3.3 Decision making techniques Flashcards
What is Moving Average?
Smoothing out fluctuations in a data series to show an average
Aims to take out the extremes of data and make it easier to spot trends.
What are the steps for calculating a three year moving average?
- Find average of first 3 years data
- Leave out first year and find average of next 3 years
- Continue the process until last 3 years
What are the steps for calculating a four year moving average?
- Add first 4 years data together
- Leave out first year and add next 4 years data together
- Add these 2 totals together
- Divide this new total by 8
What is Extrapolation in sales forecasting?
Prediction of future sales from data, often done by extending a line of best fit
What are the benefits of quantitative sales forecasting techniques?
- Not much data required
- Quick and cheap
- Spot trends/patterns
- Simple method of forecasting
What are the limitations of quantitative sales forecasting techniques?
- Reliance on historical data
- Unreliable if huge fluctuations in historical data
- Assumes past trends will continue into future
- Inability to account for SWOT and PESTLE factors
What is Investment Appraisal?
Using techniques to evaluate the financial viability of an investment opportunity
What is the Simple Payback Period?
Assess period of time a business will have to wait until initial investments are fully paid back
What are the steps to calculate the Simple Payback Period?
- Work out cumulative cash flow
- Find year of outstanding balance
- Find monthly net cash flow for following year
- Divide monthly cash flow by outstanding balance
- Add year of outstanding balance by months from the answer
What are the limitations of the Simple Payback Period?
- Doesn’t measure profitability
- Encourages short-termism approach
- Doesn’t consider time value of money
What does Average (Accounting) Rate of Return (%) assess?
Assesses how much return is made on top of initial investment cost
What is the formula for Average Rate of Return?
Average Profit for project x 100 / Initial Investment Cost
What are the steps to calculate the Average Rate of Return?
- Total profit = Total net cash flow - Initial cost of project
- Average Profit = Total profit / Number of years
- Work out Average Rate of Return
What should be compared to Average Rate of Return?
- ROCE (Return on Capital Invested)
- Banks Interest Rate
What are the limitations of the Average Rate of Return?
- Takes no account of cash flow
- Doesn’t consider time value of money
- Treats money that comes late into project the same as those that come earlier
What is Discounted Cash Flow (Net Present Value)?
Calculate the monetary value TODAY of a project’s future cash flows
What are the steps to calculate Net Present Value?
- Work out present value to be made = Net Cash Flow x Discounted factor used
- Work out expected profits (Net present value) = Total Present Value - Initial Cost of Project
What does a positive NPV indicate?
Shows project will generate a greater return on initial outlay than putting money in bank at an interest rate
What are the limitations of Discounted Cash Flow?
- More complicated to use
- Hard to compare projects with different investment amounts
- Only considers financial benefits/costs
What is a Decision Tree?
Quantitative method of tracing the outcomes of a decision to identify the most profitable decision
What are the steps involved in creating a Decision Tree?
- Draw a decision point (square) at start
- Draw branches for each course of action
- Draw a change node at end of each decision
- Add the profit or loss expected for each outcome
- Work out total expected value for A and B
- Subtract initial investment by total expected value to find net expected gain
What are the limitations of Decision Trees?
- Doesn’t take into account unforeseen costs
- Uses quantitative data only
- Probabilities are just estimates
What is Critical Path Analysis?
Method of identifying the order in which tasks need to be completed when planning a project to find the minimum time required
What is the Earliest Start Time?
Earliest time the next activity can begin
What is the Latest Finish Time?
Latest time the current activity can finish, before it delays the entire time
What is Float Time?
The spare time an activity has
What is the formula for Float Time?
Float Time = Latest Finish Time of the activity - duration of the activity - Earliest start time of the activity
What are the limitations of Critical Path Analysis?
- All data in the network is based on estimates
- Drawing the diagram is time consuming
- Doesn’t guarantee success of project
