.8 + .77t = 10.8 + .77(7) = 16.2

2. (Forecasting) Harlen Industries has a simple forecasting model: Take the actual demand for the same
month last year and divide that by the number of fractional weeks in that month. This gives the
average weekly demand for that month. This weekly average is used as the weekly forecast for the
same month this year. This technique was used to forecast eight weeks for this year, which are
shown below along with the actual demand that occurred. The following eight weeks show the
forecast (based on last year) and the demand that actually occurred:

Week Forecast Actual

1 140 137
2 140 133
3 140 150
4 140 160
5 140 180
6 150 170
7 150 185
8 150 205

a. Compute the MAD.

For month 8, the MAD is 23.75

b. Compute the tracking signal.

The tracking signal for month 8 is 7.16

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3. (Capacity-based RM) Inn at Penn has 200 rooms. For regular-fare customers, rooms are priced at
$300 per night while the rooms are priced at $700 per night for the high-paying customers who
generally arrive at the last minute. The demand for such high fare customers is distributed normally
with mean 60 and standard deviation 50. Assume that there is ample demand for regular-fare
customers.

a. What should the protection level for the high fare be to maximize expected profit?

Underage Cost = Cu = Cost of holding too few rooms (lost sales) = High fare room price - Regular fare room
price = 700 - 300 = $400
Overage Cost = Co = Cost of holding too many rooms (leftover) = Regular fare room price - Salvage value =
300 - 0 = $300
Cu/(Cu+Co)=(700-300)/700=0.5714, z=0.18, Q=60+50*0.18=69.

b. Suppose that the Inn at Penn operates with the protection level of 80 rooms for high fare
customers. What is the probability that there are at least 5 rooms left unoccupied?

For 5 rooms to be left, demand for high-fare rooms should be less than 75. z=(75-60)/50=0.3, Φ(z)=62%.

4. (Capacity-based RM) JetRed Airways flies several daily flights from Philadelphia to Chicago. Based
on historical data, the flight on Wednesday evening before Thanksgiving is always sold-out.
However, there are usually no-shows so the airline decides to improve revenues by overbooking.
The no-shows are Poisson-distributed with mean 8 and the airline estimates that the cost of bumping
a passenger is about 10 times more than ticket price.

Num. No Shows x Pr (Number of No show <= x)

1 0.00
2 0.01
3 0.04
4 0.10
5 0.19
6 0.31
7 0.45
8 0.59
9 0.72
10 0.82
11 0.89
12 0.94
13 0.97
14 0.98
15 0.99
16 1.00

a. How many seats should JetRed overbook?

Co=10*Cu

So Cu/(Cu+Co)=1/(1+10)=0.091

From the probability distribution table above, the cumulative probability of 4 no shows = 0.10 is just higher than
0.091. Therefore, JetRed should overbook 4 seats.

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b. JetRed management is dreading bad publicity around Thanksgiving so it decides instead that
it does not want to bump passengers more than 5% of the time. What is the maximum
number of seats that JetRed can overbook?

x = Number of overbooking; y = Number of no shows; T = Total number of seats

Pr(T + x – y > T) = Pr(y < x)
Since x and y are integers, Pr(y ≤ x – 1).
Pr(Bumping passengers) < 0.05
Pr(y ≤ x – 1) < 0.05
When x=4, the company faces a probability of 4% that there are 3 or fewer no-shows.

5. (Capacity-based RM) HK4 is a television station that has 25 thirty-second advertising slots during
each evening. It is early January and the station is selling advertising for Sunday, March 24. They
could sell all of the slots right now for $4,000 each, but, because on this particular Sunday the station
is televising the Oscar ceremonies, there will be an opportunity to sell slots during the week right
before March 24 for a price of $10,000. For now, assume that a slot not sold in advance and not sold
during the last week is worthless to HK4. To help make this decision, the salesforce has created the
following probability distribution for last-minute sales:

Number of Pr(Exactly x
slots, x slots are sold)
8 0.00
9 0.05
10 0.10
11 0.15
12 0.20
13 0.10
14 0.10
15 0.10
16 0.10
17 0.05
18 0.05
19 0.00

a. How many slots should HK4 sell in advance?

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 ISOM2700 Practice Questions Set 6

Cu = Cost of reserving too few slots right before March 24 = 10000 – 4000 = $6000; Co = Cost of
reserving too many slots right before March 24 = 4000 - 0 = $4000
Prob(D ≤ Q) = Cu / (Co + Cu) = 0.6
From the table, the optimal protection quantity is 13. Therefore, HK4 should sell 25 – 13 = 12 slots in
advance.

b. In practice, there are companies willing to place standby advertising messages: if there is an
empty slot available (i.e., this slot was not sold either in advance or during the last week), the
standby message is placed into this slot. Since there is no guarantee that such a slot will be
available, standby messages can be placed at a much lower cost. Now suppose that if a slot is not
sold in advance and not sold during the last week, it will be used for a standby promotional
message that costs advertisers $2,500. Now how many slots should HK4 sell in advance?

Cu = Cost of reserving too few slots right before March 24 = 10000 – 4000 = $6000
Co = Cost of reserving too many slots right before March 24 = 4000 – 2500 = $1500
Prob(D ≤ Q) = Cu / (Co + Cu) = 0.8
From the table, the optimal protection quantity is 15. Therefore, HK4 should sell 25 – 15 = 10 slots in
advance.

c. Suppose HK4 chooses a booking limit of 10 slots on advanced sales. In this case, what is the
probability there will be slots left over for stand-by messages?

If the booking limit is 10, there are 15 slots for last-minute sales. There will be standby messages if there
are 14 or fewer last-minute sales, which has probability 0.7.

d. One problem with booking for March 24 in early January is that advertisers will withdraw their
commitment to place the ad (typically this is a result of changes in promotional strategies; for
example, a product may be found to be inferior or an ad may tum out to be ineffective). Because
of such opportunistic behavior by advertisers, media companies often overbook advertising
slots. HK4 estimates that in the past the number of withdrawn ads has a distribution as follows.

S Pr(The number of
withdraws ≤ S)
0 0.00012
1 0.00123
2 0.00623
3 0.02123
4 0.05496
5 0.11569
6 0.20678
7 0.32390
8 0.45565
9 0.58741
10 0.70599

Assume each withdrawn ad slot can still be sold at a standby price of $2,500 although the
company misses an opportunity to sell these slots at $4,000 a piece. Any ad that was accepted by
HK4 but cannot be accommodated because there isn't a free slot costs the company $10,000 in
penalties. How many slots (at most) should be sold?

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Cu = Cost of selling too few slots = 4000 – 2500 = $1500; Co = Cost of selling too many slots = $10000
Prob(D ≤ Q) = Cu / (Co + Cu) = 0.1304
From the Probability Distribution Function Table,
Prob(D ≤ 5) = F(5) = 0.11569, Prob(D ≤ 6) = F(6) = 0.20678, so the optimal overbooking quantity is 6,
that is, sell up to 25 + 6 = 31 slots.

6. (Price-based RM) HKUST Center for the Arts is planning a concert by Hong Kong Philharmonic
Orchestra. A recent survey from staffs and students of HKUST reveals the willingness-to-pay for the
concert as follows:

WTP (HKD) Demand if

price = WTP
150 1
125 10
100 32
75 72
50 97
25 113

a. What is the revenue-maximizing price for the concert?

WTP (HKD) Demand if Revenue

price = WTP
150 1 150
125 10 1,250
100 32 3,200
75 72 5,400
50 97 4,850
25 113 2,825

The revenue-maximizing price is 75 HKD.

b. Estimate the parameters (a, b) of a linear demand model, D(p) = a – bp, using the WTP information.
What is the revenue-maximizing price based on the linear demand model?

∑/-01 x- y- − nx3y3
b∗ = − /
4-01 x-5 − nx3 5
a∗ = y3 − b∗ x3

(Note: the formula for b* here is different from that in the lecture note, the demand formula in lecture
note is D(p) = a + bp, where the formula here is D(p) = a – bp.)

a* = 140.27

b* = 0.984
Optimal price = a/2b = 140.27 / (2*0.984) = 71.275 HKD

c. HKUST Center for the Arts wishes to differentiate the price for staffs and students. The following
table presents the detailed information about willingness-to-pay for staffs and students,
respectively. What is the revenue-maximizing prices for staffs and students based on the WTP
information? Is it worthwhile differentiating prices for staffs and students?

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 ISOM2700 Practice Questions Set 6

WTP (HKD) Demand if Staff demand Students

price = WTP if price = demand if price
WTP = WTP
150 1 1 0
125 10 9 1
100 32 22 10
75 72 30 42
50 97 39 58
25 113 52 61

WTP (HKD) Staff demand if Revenue from Students demand Revenue from
price = WTP Staff if price = WTP Students

150 1 150 0 0
125 9 1,125 1 125

100 22 2,200 10 1,000

75 30 2,250 42 3,150

50 39 1,950 58 2,900
25 52 1,300 61 1,525

For both staffs and students, the profit-maximizing price is 75 HKD.

As the profit-maximizing price is the same as that without price differentiation, it is not worth-while to
differentiate prices between staffs and students.

7. (Capacity-based RM) An airline offers two fare classes for coach seats on a particular flight: full-fare
(H) class at $440/ticket and discount fare (I) class at $218/ticket. There are 230 coach seats on the
aircraft. Discount fare tickets must be purchased at least three weeks in advance, and these tickets
are expected to sell out. The demand for tickets at full fare is estimated to have the following discrete
distribution:

Demand for tickets

at full price Probability Cum.Prob.
40 0.0200 0.0200
41 0.0600 0.0800
42 0.0400 0.1200
43 0.0100 0.1300
44 0.0600 0.1900
45 0.0700 0.2600
46 0.0200 0.2800
47 0.0300 0.3100
48 0.0300 0.3400
49 0.0500 0.3900
50 0.0300 0.4200
51 0.0500 0.4700
52 0.0400 0.5100
53 0.0600 0.5700

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54 0.0900 0.6600
55 0.1100 0.7700

a. What’s the optimal protection level for full fare tickets?

Underage Cost = Cost of protecting too few seats = $440-$218 = $222

Overage Cost = Cost of protecting too many seats = $218
F(Q) = critical fractile = 222/(222+218) = 0.505
Protection level = 52

b. What’s the optimal booking limit for low-fare seats?

Protection level = 52
Booking limit = 230 - 52 = 178

8. (Capacity-based RM) Doubletree in Austin has 150 standard rooms. Doubletree generally sells those
rooms through two channels, one through their own website, call center and front desk usually at a
high rate and the other through agencies like Priceline at a low rate. Suppose Doubletree charges a
high rate at $120 per room per night through their own channel (they never mark down the price
through their own explicit channel to avoid any bad gambling image which hurts reputation) while
“implicitly” sells some rooms to the agencies at a low rate of $50 per room per night. Bargain
customers who seek low rate usually will buy far in advance of the premium customers through the
agency channel.

To make it simple, suppose the customers always stay for one night, there is ample demand from the
bargain customers for the low rate, and the number of premium customers is however uncertain,
which is distributed according to the following table:

Number of high fare customers Probability

90 0.10
100 0.15
110 0.15
120 0.20
130 0.25
140 0.15

a. How many rooms shall Doubletree sell to the agencies like Priceline in advance?

Decision variable Q = how many rooms to reserve for the high fare customer
Cost of underage Cu = Cost of reserving too few rooms for high fare customers= 120 - 50 = $70.
Cost of overage Co = Cost of reserving too many rooms for high fare customers = 50 - 0 = $50.

The critical ratio=70/(70+50)=0.583. Therefore, we want to find optimal Q such that

Pr (number of high fare customers <= Q) = 0.583.

The cumulative probability of 120 high fare customers = 0.6, which is just higher than the critical fractile. The
smallest such Q is 120. Hence, the optimal protection level is 120 rooms and Double tree shall sell 150-120=30
rooms in advance to the agencies.

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b. What is expected total revenue of Doubletree from both channels (using your solution from part
(1))?

The revenue from the agencies = 30*$50=$1,500;

The expected revenue from the premium customers is: $120*(90*0.1+100*0.15+110*0.15+120*(0.2+0.25+0.15))
= $13,500
Thus the expected total revenue they have is 1,500 + 13,500 = $15,000.

c. The number of no-shows at Doubletree has a distribution as that in the following table.
Doubletree estimates the cost of bumping a customer is $200. What is the optimal maximum
number of reservations to accept per day (suppose overbooked rooms are only sold to the
agency channel at $50)?
Number of no-shows Probability
0 0.05
1 0.05
2 0.10
3 0.15
4 0.15
5 0.20
6 0.20
7 0.10

Decision variable Q = number of overbooking

Cost of underage Cu=50.

Cost of overage Co=200.
The critical ratio=50/(50+200)=0.2

The smallest number Q such that Pr (the number of no-shows <= Q) = 0.2 is 2.
Therefore, they should overbook 2 rooms and book a maximum of 150 + 2 = 152 rooms.

Both Co =200 (cost of dumping a customer already takes into account the revenue collected during the
overbooking) and Co=200-50=150 will receive full credit, since the wording in the description is not precise
enough.

Alternative Solution:
Cu=50, Co=150
The critical ratio=50/(50+150)=0.25

The smallest number Q such that Pr (the number of no-shows <= Q) = 0.25 is 3.
Therefore, they should overbook 3 rooms and book a maximum of 153 rooms.

9. (Capacity-based RM) Le Meridien in San Francisco has 160 rooms. The hotel has an ample low fare
demand at the room rate of $200 per night, but the demand from the high fare class which pays $450
per night on average, is uncertain. The high fare demand is normally distributed with mean 60 and
standard deviation 42.

a. How many rooms should Le Meridien protect for high fare customers to maximize expected
revenue? (Leave your answer in decimal form, i.e., no need to round to an integer value.)

Cost of underage = Cost of protecting too few rooms = $450-$200 = $250; cost of overage = Cost of
protecting too many rooms = 200 - 0 = $200; the critical ratio = Cu / (Cu + Co) = 250/450 = 0.556. We
find the z-statistic in the Standard Normal Distribution Function Table on page 419 of the textbook such

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that F(z) = critical ratio. The ratio 0.556 falls between F(0.13) and F(0.14), we choose the entry with the
higher z, i.e., z = 0.14. Finally, we convert the chosen z into Q: Q = µ + z x σ = 60 + 0.14 x 42 = 65.88

b. Suppose Le Meridien sets a booking limit of 110 for low fare customers. What is the
probability that a high fare customer turns away due to a lack of rooms?

Setting the booking limit at 110 rooms implies a protection level of 50 rooms for the high fare customers.
P(A high fare customer turns away)
= P( N(60,422) > 50 )
= P( (N(60,422)-60)/42 > (50-60)/42)
= P( N(0,1) > -0.2381 )
= 1 – P( N(0,1) < -0.2381 )
= 1 – 0.4059
= 0.5941
Minor rounding error is acceptable.

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