UNIVERSITY OF SAINT LOUIS-TUGUEGARAO

School of Business Administration and Accountancy, 2013-2014

Junior Philippine Institute of Accountants
MEMORY AID IN MANAGEMENT ADVISORY SERVICES
Any form of reproduction of this copy is strictly prohibited!!!

CHAPTER 14:
Quantitative Techniques in Business
RATIONALE IN USING QUANTITATIVE TECHNIQUES ☛COMMONLY USED QUANTITATIVE MODELS
1. Probability Analysis
 Managers aim to influence the future. To do 2. Decision Tree
that, the future must be predicted. Second, 3. Gantt Chart
plans must be in place. Third, actions should 4. Program Evaluation and Review Technique
be controlled to see to it that it conforms to (PERT)
the plan. Moreover, Management 5. Linear Programming
accountants use quantitative techniques in 6. Queuing
developing the necessary information 7. Learning Curves
needed by management in carrying out 8. Sensitivity Analysis
their functions that include planning, 9. Regression Analysis
controlling, and decision-making. 10. Present Values
11. Inventory Models
QUANTITATIVE MODELS
(OR MATHEMATICAL MODELS ) PROBABILITY ANALYSIS

 Real-life decision situations are modeled ☛PROBABILITY ANALYSIS

mathematically under certain assumptions  commonly used in planning, as well as in
in order to achieve a deterministic solution. decision- making under uncertainty. It deals
with a chance that a future event may or
☛SIMULATION may not occur.
 a technique for experimenting with
mathematical/ logical models using a  DECISION-MAKING UNDER
computer. CERTAINTY – for each decision
alternative, there is only one
☛STEPS IN THE SIMULATION PROCEDURE event, and therefore only one
a. Defining the objective outcome. The event has a 100%
b. Formulating the model – the variables, their chance of occurrence.
behavior, and their interrelationships are
spelled out in precise logical/ mathematical  DECISION- MAKING UNDER
terms. CODITIONS OF RISK– the
c. Validating the model – to ensure realistic probability distribution of the
result of the experiment possible future states of nature is
d. Designing the experiment – involves known.
sampling the operation of the system.
e. Conducting the simulation and evaluating  DECISION-MAKING UNDER
the results CONDITIONS OF UNCERTAINTY –
each decision alternative has

Management Advisory Services (MAS) Committee: Hazeleen Martinez; Jimmy Joe Miranda; Cliff Mark Confidente;
89 Corina Bariuan; Kristina Gaddon; Rizalyn Taguibao ;Niῆo Rey Mangupag; Marjhon Maramag; Leo Jay Labasan
Adviser: Mary Queen Ramos, CPA
 UNIVERSITY OF SAINT LOUIS-TUGUEGARAO
School of Business Administration and Accountancy, 2013-2014
Junior Philippine Institute of Accountants
MEMORY AID IN MANAGEMENT ADVISORY SERVICES
Any form of reproduction of this copy is strictly prohibited!!!

several events or outcomes. The  CONDITIONAL PROBABLITY - one event will

probability distribution of the occur given that the other event has already
possible future states of nature occurred.
(events) is not known and must be  INDEPENDENT EVENTS - the occurrence of
determined subjectively. one event has no effect on the other event.
 DEPENDENT EVENTS - the occurrence of
☛PROBABILITY DISTRIBUTION one event has an effect on the other event.
 specifies the values of the variables and  PAYOFF – the value assigned to the
their respective probabilities. different outcome from a decision

☛PROBABILITY ☛EXPECTED VALUE

 a mathematical expression of doubt or  The expected value of an action is
assurance about the occurrence of a chance calculated by multiplying the probability of
event. Its value varies from zero (0) to one each outcome by its payoff and summing
(1) or 100% the products. Expected value represents the
long-term average payoff from repeated
PROBABILITY OF 0 - the event cannot occur trials.
PROBABILIT OF 1 OR 100% – the event is
certain to occur ☛PAY OFF (DECISION) TABLE
PROBABILITY BETWEEN O AND 1 –  presents the outcomes (payoffs) of specific
indicates the likelihood of the event’s occurrence. decisions when certain states of nature
(events which are not controllable by the
☛TYPES OF PROBABILITIES decision-maker) occur. The payoff table is a
1. OBJECTIVE PROBABILITIES – calculated helpful tool for identifying the best solution
from either logic or actual experience. For given several decision alternatives and
example, the probability that a coin will future conditions that involve risk.
yield heads is 0.50 or 50% on any singe toss.
2. SUBJECTIVE PROBABILITIES – estimates of
the likelihood of future events are based on EXPECTED VALUE OF PERFECT INFORMATION
judgment and past experience.
Example: The likelihood that a winner in an ☛Perfect Information
amateur singing contest will become a  the knowledge that a future state of nature
successful recording artist (event) will occur with certainty. In this
case, it is assumed that the probability
☛BASIC TERM USED IN PROBABILITY ANALYSIS distribution is an accurate representation of
the relative frequency of future demand
 MUTUAL EXCLUSIVE - if two events cannot and that the decision maker knows exactly
occur simultaneously when each possible event will occur.
 JOINT PROBABILIITY - both events will
occur ☛EXPECTED VALUE OF PERFECT INFORMATION

Management Advisory Services (MAS) Committee: Hazeleen Martinez; Jimmy Joe Miranda; Cliff Mark Confidente;
90 Corina Bariuan; Kristina Gaddon; Rizalyn Taguibao ;Niῆo Rey Mangupag; Marjhon Maramag; Leo Jay Labasan
Adviser: Mary Queen Ramos, CPA
 UNIVERSITY OF SAINT LOUIS-TUGUEGARAO
School of Business Administration and Accountancy, 2013-2014
Junior Philippine Institute of Accountants
MEMORY AID IN MANAGEMENT ADVISORY SERVICES
Any form of reproduction of this copy is strictly prohibited!!!

 the difference between the expected value 1. Identify the decision points and the
without perfect information and the result chance points
if the best action is taken given perfect 2. Determine the events that may result
information from the chance points.
3. Determine the outcome (payoffs) of
☛COST OF PERFECT INFORMATION each event, as well as their estimated
 Management may have the opportunity to probabilities.
acquire additional information that may 4. Compute the expected values of the
help in choosing the best alternative. outcomes
However, obtaining information requires 5. Evaluate the results and choose the
incurrence of cost. best course of action.

DECISION TREE GANTT CHART

☛DECISION TREE ☛GANTT CHART (or Bar Chart)

 a graphic representation of the decision  shows the different activities or tasks in a
points, the alternative courses of action project, as well as their estimated start and
available to the decision maker, and the completion times.
possible outcomes from each alternative, as
well as the relative probabilities and the ☛ADVANTAGES:
expected values of each event 1. A gantt chart is simple to construct and use
requiring no special tools or mathematics. It
☛ADVANTAGES OF USING DECISION TREE can be used on all types of projects.
1. Decision trees facilitate the evaluation 2. A gantt chart is a very useful control tool. As
of alternatives by giving the decision the project progresses, actual completion
maker a visual presentation of the time can be compared with the plan.
expected results of each alternative. 3. A gantt chart can be used to monitor the
2. Decision trees are useful when activities in a project. It shows which
sequential decisions are involved activity should be in progress as of a certain
date and how close it is to completion time.
☛LIMITATIONS OF DECISION TREE
1. It may be difficult to determine all the ☛DISADVANTAGE
possible events, outcomes, and their  A gantt chart does not show the
probabilities. interrelationships among the activities in a
2. A case involving so many events and project. Only simple relationships can be
sequential decision may result into a shown on the chart.
more complex decision tree which may
not be that easy to use. PROGRAM EVALUATION AND REVIEW TECHNIQUE
(PERT)
☛STEPS IN PREPARING A DECISION TREE

Management Advisory Services (MAS) Committee: Hazeleen Martinez; Jimmy Joe Miranda; Cliff Mark Confidente;
91 Corina Bariuan; Kristina Gaddon; Rizalyn Taguibao ;Niῆo Rey Mangupag; Marjhon Maramag; Leo Jay Labasan
Adviser: Mary Queen Ramos, CPA
 UNIVERSITY OF SAINT LOUIS-TUGUEGARAO
School of Business Administration and Accountancy, 2013-2014
Junior Philippine Institute of Accountants
MEMORY AID IN MANAGEMENT ADVISORY SERVICES
Any form of reproduction of this copy is strictly prohibited!!!

☛PERT – A networking technique used for planning

and controlling the activities in a project. It provides Series- an activity cannot be performed unless its
management pertinent information about a project, predecessor activity is finished.
such as:
 Expected completion time of the project; Parallel- activities that can be performed
when each activity in a project is scheduled simultaneously
to start and finish;
 Which part of the project must be finished Path- a series of activities from start to finish.
on time to avoid making the whole project
late; Critical path- the longest path through the network.
 How resources may be shifted from one
part to another part of the project without  [NOTE:] A delay in the completion of activities
affecting the overall completion time of the in the critical path would cause a delay in the
completion of the entire project.
project;
Shortening the total completion of the
 The progress of each part of the project as
whole project can be accomplished only by
of a certain date. shortening the critical path.

☛PERT DIAGRAM Slack time- the length of time by which a particular

 An arrow diagram on a network showing activity can slip (be delayed) without having any
the interrelationships or interdependencies delaying effect on the end event.
of the various activities of a project.
Although more complex than Gantt Charts,  [NOTE:] Activities along the critical path have
a PERT Diagram has the advantage of a slack of Zero, while all non-critical activities
incorporating probabilistic time estimates have positive slack.
and identifying the critical path.
☛Critical Path Method
-Node- can be called event when all the  may be considered as a subset of PERT.
activities leading to a node are finished. CPM is a network technique that uses
deterministic time and cost estimates. Aside
Event- represents a specified accomplishment at a from cost estimates, CPM includes the
particular instant in time. It represents the start or concept of crash efforts and crash cost.
finish of an activity, such as 1 or 2 in the network.
☛Crash time
-Branch- represents the activities in a  the time required to complete an activity
project assuming that all available resources are
devoted to such activity.
Activity – task to be accomplished. It represents the
time and resources necessary to move from one
☛Crashing the network
node or event to another.
 determining the minimum cost for
completing the project in minimum time so
☛Types of activities

Management Advisory Services (MAS) Committee: Hazeleen Martinez; Jimmy Joe Miranda; Cliff Mark Confidente;
92 Corina Bariuan; Kristina Gaddon; Rizalyn Taguibao ;Niῆo Rey Mangupag; Marjhon Maramag; Leo Jay Labasan
Adviser: Mary Queen Ramos, CPA
 UNIVERSITY OF SAINT LOUIS-TUGUEGARAO
School of Business Administration and Accountancy, 2013-2014
Junior Philippine Institute of Accountants
MEMORY AID IN MANAGEMENT ADVISORY SERVICES
Any form of reproduction of this copy is strictly prohibited!!!

that an optimum trade-off between time  a technique used to optimize an object

and cost is achieved. function (maximize revenue or profit
☛Accountants role in PERT function, or minimize a cost function),
subject to constraints (such as scare
1. Determination of cost estimates and actual resources, minimum/maximum levels of
cost of each activity in a project. production, performance etc.
2. Preparation of activity/project cost reports
and computation/analysis of cost variance. In business linear programming is used for planning
resource allocations (to make optimum use of
☛Benefit of PERT limited resources.) conditions calling for the use of
linear programming includes:
1. PERT is a very useful technique for planning 1. Specification of a cost or revenue objective
and controlling activities in a project or the formula.
entire project itself. 2. The limited resources must be subject to
2. Some of the procedures included it PERT or alternative uses.
in PERT/CPM are in harmony with the 3. The alternative uses of the limited
accountant’s budgetary tasks and in the resources must be specified.
application of a responsibility accounting
system. ☛Methods for solving linear programming problems
3. The technique may be used to solve
managerial problems pertaining to project 1. Graphical method- limited to problems with
scheduling, information system design, and only two variables
transportation system design. 2. Simplex method- applicable even when
4. PERT helps to keep the project on schedule there are more than two variables.
and to provide feedback to management
about the progress of each part of the QUEUING THEORY
project.
☛QUEUING THEORY (Waiting-line Theory)
☛Limitations of PERT  a study of random arrivals at a processing
or servicing facility of limited capacity. It
 Reliable time and cost data may not be allows the decision maker to calculate the:
readily available and obtaining them may
be difficult. Persons involved may overstate a. Lengths of future waiting lines
budgeted cost and time estimates to avoid b. Average time spent in line awaiting
unfavorable variances and pressure from service or processing
the superior. c. Additional facilities required
d. Service level or capacity that minimizes
LINEARPROGRAMMING waiting and operating cost

☛LINEAR PROGRAMING ☛EXAMPLES OF QUEUING THEORY APPLICATIONS

1. Check-out counters (cashiers) in groceries/malls
2. Movie ticket booths
Management Advisory Services (MAS) Committee: Hazeleen Martinez; Jimmy Joe Miranda; Cliff Mark Confidente;
93 Corina Bariuan; Kristina Gaddon; Rizalyn Taguibao ;Niῆo Rey Mangupag; Marjhon Maramag; Leo Jay Labasan
Adviser: Mary Queen Ramos, CPA
 UNIVERSITY OF SAINT LOUIS-TUGUEGARAO
School of Business Administration and Accountancy, 2013-2014
Junior Philippine Institute of Accountants
MEMORY AID IN MANAGEMENT ADVISORY SERVICES
Any form of reproduction of this copy is strictly prohibited!!!

3. Expressway toll booths ☛Assumptions:

4. School registrar’s office windows 1. The cumulative average time per unit is
5. Bank teller windows reduced by a certain percentage each time
production doubles.
☛COSTS INVOLVED 2. Incremental unit time (time to produce the
1. FACILITY COSTS AND OPERATING COSTS- the cost last unit) is reduced when production
of providing service doubles.
2. WAITING COST- the cost of idle resources waiting
in line, including the income foregone (opportunity SENSITIVITY ANALYSIS
cost) in the case of waiting customers
☛SENSITIVITY ANALYSIS
 the study of how the outcome of a decision
Objective: to minimize total cost involved (both the process changes as one or more of the
service and waiting costs). assumptions change.

LEARNING CURVES
Decision tree Example
☛LEARNING CURVES (or Experience Curve)
 describes the efficiencies arising from Your company is considering whether it should
tender for two contracts (MS1 and MS2) on offer
experience, because with experience comes
from a government department for the supply of
increase productivity. This productivity certain components. The company has three
increases with production size, but at a options:
decreasing rate.
 tender for MS1 only; or
 A mathematical expression of the  tender for MS2 only; or
phenomenon that incremental unit costs to  tender for both MS1 and MS2.
produce (or incremental unit time used to
produce) decrease as managers and labor If tenders are to be submitted the company will
incur additional costs. These costs will have to be
gain experience from practice.
entirely recouped from the contract price. The risk,
of course, is that if a tender is unsuccessful the
 The time required to perform a given task company will have made a loss.
becomes progressively shorter, but this is
applicable only to the early stages of The cost of tendering for contract MS1 only is
production or any new task. £50,000. The component supply cost if the tender is
successful would be £18,000.
 The curve is expressed as a percentage of
reduced time (usually between 60% and The cost of tendering for contract MS2 only is
£14,000. The component supply cost if the tender is
80%) to complete a task of each doubling of
successful would be £12,000.
cumulative production. Hence, the time
required is reduced by 20% to 40% each The cost of tendering for both contract MS1 and
time cumulative production is doubled. contract MS2 is £55,000. The component supply cost
if the tender is successful would be £24,000.
Management Advisory Services (MAS) Committee: Hazeleen Martinez; Jimmy Joe Miranda; Cliff Mark Confidente;
94 Corina Bariuan; Kristina Gaddon; Rizalyn Taguibao ;Niῆo Rey Mangupag; Marjhon Maramag; Leo Jay Labasan
Adviser: Mary Queen Ramos, CPA
 UNIVERSITY OF SAINT LOUIS-TUGUEGARAO
School of Business Administration and Accountancy, 2013-2014
Junior Philippine Institute of Accountants
MEMORY AID IN MANAGEMENT ADVISORY SERVICES
Any form of reproduction of this copy is strictly prohibited!!!

For each contract, possible tender prices have been

determined. In addition, subjective assessments
have been made of the probability of getting the
contract with a particular tender price as shown
below. Note here that the company can only submit
one tender and cannot, for example, submit two
tenders (at different prices) for the same contract.

Option Possible Probability

tender of getting
prices (£) contract
MS1 only 130,000 0.20
115,000 0.85
MS2 only 70,000 0.15
65,000 0.80
60,000 0.95
MS1 and MS2 190,000 0.05
140,000 0.65
Below we carry out step 1 of the decision tree
solution procedure which (for this example) involves
In the event that the company tenders for both MS1
and MS2 it will either win both contracts (at the working out the total profit for each of the paths
price shown above) or no contract at all. from the initial node to the terminal node (all figures
in £'000).
 What do you suggest the company should
do and why? Step 1
 What are the downside and the upside of
your suggested course of action?  path to terminal node 12, we tender for
 A consultant has approached your company MS1 only (cost 50), at a price of 130, and
with an offer that in return for £20,000 in win the contract, so incurring component
cash she will ensure that if you tender supply costs of 18, total profit 130-50-18 =
£60,000 for contract MS2 only your tender 62
is guaranteed to be successful. Should you  path to terminal node 13, we tender for
accept her offer or not and why? MS1 only (cost 50), at a price of 130, and
lose the contract, total profit -50
The decision tree for the problem is shown below.  path to terminal node 14, we tender for
MS1 only (cost 50), at a price of 115, and
win the contract, so incurring component
supply costs of 18, total profit 115-50-18 =
47
 path to terminal node 15, we tender for
MS1 only (cost 50), at a price of 115, and
lose the contract, total profit -50
 path to terminal node 16, we tender for
MS2 only (cost 14), at a price of 70, and win
the contract, so incurring component
supply costs of 12, total profit 70-14-12 = 44

Management Advisory Services (MAS) Committee: Hazeleen Martinez; Jimmy Joe Miranda; Cliff Mark Confidente;
95 Corina Bariuan; Kristina Gaddon; Rizalyn Taguibao ;Niῆo Rey Mangupag; Marjhon Maramag; Leo Jay Labasan
Adviser: Mary Queen Ramos, CPA
 UNIVERSITY OF SAINT LOUIS-TUGUEGARAO
School of Business Administration and Accountancy, 2013-2014
Junior Philippine Institute of Accountants
MEMORY AID IN MANAGEMENT ADVISORY SERVICES
Any form of reproduction of this copy is strictly prohibited!!!

 path to terminal node 17, we tender for 20 34

MS2 only (cost 14), at a price of 70, and lose 21 -14
the contract, total profit -14 22 111
 path to terminal node 18, we tender for 23 -55
MS2 only (cost 14), at a price of 65, and win 24 61
the contract, so incurring component 25 -55
supply costs of 12, total profit 65-14-12 = 39
 path to terminal node 19, we tender for We can now carry out the second step of the
MS2 only (cost 14), at a price of 65, and lose decision tree solution procedure where we work
the contract, total profit -14 from the right-hand side of the diagram back to the
 path to terminal node 20, we tender for left-hand side.
MS2 only (cost 14), at a price of 60, and win
the contract, so incurring component Step 2
supply costs of 12, total profit 60-14-12 = 34
 path to terminal node 21, we tender for
MS2 only (cost 14), at a price of 60, and lose  For chance node 5 the EMV is 0.2(62) + 0.8(-
the contract, total profit -14 50) = -27.6
 path to terminal node 22, we tender for  For chance node 6 the EMV is 0.85(47) +
MS1 and MS2 (cost 55), at a price of 190, 0.15(-50) = 32.45
and win the contract, so incurring
component supply costs of 24, total profit Hence the best decision at decision node 2 is to
190-55- 24=111 tender at a price of 115 (EMV=32.45).
 path to terminal node 23, we tender for
MS1 and MS2 (cost 55), at a price of 190,  For chance node 7 the EMV is 0.15(44) +
and lose the contract, total profit -55 0.85(-14) = -5.3
 path to terminal node 24, we tender for  For chance node 8 the EMV is 0.80(39) +
MS1 and MS2 (cost 55), at a price of 140, 0.20(-14) = 28.4
and win the contract, so incurring  For chance node 9 the EMV is 0.95(34) +
component supply costs of 24, total profit 0.05(-14) = 31.6
140-55- 24=61
 path to terminal node 25, we tender for Hence the best decision at decision node 3 is to
MS1 and MS2 (cost 55), at a price of 140, tender at a price of 60 (EMV=31.6).
and lose the contract, total profit -55
 For chance node 10 the EMV is 0.05(111) +
Hence we can arrive at the table below indicating for 0.95(-55) = -46.7
each branch the total profit involved in that branch  For chance node 11 the EMV is 0.65(61) +
from the initial node to the terminal node. 0.35(-55) = 20.4

Terminal Node Total profit £'000 Hence the best decision at decision node 4 is to
12 62 tender at a price of 140 (EMV=20.4).
13 -50
14 47 Hence at decision node 1 have three alternatives:
15 -50
16 44  tender for MS1 only EMV=32.45
17 -14  tender for MS2 only EMV=31.6
18 39  tender for both MS1 and MS2 EMV = 20.4
19 -14

Management Advisory Services (MAS) Committee: Hazeleen Martinez; Jimmy Joe Miranda; Cliff Mark Confidente;
96 Corina Bariuan; Kristina Gaddon; Rizalyn Taguibao ;Niῆo Rey Mangupag; Marjhon Maramag; Leo Jay Labasan
Adviser: Mary Queen Ramos, CPA
 UNIVERSITY OF SAINT LOUIS-TUGUEGARAO
School of Business Administration and Accountancy, 2013-2014
Junior Philippine Institute of Accountants
MEMORY AID IN MANAGEMENT ADVISORY SERVICES
Any form of reproduction of this copy is strictly prohibited!!!

Hence the best decision is to tender for MS1 only (at Learning Curve Example
a price of 115) as it has the highest expected
monetary value of 32.45 (£'000). Examples of Expected Average and Total Times
Total Output in Expected Expected Total
The downside is a loss of 50 and the upside is a profit Batches Average Time Time (hours)
of 47. per Batch
(hours)
With regard to the consultants offer then, ignoring 1 10 (given) 10
ethical considerations, we could of course, tender 60 2 8 ( 10 x 80% ) 16 ( 2 x 8 )
for MS2 only without her help and if we were to do 4 6.4 ( 8 x80%) 25.6 ( 4 x 6.4 )
that we would have a 0.95 probability of having our 8 5.12 ( 6.4 x80%) 40.96 ( 8 x 5.12
tender accepted. Hence there are essentially three )
options:
Notice that the schedule shows results only at
 as before, tender for MS1 only at a price of doubling points (2 is double 1, 4 is double 2, 8 is
115: EMV 32.45, downside -50 (probability double 4). To determine the average time for some
0.15), upside 47 (probability 0.85) other number of batches, we can use the following
 tender for MS2 only at a price of 60, formula.
unaided by the consultant: EMV 31.6,
downside -14 (probability 0.05), upside 34 Y= aXb
(probability 0.95)
 tender for MS2 only at a price of 60, with where:
the consultants help, then (assuming she Y= average time for X number of batches
can fulfill her promise of guaranteeing we a= the time required for the first batch (or unit)
will be successful), we have a certain X= total output (number of batches)
outcome with a profit of 34 (terminal node b= the learning exponent
20) - 20 (cash paid to the consultant) = 14
The value of b is the log of the learning RATE
(express as a decimal) divided by the log of 2. With
On an EMV basis we would still support our original
the formula you can find the average time for any
decision. Looking at the risks (probabilities) of
output level.
loosing money, and considering tendering for MS2
only at 60, we would essentially be paying the
consultant 20 to avoid a 0.05 chance of loosing 14,
the downside of tendering unaided.

Paying 20 to guarantee not incurring a loss of 14

which will occur with a probability of 0.05 (one in
twenty) does not seem like an awfully good
investment and so we should reject her offer (or
offer her a smaller sum of money in return for her
guarantee!).

Management Advisory Services (MAS) Committee: Hazeleen Martinez; Jimmy Joe Miranda; Cliff Mark Confidente;
97 Corina Bariuan; Kristina Gaddon; Rizalyn Taguibao ;Niῆo Rey Mangupag; Marjhon Maramag; Leo Jay Labasan
Adviser: Mary Queen Ramos, CPA