QUANTITATIVE ANALYSIS

AND DECISION MAKING

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Chapter 1
Introduction
§ Body of Knowledge
§ Problem Solving and Decision Making
§ Quantitative Analysis and Decision Making
§ Models of Cost, Revenue, and Profit
§ Quantitative Methods in Practice

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 Problem Solving & Decision Making
§ Problem solving – the process of identifying a difference between the actual and the
desired state of affairs and the taking action to resolve the difference
§ Decision making – generally associated with the first five steps of the problem-solving
process
Define the Problem

Identify the Alternatives

Decision
Determine the Criteria
Making

Problem
Evaluate the Alternatives
Solving

Choose an Alternative

Implement the Decision Decision

< The Relationship between Problem Solving and Decision Making >

Evaluate the Results

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Quantitative Analysis and Decision Making

Decision-Making Process

• Problems in which the objective is to find the best solution with respect to
one criterion are referred to as single-criterion decision problems.
• Problems that involve more than one criterion are referred to as multi-
criteria decision problems.
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 Quantitative Analysis and Decision Making

Analysis Phase of Decision-Making Process

Qualitative Analysis
• based largely on the manager’s judgment and experience
• includes the manager’s intuitive “feel” for the problem
• is more of an art than a science

Quantitative Analysis and Decision Making

Analysis Phase of Decision-Making Process

Quantitative Analysis
• analyst will concentrate on the quantitative facts or data
associated with the problem
• analyst will develop mathematical expressions that
describe the objectives, constraints, and other relationships
that exist in the problem
• analyst will use one or more quantitative methods to make
a recommendation

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 Quantitative Analysis
§ Quantitative Analysis Process
• Model Development
• Data Preparation
• Model Solution
• Report Generation

Model Development -- Advantages of Models

§ Generally, experimenting with models (compared to
experimenting with the real situation):
• requires less time
• is less expensive
• involves less risk
§ The more closely the model represents the real situation, the
more accurate the conclusions and predictions will be.

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 Mathematical Models
§ Objective Function – a mathematical expression that describes
the problem’s objective, such as maximizing profit or minimizing
cost
• Consider a simple production problem.
• Suppose x denotes the number of units produced and sold
each week
• The firm’s objective is to maximize total weekly profit.
• With a profit of $10 per unit, the objective function is 10x.

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Mathematical Models
Constraints – a set of restrictions or limitations, such as production
capacities
o To continue our example, a production capacity constraint would be
necessary if, for instance, 5 hours are required to produce each unit and
only 40 hours are available per week. The production capacity constraint
is given by 5x < 40.
o The value of 5x is the total time required to produce x units; the symbol
indicates that the production time required must be less than or equal to
the 40 hours available.

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 Mathematical Models

Uncontrollable Inputs – environmental factors that are not

under the control of the decision maker
In the preceding mathematical model,
the profit per unit ($10), the production time per unit (5
hours)
The production capacity (40 hours) are environmental
factors not under the control of the manager or decision
maker.

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Mathematical Models

Decision Variables – controllable inputs; decision alternatives

specified by the decision maker, such as the number of units
of a product to produce.
In the preceding mathematical model, the production
quantity x is the controllable input to the model.

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 Mathematical Models

A complete mathematical model for our simple production

problem is:

Maximize P = 10x … objective function

Subject to (s.t.)

5x ≤ 40 … constraints
X≥0 … constraints

[The second constraint reflects the fact that it is not possible to

manufacture a negative number of units.]

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Mathematical Models
Deterministic Model – if all uncontrollable inputs to the model
are known and cannot vary
Stochastic (or Probabilistic) Model – if any uncontrollable are
uncertain and subject to variation
Stochastic models are often more difficult to analyze.
• In our simple production example, if the number of hours
of production time per unit could vary from 3 to 6 hours
depending on the quality of the raw material, the model
would be stochastic.

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 Mathematical Models
Cost/benefit considerations must be made in selecting an
appropriate mathematical model.

Frequently a less complicated (and perhaps less precise)

model is more appropriate than a more complex and accurate
one due to cost and ease of solution considerations.

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Transforming Model Inputs into Output

Uncontrollable Inputs
(Environmental Factors)

Controllable
Output
Inputs Mathematical
(Projected
(Decision Model
Results)
Variables)

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 Quantitative Analysis
§ Quantitative Analysis Process
• Model Development
• Data Preparation
• Model Solution
• Report Generation

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Data Preparation
§ Data preparation is not a trivial step, due to the time required
and the possibility of data collection errors.
§ A model with 50 decision variables and 25 constraints could
have over 1,300 data elements!
§ Often, a fairly large database is needed.
§ Information systems specialists might be needed.

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 Quantitative Analysis
§ Quantitative Analysis Process
• Model Development
• Data Preparation
• Model Solution
• Report Generation

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Model Solution
§ The analyst attempts to identify the alternative (the set of decision
variable values) that provides the “best” output for the model.
§ The “best” output is the optimal solution.
§ If the alternative does not satisfy all of the model constraints, it is
rejected as being infeasible, regardless of the objective function
value.
§ If the alternative satisfies all of the model constraints, it is feasible
and a candidate for the “best” solution.

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 Model Solution
§ Trial-and-Error Solution for Production Problem
Production Projected Total Hours Feasible Solution
Quantity Profit of Production (Hours Hours Used < 40 40)

0 0 0 Yes
2 20 10 Yes
4 40 20 Yes
6 60 30 Yes
8 80 40 Yes
10 100 50 No
12 120 60 No

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Quantitative Analysis – Model Development (ctn’d)

< Flow Chart for the Production Model >

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 Report Generation
§ A managerial report, based on the results of the model, should
be prepared.
§ The report should be easily understood by the decision maker.
§ The report should include:
• the recommended decision
• other pertinent information about the results (for example,
how sensitive the model solution is to the assumptions and
data used in the model)

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Models of Cost, Revenue, and Profit

Iron Works, Inc. manufactures two products made from steel and
just received this month's allocation of b pounds of steel. It takes a1
pounds of steel to make a unit of product 1 and a2 pounds of steel to
make a unit of product 2.
Let x1 and x2 denote this month's production level of product 1
and product 2, respectively. Denote by p1 and p2 the unit profits for
products 1 and 2, respectively.
Iron Works has a contract calling for at least m units of product 1
this month. The firm's facilities are such that at most u units of
product 2 may be produced monthly.

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 Example: Iron Works, Inc.
Mathematical Model
The total monthly profit =
(profit per unit of product 1) x (monthly production of product 1) +
(profit per unit of product 2) x (monthly production of product 2)
= p 1x1 + p 2x2

We want to maximize total monthly profit:

Max p1x1 + p2x2

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Example: Iron Works, Inc.

Mathematical Model (continued)
• The total amount of steel used during monthly production =
(steel required per unit of product 1) x (monthly production of product 1) +
(steel required per unit of product 2) x (monthly production of product 2)
= a 1x1 + a2x 2

This quantity must be less than or equal to the allocated b

pounds of steel:
a 1x1 + a 2x2 < b

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 Example: Iron Works, Inc.
Mathematical Model (continued)
• The monthly production level of product 1 must be greater than
or equal to m :
x1 > m
• The monthly production level of product 2 must be less than or
equal to u :
x2 < u
• However, the production level for product 2 cannot be negative:
x2 > 0
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Example: Iron Works, Inc.

§ Mathematical Model Summary
Max p1x1 + p2x2 Constraints
Objective s.t. a1x1 + a2x2 < b
Function
x1 > m
x2 < u
“Subject to”
x2 > 0

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 Example: Iron Works, Inc.
§ Question:
Suppose b = 2000, a1 = 2, a2 = 3, m = 60, u = 720,
p1 = 100, p2 = 200. Rewrite the model with these specific
values for the uncontrollable inputs.

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Example: Iron Works, Inc.

§ Answer:
Substituting, the model is:
Max 100x1 + 200x2
s.t. 2x1 + 3x2 < 2000
x1 > 60
x2 < 720
x2 > 0

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 Example: Iron Works, Inc.
§ Question:
The optimal solution to the current model is x1 = 60 and
x2 = 626 If the product were engines, explain why this is
not a true optimal solution for the "real-life" problem.

Answer:
One cannot produce and sell 2/3 of an engine. Thus the
problem is further restricted by the fact that both x1 and x2 must
be integers. (They could remain fractions if it is assumed these
fractions are work in progress to be completed the next month.)
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Example: Iron Works, Inc.

Uncontrollable Inputs

$100 profit per unit Prod. 1

$200 profit per unit Prod. 2
2 lbs. steel per unit Prod. 1
3 lbs. Steel per unit Prod. 2
2,000 lbs. steel allocated
60 units minimum Prod. 1
720 units maximum Prod. 2
0 units minimum Prod. 2

60 units Prod. 1 Max 100(60) + 200(626.67) Profit = $131,333.33

626.67 units Prod. 2 s.t. 2(60) + 3(626.67) < 2000 Steel Used = 2,000
60 > 60
Controllable Inputs 626.67 < 720 Output
626.67 > 0

Mathematical Model

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 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.

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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 7 permanent office
employees whose monthly salaries are given on the next slide.

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 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

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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.

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 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 = 105,000 x + 40,000
r (x) = 115,000 x
p (x) = r (x) - c (x) = 10,000 x - 40,000

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Example: Ponderosa Development Corp.

§ Question:
What is the breakeven point for monthly sales
of the houses?

Answer:
r (x ) = c (x )
115,000 x = 105,000 x + 40,000
Solving, x = 4.

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 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

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Example: Ponderosa Development Corp.

1200
Total Revenue =
1000
115,000x
Thousands of Dollars

800

600

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

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 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.

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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

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 Example: Ponderosa Development Corp.

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

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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

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