Lesson

Introduction to Management Science

Topics
1. The Management Science Process
2. Pioneers of Management Science
3. Decision Model
4. Break-even Analysis

Learning Outcomes:

After completing this chapter, the students will be able to:

1. Define different terminologies relating to Management

Science. 2. Determine the Management Science Approaches
and its business applications.
3. Recognize the Pioneers of Management Science.
4. Determine the break-even points in sales and units.
5. Analyze the changes of different cost functions.
6. Apply break-even analysis in business operations.

Management science plays a significant role in business decision making.

The applications of management science techniques are recognized, and they
have been found useful in increasing the efficiency and productivity of business
firms. Survey results show that the use of management science in the
organization is valuable. Management science (also referred to as operations
research, quantitative methods, quantitative analysis, decision sciences, and
business analytics) is part of the fundamental curriculum of most programs in
business.

In order to help managers in making better decision, management science

can be applied. It helps in solving management problems through step by step
process of different quantitative techniques. Management science comprises a
large number of both quantitative and qualitative techniques. Quantitative
factors in solving problems and qualitative factors in interpreting the result.
Management science cannot only be applied in business but can also be used in
different related studies such as engineering, statistics and natural sciences.

Topic 1 The Management Science Process

Scientific method of solving problems and management science are

closely related. These techniques both involve systematic and logical process in
 solving problems.
The steps of the scientific method
are (1) observation, (2) problem
definition, (3) model construction,
(4) model solution, and
(5) implementation.

Dr. Vannevar Bush

Topic 2 Pioneers of Management
Science

Although a number of the mathematical

techniques that make up management
science date to the turn of the twentieth
century or before, the field of management
science itself can trace its beginnings to
military operations research (OR) groups
formed during World War II in Great Britain Dr. James B.
circa 1939. These OR groups typically Conant
find solutions to military-related problems.
consisted of a team of about a dozen
One of the most famous of these groups—
individuals from different fields of science,
called “Blackett’s circus” after its leader,
mathematics, and the
Nobel Laureate P. M. S. Blackett of the
military, brought together to
University of Manchester and a former naval
officer—included three physiologists, two
mathematical physicists, one astrophysicist,
one general physicist, two mathematicians,
an Army officer, and a surveyor. Blackett’s
group and the other OR teams made
significant contributions in improving
Britain’s early-warning radar system (which was instrumental in their victory in
the Battle of Britain), aircraft gunnery, antisubmarine warfare, civilian defense,
convoy size determination, and bombing raids over Germany

The successes achieved by the British OR groups were observed by two

Americans working for the U.S. military, Dr. James B. Conant and Dr. Vannevar
Bush, who recommended that OR teams be established in the U.S. branches of
the military. Subsequently, both the Air Force and Navy created OR groups.

After World War II, the contributions of the OR groups were considered so
valuable that the Army, Air Force, and Navy set up various agencies to continue
research of military problems. Two of the more famous agencies were the Navy’s
Operations Evaluation Group at MIT and Project RAND, established by the Air
Force to study aerial warfare. Many of the individuals who developed OR and
management science techniques did so while working at one of these agencies
after World War II or as a result of their work there.
As the war ended and the mathematical models and techniques that were
kept secret during the war began to be released, there was a natural inclination
to test their applicability to business problems. At the same time, various
consulting firms were established to apply these techniques to industrial and
business problems, and courses in the use of quantitative techniques for
business management began to surface in American universities. In the early
1950s, the use of these quantitative techniques to solve management problems
became known as management science, and it was popularized by a book of that
name by Stafford Beer of Great Britain.

Topic 3 Decision Model

Identify the problem

Obtain necessary
information and
Identify and evaluate
make estimates the available
alternatives, then
choose the best
alternative
Implement the decision Evaluate the result of the decision
implemented to
provide feedback.

We may not be aware of how often we make decisions in our everyday

life. When we choose attending classes or watching movies, wearing school
uniform or a civilian, reviewing for an exam or browsing the internet, buying a
book or buying a new pair of shoes, etc., we usually make decisions, for decision
making means choosing the best solutions among alternative courses of action.
The decision making process does not exist when there is only one course of
action, given the fact, that one has no option to disregard the available course of
action.
The person who usually identifies a problem is the manager because
manager works in places where problem might occur. However, problems can
often be identified by an individual who is capacitated to identify problems
especially of those who are skilled in the techniques of management science.
 Decision model is a formal method used by managers for making a choice.
It often involves both quantitative and qualitative analyses.
Basic steps in a decision model.

A. IDENTIFY THE PROBLEM. The very first step in the decision making process is
identifying and recognizing the problem. Since managers need to be careful in
decision making, it is of utmost important that they use management science
techniques.

The following are examples of management problems:

∙ whether to accept or reject a special order or business proposal; ∙ Whether
to make or buy a part, sub-assembly, or product line (insourcing vs.
outsourcing cases);
∙ whether to sell or process a product further;
∙ whether to continue operating or close a business segment;
∙ which is the best product-mix considering capacity constraints;
∙ how profit factors should be changed to achieve a profit goal;
∙ How much price should be charged for the company's product or services
(Pricing decisions)

B. OBTAIN NECESSARY INFORMATION AND MAKE ESTIMATES

∙ QUALITATIVE AND QUANTITATIVE INFORMATION
a. Qualitative factors – results that are not quantifiable. These outcomes
cannot be expressed in mathematical terms.
∙ Quantitative factors- results that are quantifiable. These outcomes can be
expressed in mathematical terms.
∙ RELEVANT INFORMATION - the information to be gathered should only be
related and essential to the decision-making case.
a. Relevant Costs and Revenues – these are costs related to the decision

making and may have effect in the available alternatives.

The following are relevant:

i. Differential costs – these are costs present in one alternative and absent to
another alternative.
Example: In making a decision whether to take Master’s Degree or
continue working the cost associated in choosing the degree is the tuition fee.
ii. Avoidable costs - costs that can be removed, in whole or in part, when one
alternative is chosen over another in a decision-making case.
Example: In making a decision whether to stay in a dormitory or not,
when one choses the dormitory, the transportation cost from home to
school, and vice-versa will be removed.
iii. Opportunity cost - refers to foregone benefit when one alternative is
chosen over the other.
Example: Opportunity cost in choosing to work abroad over working in
the Philippines.

The following are irrelevant:

i. Sunk cost (or Past cost) – a cost that have already been acquired. Thus, it
cannot be avoided regardless of what type of alternative to choose.
Example: Whether to enroll in a private or public, your expenses in buying
 a book is irrelevant.
⮚ Although past (sunk, historical) costs are always irrelevant in decision-
making, they may serve as a basis for making predictions.

ii. Future costs are costs that may be incurred but may not affect the alternatives.
C. IDENTIFY AND EVALUATE THE AVAILABLE ALTERNATIVES, THEN CHOOSE THE
BEST ONE
⮚ Only those related information must be gathered
⮚ As a general rule, the best alternative is the one that will give the
organization the benefits.

D. IMPLEMENT THE DECISION

E. EVALUATE THE PERFORMANCE OF THE DECISION IMPLEMENTED TO PROVIDE
FEEDBACK

Topic 4 Break-Even Analysis

Break-even Analysis
- A technique use to determine the sales volume level (in pesos or in units)
where total revenues equal total costs, that is neither profit nor loss.

Elements of Break-Even Analysis

1. Sales – refers to the monthly rental income, Sales mix

amount after multiplying the depreciation expense, and
Sales
total units sold by the selling salaries of personnel.
price per unit. 3. Variable costs – are costs
2. Total fixed costs – refers to that solely depend on the
the total costs that do not level of activity of the
Total fixed
depend on the level of
costs
activity of the organization.
These costs remain constant
regardless of the change in
activity level. For example, Variable
costs

firm. It varies directly proportional to the activity level. Thus, if activity

level increases the variable cost also increases. Examples include direct
materials, direct labor, sales commission, office supplies, and inventories.
4. Sales mix – can be obtained by dividing the contribution margin over the
sales. Where contribution margin can be obtained by deducting variable
costs from sales.

Methods of determining the Break-Even Point

A. Graphical method
B. Contribution margin method

The contribution margin income statement

 The Contribution Margin Income Statement is presented below. The formula
depicts that contribution is the difference between sales and variable costs. Two
factors are involved in computation of contribution margin, these are variable
and fixed costs.
CONTRIBUTION MARGIN INCOME STATEMENT

Sales (units x selling price) xx Less: Variable costs (units x

variable cost per unit) xx Contribution margin xx Less: Fixed
costs xx Income before tax xx

A. Single-Product Break-even Calculations

1. Break-even Point in Pesos : Where: BEPp = Break-even point in pesos FxC

= Total fixed costs
BEPp = FxC CMR = Contribution margin ratio
CMR

2. Break-even Point in Units : BEPu = FxC Where: BEPu =Break-even point in units FxC =
CM/u Total fixed costs
CM/u = Contribution margin per unit
B. Multiple-Product/Service Break-even

Calculations BEPp = FxC

WaCMR Illustrative example 1:

Where: WaCMR = Weighted average
contribution margin ratio WaUCM =
BEPu = FxC Weighted average unit contribution margin
WaUCM

Saveh Konna Company produces and sells Barbie dolls. The variable costs
to produce and sell one unit of Barbie doll amount to P15.00, while the total
fixed manufacturing, selling, and administrative costs per period are P15, 000.
The Barbie dolls are sold at P35.00 per unit. Determine the break even sales in
units and in pesos.

Contribution margin method:

Let us rewrite here our equation in the previous section:

1. Break-even Point in Pesos : BEPp = FxC =26, 316.00

CMR 2. Break-even Point in Units: BEPu = FxC
= 15, 000 CM/u
(35-15/35) = 15, 000
= 15,000 20
57% = 750 units
 Illustrative example 2:

A company sells Products A, B, and C. Data about the three products are as follows:

A B C Total
Selling price 100 120 50
Variable costs/unit 60 90 40 Contribution margin
(units) 40 30 10
Sales in units 1000 2000 5000 Total fixed costs P101, 680

1. The company’s break-even point in pesos is:

BEPp = FxC = P101, 680 = P400, 000

WaCMR 25.42%

Computation of Weighted average contribution margin ratio (a):

Product A Product B Product C Total

S* 100,000 240,000 250,000 590,000 Less : VC** 60,000 180,000 200,000
440,000 CM 40,000 60,000 50,000 150,000 *units x SP
**units x VC/u

Total CM WaCMR = 25.42%

=150,000 Total Sales 590,000

Computation of Weighted average contribution margin ratio (b):

Product A Product B Product C

(40/100) (60/240) (50/250)
CMR (CM/S) 40.00% 25.00% 20.00%
x Sales Mix Ratio (100/590)16.95% (240/590)40.68% (250/590) 42.37% WaCMR 6.78%
10.17% 8.47%

WaCMR: Product A 6.78%

Product B 10.17%
Product C 8.47%
25.42%

*Note: For purposes of computing the WaCMR, the sales mix ratio (sales mx
percentage) is determined using the sales volume in pesos.
Break down of the Break-even Sales:

Product A Product B Product C

CMR (CM/S) P40 P30 P10
x Sales Mix Ratio *(1000/8000)16.95% (2000/8000)40.68% (5000/8000) 42.37% WaCMR
 6.78% 10.17% 8.47%

Total Product A Product B Product C

(100/590)
16.95% (240/590)40.68% 250/590) 42.37%
Break-even sales 400,000 67,800 162,720 169, 480

2. The company’s break-even sales in units:

BEPu = FxC P101,680

= = 5,422.93 WaUCM P18.75

Computation of Weighted average contribution margin ratio (a):

WaUCM = Total CM 150,000

= = P18.75 Total Units 8,000

Breakdown of the Break-even Sales in units:

Total Product A Product B Product C

(1000/8000)
12.5% (2000/8000)25% (5000/8000) 62.5%
Break-even sales Or
Total Product A Product B Product C P67,
800 P162, 720 P169, 480
Break-even Peso-Sales*
5,422.93 677.87 1,355.73 3,389.33

÷ Selling Price P100 P120 P50

Break-even sales 5,422.93 677.87 1,355.73 3,389.33
Lesson One
ACTIVITIES Introduction to Management Science

Activity 1

Classify the following items as differential, avoidable,

opportunity or sunk costs. __________ 1. The cost of materials, labor, and
factory overhead items that will no longer be incurred as a result of
discontinuance of
production of a certain product line.
__________ 2. A decrease in direct labor costs of P2,000 after Ms. Minchin
chose alternative A over B.
__________ 3. Mr. Baltazar decided to work abroad for P10, 000 and lose his
present income of P6, 000.
__________ 4. The book value of an old equipment which was purchased by
the company in the past.
__________ 5. A P200 cost incurred by Mr. Sonny after taking a taxi rather
 than a bus.

Activity 2

Mr. Covid Bryan is in quandary whether to accept the job being offered by
his Uncle Sars or the job situated 15 kilometers away from his home. Covid is
currently employed as a part-time instructor in State College with a monthly
income of P18, 000. His Uncle Sars offered him a P35, 000 montly salary which he
will work as internal auditor in a private company. Also, a financial institution
called him today about his willingness in accepting the vacant position. Uncle
Sars offered him room in his house which is about two (5) kilometers away from
the company and will shoulder some of its household expenses. Additionally,
Covid will stay in the dormitory if he will be working in his town. Today, his uncle
called her and Covid immediately answers the phone call. The differential
analysis conducted by Covid are as follows:

Uncle’s Offer Vacant job

Bus ticket P900
Board and lodging fee P700 Food and household expenses P3, 000 P5,
000 Clothes to be brought to Manila P 7,000 P7,000 Personal supplies P
2,000 P2, 000 Snacks P 4,000 P 4,000 Clothing Allowance P1, 500 P1, 500

1. If the alternatives are whether to accept his uncle’s offer or accept the
vacant position, how much is the relevant cost?
2. What is the opportunity cost of accepting the job?
3. How much is the irrelevant future cost?
4. Included in Covid’s list are some costs which are considered irrelevant
because they have been incurred in the past. How much is the sunk
cost?
Activity 3

Answer the following:

1. The total fixed cost is P510, 000. The variable cost ratio is 30%. How much
is the break-even point?
2. The company’s product is sold for P30 per unit. The variable cost is 75% of
sales while total fixed amounts to P425, 000. What is the break-even point in
units? 3. Each unit of the company’s product contributes P20 to the recovery
of fixed cost
and generation of profit. Total fixed cost is P340, 00. What is the break-
even point in units?
4. At break even point of 50,000 units total fixed cost amounts to P100,000.
Assuming that the selling price is P5.00 per unit, what is the unit variable
cost? 5. The company’s contribution margin is 25% of sales. The selling price
is P50% per
unit. Total fixed cost amounts to P250,000. How many units must be sold
in order to break-even?
 Activity 4

Break-even Chart. The graph below represents the break-even chart for
Covidubidapdap Enterprises:
Pesos

Sales

Total Cost

P90, 000
A. The break-even point in pesos is
____________. B. The total fixed cost
amounts to _____________.

P20, 000

Units

C. The total variable cost at the break-even volume is __________. D.

Assuming that the selling price is P10.00 per unit, the break-even points in
units is _________.
E. Assuming that the selling price is P10.00 per unit, the variable cost per
unit is P ______; the unit contribution margin is P ________, and the
variable cost ratio and contribution margin ratio are __% and ___%
respectively.