1. Chapter 2 Introduction Influence Diagrams BASIC PROFIT MODEL

2. Introduction

3. In building spreadsheets for deterministic models, we will look at: ways to translate the black box representation into a spreadsheet model. recommendations for good spreadsheet model design and layout suggestions for documenting your models useful features of Excel for modeling and analysis

4. PriceRevenue received from selling units Total Revenue Fixed Cost Variable Costs Overhead Costs Sunk Costs Total Costs

5. Profit Breakeven Point Crossover Point

6. Examples

7. Step 1: Study the Environment and Frame the Situation The Pies are then processed and sold to local grocery stores in order to generate a profit. Follow the three steps of model building. Example 1: Simon Pie Critical Decision: Setting the wholesale pie price Decision Variable: Price of the apple pies (this plus cost parameters will determine profits) Two ingredients combine to make Apple Pies: Fruit and frozen dough

8. Step 2: Formulation Model Using “Black Box” diagram, specify cost parameters The next step is to develop the logic inside the black box. A good way to approach this is to create an Influence Diagram. Pie Price Unit Cost, Filling Unit Cost, Dough Unit Pie Processing Cost Fixed Cost An Influence Diagram pictures the connections between the model’s exogenous variables and a performance measure (e.g., profit). Exogenous Variables Profit

9. Black Box View of Simon Pie Model MODEL Unit Cost, Filling Pie Price Unit Cost, Dough Fixed Cost Unit Pie Processing Cost Profit

10. Influence Diagram

11. To create an Influence Diagram: start with a performance measure variable. Further decompose each of the intermediate variables into more related intermediate variables. Decompose this variable into two or more intermediate variables that combine mathematically to define the value of the performance measure. Continue this process until an exogenous variable is defined (i.e., until you define an input decision variable or a parameter).

12. performance measure variable Profit Start here: Decompose this variable into the intermediate variables Revenue and Total Cost

13. Profit Revenue Total Cost Now, further decompose each of these intermediate variables into more related intermediate variables...

14. Profit Revenue Total Cost Pies Demanded Pie Price Unit Pie Processing Cost Fixed Cost Processing Cost Ingredient Cost Unit Cost Filling Unit Cost Dough Required Ingredient Quantities

15. Step 3: Model Construction Based on the previous Influence Diagram, create the equations relating the variables to be specified in the spreadsheet.

16. Profit Revenue Total Cost Profit = Revenue – Total Cost

17. Profit Revenue Pie Price Pies Demanded Revenue = Pie Price * Pies Demanded

18. Fixed Cost Processing Cost Ingredient Cost Profit Total Cost Total Cost = Processing Cost + Ingredients Cost + Fixed Cost

19. Processing Cost = Pies Demanded * Unit Pie Processing Cost Processing Cost Total Cost Pies Demanded Unit Pie Processing Cost Profit

20. Ingredients Cost = Qty Filling * Unit Cost Filling + Qty Dough * Unit Cost Dough Ingredient Cost Profit Total Cost Unit Cost Filling Unit Cost Dough Required Ingredient Quantities

21. Examples