12.3 Expected Value and Sensitivity Analysis Flashcards
A widely used approach that managers use to recognize uncertainty about individual items and to obtain an immediate financial estimate of the consequences of possible prediction errors is
Sensitivity Analysis
After a problem has been formulated into any mathematical model, it may be subjected to sensitivity analysis, which examines how the model’s outcomes change as the parameters change.
Difference between the expected profit under certainty and the expected monetary value of the best act under uncertainty is
the expected value of perfect information
In decision making under conditions of uncertainty, expected value refers to the
weighted average of probable outcomes of an action
Sum of the conditional profit (loss) for each event times the probability of each event’s occurence.
Expected monetary value
A widely used approach that managers use to recognize uncertainty about individual items and to obtain an immediate financial estimate of the consequences of possible prediction errors is
sensitivity analysis
After a problem has been formulated into any mathematical model, it may be subjected to
sensitivity analysis
The probabilistically weighted average of the outcome of an action
expected value
Gleason Co. has two products, a frozen dessert and ready-to-bake breakfast rolls, ready for introduction. However, plant capacity is limited, and only one product can be introduced at present. Therefore, Gleason has conducted a market study at a cost of $26,000, to determine which product will be more profitable. The results of the study follow.
Sales of Desserts at $1.80/unit
Volume & Probability
250,000 –> .30
300,000 –> .40
350,000 –> .20
400,000 –> .10
Sales of Rolls at $1.20/unit
Volume & Probability
200,000 –> .20
250,000 –> .50
300,000 –> .20
350,000 –> .10
The costs associated with the two products have been estimated by Gleason’s cost accounting department and are as follows.
Ingredients per unit
- Dessert: $ .40
- Rolls: $ .25
Direct labor per unit
- Dessert: .35
- Rolls: .30
Variable overhead per unit
- Dessert: .40
- Rolls: .20
Production tooling*
- Dessert: 48,000
- Rolls: 25,000
Advertising
- Dessert: 30,000
- Rolls: 20,000
*Gleason treats production tooling as a current operating expense rather than capitalizing it as a fixed asset.
According to Gleason’s market study, the expected value of the sales volume of the breakfast rolls is
A. Some amount other than those given.
B. 275,000 units.
C. 125,000 units.
D. 260,000 units.
D. 260,000 units.
The expected value is found by multiplying the probability of each possibility by the potential volumes:
200,000 × .20 = 40,000
250,000 × .50 = 125,000
300,000 × .20 = 60,000
350,000 × .10 = 35,000
Total units 260,000
The College Honor Society sells hot pretzels at the home football games. The pretzels are sold for $1.00 each, and the cost per pretzel is $.30. Any unsold pretzels are discarded because they will be stale before the next home game.
The frequency distribution of the demand for pretzels per game is presented as follows:
Unit Sales Volume Probability
2,000 pretzels .10
3,000 pretzels .15
4,000 pretzels .20
5,000 pretzels .35
6,000 pretzels .20
The conditional profit per game of having 4,000 pretzels available but only selling 3,000 pretzels is
A. Some amount other than those given.
B. $2,100
C. $2,800
D. $1,800
D. $1,800
Each pretzel costs $.30. Thus, the cost of 4,000 pretzels is $1,200 (4,000 × $.30). Selling 3,000 pretzels at $1 each produces revenue of $3,000. Subtracting the $1,200 of costs from the $3,000 of revenue results in a conditional profit of $1,800.
