To Accompany Ritzman & Krajewski Foundations of Operations Management, © 2003 Prentice Hall, Inc. All rights reserved. Supplement A Decision Making

To Accompany Ritzman & Krajewski Foundations of Operations Management, © 2003 Prentice Hall, Inc. All rights reserved. Learning Objectives Be able to apply concepts in learning goals Be able to use decision-making solvers manually –Breakeven analysis –Decision theory –Preference matrix Be able to formulate a decision tree manually and solve for optimum expected value

To Accompany Ritzman & Krajewski Foundations of Operations Management, © 2003 Prentice Hall, Inc. All rights reserved. Learning Objectives Understand & be able to apply the following formulas

To Accompany Ritzman & Krajewski Foundations of Operations Management, © 2003 Prentice Hall, Inc. All rights reserved. Break-Even Analysis 400 – 300 – 200 – 100 – 0 – Patients (Q) Dollars (in thousands) |||| Example A.1 QuantityTotal AnnualTotal Annual (patients)Cost ($)Revenue ($) (Q)(100, Q)(200Q) 0100, ,000400,000

To Accompany Ritzman & Krajewski Foundations of Operations Management, © 2003 Prentice Hall, Inc. All rights reserved. Break-Even Analysis 400 – 300 – 200 – 100 – 0 – Total annual revenues Patients (Q) Dollars (in thousands) |||| (2000, 400) Example A.1 QuantityTotal AnnualTotal Annual (patients)Cost ($)Revenue ($) (Q)(100, Q)(200Q) 0100, ,000400,000

To Accompany Ritzman & Krajewski Foundations of Operations Management, © 2003 Prentice Hall, Inc. All rights reserved. Break-Even Analysis Total annual revenues Total annual costs Patients (Q) Dollars (in thousands) 400 – 300 – 200 – 100 – 0 – |||| Fixed costs (2000, 400) (2000, 300) Example A.1 QuantityTotal AnnualTotal Annual (patients)Cost ($)Revenue ($) (Q)(100, Q)(200Q) 0100, ,000400,000

To Accompany Ritzman & Krajewski Foundations of Operations Management, © 2003 Prentice Hall, Inc. All rights reserved. Break-Even Analysis Total annual revenues Total annual costs Patients (Q) Dollars (in thousands) 400 – 300 – 200 – 100 – 0 – |||| Fixed costs Break-even quantity (2000, 400) (2000, 300) Profits Loss Example A.1 QuantityTotal AnnualTotal Annual (patients)Cost ($)Revenue ($) (Q)(100, Q)(200Q) 0100, ,000400,000

To Accompany Ritzman & Krajewski Foundations of Operations Management, © 2003 Prentice Hall, Inc. All rights reserved. Break-Even Analysis 400 – 300 – 200 – 100 – 0 – Figure A.1 Total annual revenues Total annual costs Patients (Q) Dollars (in thousands) |||| Fixed costs Break-even quantity (2000, 400) (2000, 300) Profits Loss

To Accompany Ritzman & Krajewski Foundations of Operations Management, © 2003 Prentice Hall, Inc. All rights reserved. Sensitivity Analysis 400 – 300 – 200 – 100 – 0 – Total annual revenues Total annual costs Patients (Q) Dollars (in thousands) |||| Fixed costs Profits Loss Example A.2

To Accompany Ritzman & Krajewski Foundations of Operations Management, © 2003 Prentice Hall, Inc. All rights reserved. Sensitivity Analysis 400 – 300 – 200 – 100 – 0 – Example A.2 Total annual revenues Total annual costs Patients (Q) Dollars (in thousands) |||| Fixed costs Profits Loss Forecast = 1,500

To Accompany Ritzman & Krajewski Foundations of Operations Management, © 2003 Prentice Hall, Inc. All rights reserved. Sensitivity Analysis 400 – 300 – 200 – 100 – 0 – Total annual revenues Total annual costs Patients (Q) Dollars (in thousands) |||| Fixed costs Profits Loss Example A.2 Forecast = 1,500 pQ – ( F + cQ )

To Accompany Ritzman & Krajewski Foundations of Operations Management, © 2003 Prentice Hall, Inc. All rights reserved. Sensitivity Analysis 400 – 300 – 200 – 100 – 0 – Total annual revenues Total annual costs Patients (Q) Dollars (in thousands) |||| Fixed costs Profits Loss Example A.2 Forecast = 1,500 pQ – ( F + cQ ) 200(1500) – [100, (1500)] $50,000

To Accompany Ritzman & Krajewski Foundations of Operations Management, © 2003 Prentice Hall, Inc. All rights reserved. Preference Matrix PerformanceWeightScoreWeighted Score Criterion(A)(B)(A x B) Market potential Unit profit margin Operations compatibility Competitive advantage Investment requirement Project risk Threshold score =.800

To Accompany Ritzman & Krajewski Foundations of Operations Management, © 2003 Prentice Hall, Inc. All rights reserved. Preference Matrix PerformanceWeightScoreWeighted Score Criterion(A)(B)(A x B) Market potential.30 Unit profit margin.20 Operations compatibility.20 Competitive advantage.15 Investment requirement.10 Project risk.05 Threshold score =.800

To Accompany Ritzman & Krajewski Foundations of Operations Management, © 2003 Prentice Hall, Inc. All rights reserved. Preference Matrix PerformanceWeightScoreWeighted Score Criterion(A)(B)(A x B) Market potential.30.8 Unit profit margin Operations compatibility.20.6 Competitive advantage Investment requirement.10.2 Project risk.05.4 Threshold score =.800

To Accompany Ritzman & Krajewski Foundations of Operations Management, © 2003 Prentice Hall, Inc. All rights reserved. Preference Matrix PerformanceWeightScoreWeighted Score Criterion(A)(B)(A x B) Market potential Unit profit margin Operations compatibility Competitive advantage Investment requirement Project risk Threshold score =.800

To Accompany Ritzman & Krajewski Foundations of Operations Management, © 2003 Prentice Hall, Inc. All rights reserved. Preference Matrix PerformanceWeightScoreWeighted Score Criterion(A)(B)(A x B) Market potential Unit profit margin Operations compatibility Competitive advantage Investment requirement Project risk Weighted score =.750 Threshold score =.800

To Accompany Ritzman & Krajewski Foundations of Operations Management, © 2003 Prentice Hall, Inc. All rights reserved. Preference Matrix PerformanceWeightScoreWeighted Score Criterion(A)(B)(A x B) Market potential Unit profit margin Operations compatibility Competitive advantage Investment requirement Project risk Weighted score =.750 Threshold score =.800 < 800

To Accompany Ritzman & Krajewski Foundations of Operations Management, © 2003 Prentice Hall, Inc. All rights reserved. Preference Matrix PerformanceWeightScoreWeighted Score Criterion(A)(B)(A x B) Market potential Unit profit margin Operations compatibility Competitive advantage Investment requirement Project risk Weighted score =.750 Threshold score =.800 Not At This Time

To Accompany Ritzman & Krajewski Foundations of Operations Management, © 2003 Prentice Hall, Inc. All rights reserved. Under Certainty AlternativeLowHigh Small facility Large facility Do nothing00 Possible Future Demand

To Accompany Ritzman & Krajewski Foundations of Operations Management, © 2003 Prentice Hall, Inc. All rights reserved. Under Certainty AlternativeLowHigh Small facility Large facility Do nothing00 Possible Future Demand If future demand will be low —

To Accompany Ritzman & Krajewski Foundations of Operations Management, © 2003 Prentice Hall, Inc. All rights reserved. Under Certainty AlternativeLowHigh Small facility Large facility Do nothing00 Possible Future Demand If future demand will be low—Choose the small facility.

To Accompany Ritzman & Krajewski Foundations of Operations Management, © 2003 Prentice Hall, Inc. All rights reserved. Under Certainty AlternativeLowHigh Small facility Large facility Do nothing00 Possible Future Demand If future demand will be low—Choose the small facility.

To Accompany Ritzman & Krajewski Foundations of Operations Management, © 2003 Prentice Hall, Inc. All rights reserved. Under Uncertainty AlternativeLowHigh Small facility Large facility Do nothing00 Possible Future Demand

To Accompany Ritzman & Krajewski Foundations of Operations Management, © 2003 Prentice Hall, Inc. All rights reserved. Under Uncertainty AlternativeLowHigh Small facility Large facility Do nothing00 Possible Future Demand Maximin —

To Accompany Ritzman & Krajewski Foundations of Operations Management, © 2003 Prentice Hall, Inc. All rights reserved. Under Uncertainty AlternativeLowHigh Small facility Large facility Do nothing00 Possible Future Demand Maximin— Best of the worst

To Accompany Ritzman & Krajewski Foundations of Operations Management, © 2003 Prentice Hall, Inc. All rights reserved. Under Uncertainty AlternativeLowHigh Small facility Large facility Do nothing00 Possible Future Demand Maximin—Small Best of the worst

To Accompany Ritzman & Krajewski Foundations of Operations Management, © 2003 Prentice Hall, Inc. All rights reserved. Under Uncertainty AlternativeLowHigh Small facility Large facility Do nothing00 Possible Future Demand Maximin - Small Maximax -

To Accompany Ritzman & Krajewski Foundations of Operations Management, © 2003 Prentice Hall, Inc. All rights reserved. Under Uncertainty AlternativeLowHigh Small facility Large facility Do nothing00 Possible Future Demand Maximin—Small Maximax— Best of the best

To Accompany Ritzman & Krajewski Foundations of Operations Management, © 2003 Prentice Hall, Inc. All rights reserved. Under Uncertainty AlternativeLowHigh Small facility Large facility Do nothing00 Possible Future Demand Maximin—Small Maximax—Large Best of the best

To Accompany Ritzman & Krajewski Foundations of Operations Management, © 2003 Prentice Hall, Inc. All rights reserved. Under Uncertainty AlternativeLowHigh Small facility Large facility Do nothing00 Possible Future Demand Maximin—Small Maximax—Large Laplace—

To Accompany Ritzman & Krajewski Foundations of Operations Management, © 2003 Prentice Hall, Inc. All rights reserved. Under Uncertainty AlternativeLowHigh Small facility Large facility Do nothing00 Possible Future Demand Maximin—Small Maximax—Large Laplace— Best weighted payoff Small facility0.5(200) + 0.5(270) = 235

To Accompany Ritzman & Krajewski Foundations of Operations Management, © 2003 Prentice Hall, Inc. All rights reserved. Under Uncertainty AlternativeLowHigh Small facility Large facility Do nothing00 Possible Future Demand Maximin—Small Maximax—Large Laplace— Best weighted payoff Small facility0.5(200) + 0.5(270) = 235 Large facility0.5(160) + 0.5(800) = 480

To Accompany Ritzman & Krajewski Foundations of Operations Management, © 2003 Prentice Hall, Inc. All rights reserved. Under Uncertainty AlternativeLowHigh Small facility Large facility Do nothing00 Possible Future Demand Maximin—Small Maximax—Large Laplace—Large Best weighted payoff Small facility0.5(200) + 0.5(270) = 235 Large facility0.5(160) + 0.5(800) = 480

To Accompany Ritzman & Krajewski Foundations of Operations Management, © 2003 Prentice Hall, Inc. All rights reserved. Under Uncertainty AlternativeLowHigh Small facility Large facility Do nothing00 Possible Future Demand Maximin—Small Maximax—Large Laplace—Large Minimax Regret—

To Accompany Ritzman & Krajewski Foundations of Operations Management, © 2003 Prentice Hall, Inc. All rights reserved. Under Uncertainty AlternativeLowHigh Small facility Large facility Do nothing00 Possible Future Demand Maximin—Small Maximax—Large Laplace—Large Minimax Regret— Best worst regret Regret Low DemandHigh Demand Small facility200 – 200 = 0800 – 270 = 530

To Accompany Ritzman & Krajewski Foundations of Operations Management, © 2003 Prentice Hall, Inc. All rights reserved. Under Uncertainty AlternativeLowHigh Small facility Large facility Do nothing00 Possible Future Demand Maximin—Small Maximax—Large Laplace—Large Minimax Regret— Best worst regret Regret Low DemandHigh Demand Small facility200 – 200 = 0800 – 270 = 530 Large facility200 – 160 = – 800 = 0

To Accompany Ritzman & Krajewski Foundations of Operations Management, © 2003 Prentice Hall, Inc. All rights reserved. Under Uncertainty AlternativeLowHigh Small facility Large facility Do nothing00 Possible Future Demand Maximin—Small Maximax—Large Laplace—Large Minimax Regret—Large Best worst regret Regret Low DemandHigh Demand Small facility200 – 200 = 0800 – 270 = 530 Large facility200 – 160 = – 800 = 0

To Accompany Ritzman & Krajewski Foundations of Operations Management, © 2003 Prentice Hall, Inc. All rights reserved. Under Uncertainty AlternativeLowHigh Small facility Large facility Do nothing00 Possible Future Demand Maximin—Small Maximax—Large Laplace—Large Minimax Regret—Large

To Accompany Ritzman & Krajewski Foundations of Operations Management, © 2003 Prentice Hall, Inc. All rights reserved. Under Risk AlternativeLowHigh Small facility Large facility Do nothing00 Possible Future Demand P low = 0.4 P high = 0.6

To Accompany Ritzman & Krajewski Foundations of Operations Management, © 2003 Prentice Hall, Inc. All rights reserved. Under Risk AlternativeLowHigh Small facility Large facility Do nothing00 Possible Future Demand P low = 0.4 P high = 0.6 AlternativeExpected Value Small facility0.4(200) + 0.6(270) = 242

To Accompany Ritzman & Krajewski Foundations of Operations Management, © 2003 Prentice Hall, Inc. All rights reserved. Under Risk AlternativeLowHigh Small facility Large facility Do nothing00 Possible Future Demand P low = 0.4 P high = 0.6 AlternativeExpected Value Small facility0.4(200) + 0.6(270) = 242 Large facility0.4(160) + 0.6(800) = 544

To Accompany Ritzman & Krajewski Foundations of Operations Management, © 2003 Prentice Hall, Inc. All rights reserved. Under Risk Highest Expected Value AlternativeLowHigh Small facility Large facility Do nothing00 Possible Future Demand P low = 0.4 P high = 0.6 AlternativeExpected Value Small facility0.4(200) + 0.6(270) = 242 Large facility0.4(160) + 0.6(800) = 544

To Accompany Ritzman & Krajewski Foundations of Operations Management, © 2003 Prentice Hall, Inc. All rights reserved. Perfect Information AlternativeLowHigh Small facility Large facility Do nothing00 Possible Future Demand P low = 0.4 P high = 0.6

To Accompany Ritzman & Krajewski Foundations of Operations Management, © 2003 Prentice Hall, Inc. All rights reserved. Perfect Information AlternativeLowHigh Small facility Large facility Do nothing00 Possible Future Demand P low = 0.4 P high = 0.6 EventBest Payoff Low demand200 High demand800

To Accompany Ritzman & Krajewski Foundations of Operations Management, © 2003 Prentice Hall, Inc. All rights reserved. Perfect Information EventBest Payoff Low demand200EV perfect = 200(0.4) + 800(0.6) = 560 High demand800 AlternativeLowHigh Small facility Large facility Do nothing00 Possible Future Demand P low = 0.4 P high = 0.6

To Accompany Ritzman & Krajewski Foundations of Operations Management, © 2003 Prentice Hall, Inc. All rights reserved. Perfect Information AlternativeLowHigh Small facility Large facility Do nothing00 Possible Future Demand P low = 0.4 P high = 0.6 EventBest Payoff Low demand200EV perfect = 200(0.4) + 800(0.6) = 560 High demand800EV imperfect = 160(0.4) + 800(0.6) = 544

To Accompany Ritzman & Krajewski Foundations of Operations Management, © 2003 Prentice Hall, Inc. All rights reserved. Perfect Information AlternativeLowHigh Small facility Large facility Do nothing00 Possible Future Demand P low = 0.4 P high = 0.6 EventBest Payoff Low demand200EV perfect = 200(0.4) + 800(0.6) = 560 High demand800EV imperfect = 160(0.4) + 800(0.6) = 544 Value of perfect information = $560,000 - $544,000

To Accompany Ritzman & Krajewski Foundations of Operations Management, © 2003 Prentice Hall, Inc. All rights reserved. Perfect Information AlternativeLowHigh Small facility Large facility Do nothing00 Possible Future Demand P low = 0.4 P high = 0.6 EventBest Payoff Low demand200EV perfect = 200(0.4) + 800(0.6) = 560 High demand800EV imperfect = 160(0.4) + 800(0.6) = 544 Value of perfect information = $16,000

To Accompany Ritzman & Krajewski Foundations of Operations Management, © 2003 Prentice Hall, Inc. All rights reserved. Decision Trees = Event node = Decision node E i = Event i P(E i ) = Probability of event i 1st decision Possible 2nd decision Payoff 1 Payoff 2 Payoff 3 Alternative 3 Alternative 4 Alternative 5 Payoff 1 Payoff 2 Payoff 3 E 1 [P(E 1 )] E 2 [P(E 2 )] E 3 [P(E 3 )] E 2 [P(E 2 )] E 3 [P(E 3 )] E 1 [P(E 1 )] Alternative 1 Alternative 2 Payoff 1 Payoff 2 12

To Accompany Ritzman & Krajewski Foundations of Operations Management, © 2003 Prentice Hall, Inc. All rights reserved. Decision Trees Small facility Large facility 1

To Accompany Ritzman & Krajewski Foundations of Operations Management, © 2003 Prentice Hall, Inc. All rights reserved. Decision Trees Small facility Large facility Low demand [0.4] Don’t expand Expand $200 $223 $270 High demand [0.6] 1 2

To Accompany Ritzman & Krajewski Foundations of Operations Management, © 2003 Prentice Hall, Inc. All rights reserved. Decision Trees Low demand [0.4] Small facility Large facility Low demand [0.4] Don’t expand Expand Do nothing Advertise $200 $223 $270 $40 $800 Modest response [0.3] Sizable response [0.7] $20 $220 High demand [0.6] 1 2 3

To Accompany Ritzman & Krajewski Foundations of Operations Management, © 2003 Prentice Hall, Inc. All rights reserved. Decision Trees Low demand [0.4] Small facility Large facility Low demand [0.4] Don’t expand Expand Do nothing Advertise $200 $223 $270 $40 $800 Modest response [0.3] Sizable response [0.7] $20 $220 High demand [0.6] 1 2 3

To Accompany Ritzman & Krajewski Foundations of Operations Management, © 2003 Prentice Hall, Inc. All rights reserved. Decision Trees Low demand [0.4] Small facility Large facility Low demand [0.4] Don’t expand Expand Do nothing Advertise $200 $223 $270 $40 $800 Modest response [0.3] Sizable response [0.7] $20 $220 High demand [0.6] (20) + 0.7(220)

To Accompany Ritzman & Krajewski Foundations of Operations Management, © 2003 Prentice Hall, Inc. All rights reserved. Decision Trees $160 Low demand [0.4] Small facility Large facility Low demand [0.4] Don’t expand Expand Do nothing Advertise $200 $223 $270 $40 $800 Modest response [0.3] Sizable response [0.7] $20 $220 High demand [0.6] (20) + 0.7(220)

To Accompany Ritzman & Krajewski Foundations of Operations Management, © 2003 Prentice Hall, Inc. All rights reserved. Decision Trees $160 Low demand [0.4] $160 Small facility Large facility Low demand [0.4] Don’t expand Expand Do nothing Advertise $200 $223 $270 $40 $800 Modest response [0.3] Sizable response [0.7] $20 $220 High demand [0.6] $270

To Accompany Ritzman & Krajewski Foundations of Operations Management, © 2003 Prentice Hall, Inc. All rights reserved. Decision Trees ($160) Low demand [0.4] $270 $160 Small facility Large facility Low demand [0.4] Don’t expand Expand Do nothing Advertise $200 $223 $270 $40 $800 Modest response [0.3] Sizable response [0.7] $20 $220 High demand [0.6] (200) + 0.6(270) 0.4(160) + 0.6(800)

To Accompany Ritzman & Krajewski Foundations of Operations Management, © 2003 Prentice Hall, Inc. All rights reserved. Decision Trees ($160) Low demand [0.4] $270 $160 Small facility Large facility $242 $544 Low demand [0.4] Don’t expand Expand Do nothing Advertise $200 $223 $270 $40 $800 Modest response [0.3] Sizable response [0.7] $20 $220 High demand [0.6] (200) + 0.6(270) 0.4(160) + 0.6(800)

To Accompany Ritzman & Krajewski Foundations of Operations Management, © 2003 Prentice Hall, Inc. All rights reserved. Decision Trees $160 Low demand [0.4] $270 $160 Small facility Large facility $544 $242 $544 Low demand [0.4] Don’t expand Expand Do nothing Advertise $200 $223 $270 $40 $800 Modest response [0.3] Sizable response [0.7] $20 $220 High demand [0.6] 1 2 3

To Accompany Ritzman & Krajewski Foundations of Operations Management, © 2003 Prentice Hall, Inc. All rights reserved. Decision Trees $160 Low demand [0.4] $270 $160 Small facility Large facility $544 $242 $544 Low demand [0.4] Don’t expand Expand Do nothing Advertise $200 $223 $270 $40 $800 Modest response [0.3] Sizable response [0.7] $20 $220 High demand [0.6] 1 2 3