Decision-Making Techniques 3.3 Flashcards
what are the four main methods used to provide a quantitative sales forecast?
- moving averages
- extrapolation
- correlation
- test market
what are the two main circumstances where moving averages are helpful?
- where there are strong seasonal influences on sales
2. where sales are erratic for no obvious reason
Describe how to find moving averages:
- calculate the moving total (usually a three month total e.g. jan, feb and march, and then feb, march and April)
- The second column has the total of the three months (centred average) is divided by three to make the centred three month average, and centred back to February
what is forecasting using extrapolation?
It is the simplest was to predict the future - just using previous values, so on a graph you continue the line that was previously there. You must still ensure that the graph makes sense for it to continue up, for example ice creams in bad weather are likely to not go up.
what is the table which uses correlation called?
a scatter graph
what are 6 limitations of quantitative sales forecasting techniques?
- new entrants into the market
- a sudden wave of viral, social media support or criticism of the product or celebrity promoting the products
- population changes
- changes in weather conditions
- legal changes
- internal factors - changes in sales force, changes in the amount of spending on promotion our way the product is being spent
what is the definition of a sales forecast?
a method of predicting future sales using statistical methods
what is the definition of seasonal variation?
change in the value of a variable that is related to the seasons
what is the definition of a trend?
the general path a series of values follows over time, disregarding variations or random fluctuations
what are the three types of investment appraisal?
- payback period
- average rate of return
- net present value (NPV)
what are 5 reasons that a business should invest?
- demand for business/ product
- lower levels of risk
- amount of rewards
- reputation improvement
- enough finance to fund the investment
what are 4 advantages of payback period (IA method):
- useful to decide between two options as its straightforward to compare
- simple and easy to calculate and easy to understand the results
- focuses on cash flows
- good for future planning as it gives you a timeline for what could happen
what are 4 disadvantages of payback period (IA method):
- doesn’t take into consideration other unexpected events
- it will only be a forecast/ prediction
- it doesn’t look at the long term after the payback has been reached
- ignores qualitative aspects of a decision (opinion/ if anything changes)
what is the definition of payback?
the time it takes for a project to repay its initial investment
what is the average rate of return?
The percentage return on the investment made
what is the formula for the average rate of return?
(average annual profit/ initial investment) x100
what is the formula for average annual profit?
profit for the period/ years
do you want the average annual profit to be as high as possible or as low as possible?
as high as possible
When working out the average rate of return, and you are given the net cash flow, not the profit, what do you do?
times the net cash flow by the years and minus the initial investment
what is the definition of net present value/ discounted cash flow?
the value in the present of a sum of money, in contrast to some future value it will have when it has been invested at compound interest
what is the other name for net present value?
discounted cash flow
what is net present value?
the difference between the present value of cash inflows and the value of cash outflows
what is investment appraisal?
its the process of analysing whether investment projects are worthwhile
what happens if a NPV value is positive/ negative?
- NPV is positive then the project can be invested in
- NPV is negative then the project will be avoided/ rejected
what is the calculation for a payback period?
sum invested/ net cash per time period
what is the interpretation of payback period?
its the length of time the money is at risk. Every business should want as short a payback period as possible
what are the three steps in calculating ARR?
- calculate the total profit over the lifetime of the investment ( total net cash flows minus the investment outlay)
- divide by the number of years of the investment project to give the average annual profit
- apply the formula
to discount a future cash flow, what is it necessary to know? (NPV)
- how many years into the future we are looking, since the greater the length of time involved, the smaller the present or discounted value of money will be
- what the prevailing rate of interest is likely to be
what are three advantages of ARR?
- Uses all the cash flows over the projects life
- focuses on profitability
- easy to compare percentage returns on different investments to help make a decision
what are two disadvantages of ARR?
- ignore the timings of the cash flows
2. ignores the opportunity cost of the money invested
what are three advantages of NPV?
- takes the opportunity cost of money into account
- a single measure that takes the amount and the timing of cash flows into account
- can consider different scenarios
what are three disadvantages to NPV?
- complex to calculate and communicate
- the meaning of the result is often misunderstood
- only comparable between projects if the initial investment is the same
when forecasting cash flows 3/4 years in the future, what could go wrong? (4)
- costs could rise unexpectedly, perhaps because of a fall in the value of a pound
- a new competitor might push prices down undermining forecast cash inflows
- consumer tastes might move away from your product
- a cyclical downturn may turn into a full blown recession.
what are 3 other factors affecting investment decisions?
- non financial factors in investment appraisal
- investment criteria
- risk and uncertainty
what are 4 other reasons why investment projects may be rejected?
- corporate objectives
- company finances
- confidence in the data
- social responsibilities
what is the definition of criterion level?
a yardstick set by directors to enable managers to judge whether investment ideas are worth pursuing
what is the definition of cumulative cash?
the build up of cash overall several time periods
what is the definition of discounting?
applying a discount factor to a money sum to take into account the opportunity cost of money over time
what is the definition of present values?
the discounting of future future cash flows to make them comparable with todays cash. This takes into account the opportunity cost of waiting for the cash to arrive
what is the definition of short-termism?
making decisions on the basis of the immediate future and therefore ignoring the long term future of the business
what is the definition of tactical decisions?
those that are day to day events and therefore do not require a lengthy decision making process
what is the step-by-step approach to decision tree analysis? (3 steps)
- the tree is a diagram setting out the key features of a decision making problems
- the decision problem is set out from left to right
- the branches consist of:
- a decision to be made, shown by a square
- chance of events or alternatives beyond the decision makers control, shown by a circle
with probability, what do the numbers 0 and 1 represent?
0 - definitely will not occur
1 - definitely will occur
what does the circle represent on a decision tree?
chance of events beyond the decision makers control (E.G. success/ failure)
what does the square represent on a decision tree?
a decision to be made
what are four advantages of using decision trees?
- it allows for uncertainty
- demand that managers consider all the possible alternative outcomes
- set out the problems clearly and encourage a logical approach
- encourage a quantitive approach and force assessments of the chances and implications of success and failure
what are three disadvantages of using decision trees?
- may be difficult to get meaningful data, especially for estimated probabilities of success or failure
- less useful in the case of completely new problems or one-off strategic problems
- can be relatively easy for a manager seeking to prove a case to manipulate any data
what is the definition of a node?
a point in a decision tree where chance takes over. It is denoted by a circle and at this point it should be possible to calculate the expected value of this pathway
what is the definition of an actual value?
the forecasts of the net cash flow which result from following a sequence of decisions and chance events through a decision tree
what is the definition of an expected value?
these are the forecast actual values adjusted by the probability of their occurrence
what is the definition of a net gain (or loss)?
subtracting the initial outlay from the expected value to find out whether or not a decision is likely to produce a surplus
what is the definition of probability?
the likelihood of something occurring. This can be expressed as a numerical value which can be a percentage, a fraction, or a decimal. the probabilities range from 0 to 1.
what is critical path analysis?
a technique used to consider the most efficient way to complete an activity.
what are the rules/ oder of completing a CPA? (8)
- work from left to right
- complete EST first (top right)
- when two activities go into one node select the highest value
- at the end you duplicate the number
- work from right to left
- complete all LFT
- when two activities go into a node. select the lower value
- Reach the final node, you identify the critical path (path where the numbers are the same)
what is another name for critical path analysis?
a network diagram
why do businesses need to plan complex projects? (5)
- mitigate the risk
- ensure the right path is taken - by identifying the most efficient method
- useful to secure finance
- time planning - to prioritise critical tasks
- to find the float time to find the flexibility
what is the calculation for float time for a certain activity?
LFT-duration-EST
what is LFT?
latest finish time
what is EST?
earliest start time
what are four positives of CPA?
- find out the float time and the overall time frame
- identify where there is flexibility
- reduce risk and cost of complex projects
- provides managers with overview of project
what are three negatives of CPA?
- Numbers are all based on predictions
- CPA doesn’t guarantee success
- Resources may not be as flexible as managers hope with the network float
what does the network analysis show?
- the order in which each task must be undertaken
- how long each stage should take
- the earliest date at which the later stages can start
what is the critical path?
the critical path is the route which allows the project to be completed in the shortest amount of time
where is the float time found on the CPA diagram?
in the non critical activities
what are three benefits of using network/ critical path analysis?
- requires careful planning of the order in which events need to occur, and the length of time each one should take, this should improve smooth operation
- the resources needed for each activity can be ordered or hired no earlier than their EST, so the working capital is minimised
- can identify events which can take place simultaneously, it shortens the length of time taken to complete a project
what are two limitations of using network/ critical path analysis?
- a complex project entails so many activities that a drawing becomes unmanageable.
- drawing a diagram doesn’t ensure the effective management of a project, it provides a plan but can only be as successful as the staff’s commitment to it
what is the definition of a critical path?
the activities that must be completed on time for the project to finish on time. they have no float time at all
what is the definition of float time?
any spare time that arises between the completion of an activity and the starting time of the next
what is the definition of management by exception?
the principle that because managers cannot supervise every activity within the organisation they should focus their energies on the most important issues
what is the definition of network?
a diagram showing all the activities needed to complete a project, the order which they must be completed and the critical path
what is the definition of network analysis?
breaking the project down into its component parts to identify the sequence of events involved
