Decision-making techniques

Question 1

What is a moving average?

Answer 1

A moving average is a quantitive method used to identify underlying trends in a set of raw data.

Question 2

When is a moving average useful?

Answer 2

When identifying an underlying trend in a set of data with strong seasonal variations or an erratic pattern.

Question 3

What is extrapolation?

Answer 3

Extrapolation means predicting by projecting past trends into the future.

Question 4

What is time series data?

Answer 4

Time series data is a series of figures converting an extended period of time.

Question 5

Along with sales, what could the other variable be in a scatter graph be when forecasting sales?

Answer 5

Sales and advertising expenditure
Sales and temperature
Sales and the number of stores open
Sales and the level of staff bonuses available

Question 6

What are the two major limitations of quantitive forecasting techniques?

Answer 6

The future may not be like the past: changes in any number of external factors may have a significant impact of sales. E.g. changes in tastes and fashion or new entrants to the market.

The quality of the forecast is reliant on the ability of the forecaster to interpret the data being used to generate the forecast. Whether the trend is likely to continue in the long term or if it’s just a short-term change.

Question 7

What are quantitative forecasting techniques, and what are the two main types used in business?

Answer 7

Quantitative method of forecasting uses numerical facts and historical data to predict upcoming events.
The two main types of quantitative forecasting used by business analysts are the explanatory method that attempts to correlate two or more variables and the time series method that uses past trends to make forecasts.

Question 8

What is investment appraisal?

Answer 8

Investment appraisal is the process of using forecast cash flows to assess the financial attractiveness of an investment decision, linked with a consideration of non-financial factors.

Question 9

What are the three methods of investment appraisal?

Answer 9

Payback period,
Average rate of return,
Net present value.

Question 10

What does the payback period involve and how does it help businesses when making investment decisions?

Answer 10

Assessing the period of time a business must wait until its initial investment has been recovered allows a firm to prioritise risk reduction when making investment decisions.

Question 11

What is the calculation of payback period if it occurs part way through a year?

Answer 11

(Outlay outstanding) ÷ (Monthly cash flow in year of payback)

Question 12

What is the average rate of return (ARR)?

Answer 12

This method considers the profit generated by the investment. It involves calculating the average annual profit as a percentage of the initial outlay.

Question 13

What are the steps to calculate the average rate of return (ARR)?

Answer 13

1) Calculate the total profit over the lifetime of the project but adding all the net cash flow is going to talk to the initial outlay.
2) Divide by the number of years the project lasts.
3) use the formula:
(Average annual profit - from step 2-) ÷ initial outlay x100

Question 14

How can you interpret ARR values?

Answer 14

The higher the ARR, the more profitable the investment.

Question 15

What is the net present value (NPV) using discounted cash flows?

Answer 15

Future cash flows may not be worth what they seem, money that’s received sooner can be used for other purposes and money tied up in an investment has an opportunity cost. This can be accounted for by discounting the value of future cash flows to allow for a given percentage return that could be achieved if the money was available now and generated that return.

(Check this!) Net present value (NPV) is the difference between the present value of cash inflows and the present value of cash outflows over a period of time.

Question 16

What is the calculation for net present value (NPV)?

Answer 16

Each years net cash flow is multiplied by the relevant discount factor to calculate the present value of the cash flow. These are then totalled to give the overall net present value (NPV) of the project.

Question 17

How can you interpret the net present value (NPV)?

Answer 17

A positive NPV shows that the project generates a greater return on its initial outlay than simply putting the money in the bank at an interest rate equal to the percentage discount factor used. The higher the figure, the more profitable it will be.

Question 18

What are the strengths of using the payback period as a quantitive investment appraisal technique?

Answer 18

Easy to calculate and understand,
May be more accurate as it ignores longer term forecasts which may be less accurate,
Takes into account the timing of cash flows,
Very useful for businesses with weak cash flow.

Question 19

What are the limitations of using the payback period as a quantitive investment appraisal technique?

Answer 19

Tells you nothing about profitability,
Ignores what happens after payback is achieved,
May encourage a short-termist attitude.

Question 20

What is short-termism?

Answer 20

Short termism is the tendency to focus on achieving short-term objectives by taking decisions that may preclude better, longer-term options.

Question 21

What are the strengths of the average rate of return method?

Answer 21

Clear focus on profitability,
Considers cash flows over the whole project’s lifetime,
Easy to compare with other measures of return expressed as percentages such as interest rates.

Question 22

What are the limitations of the average rate of return method?

Answer 22

Ignores the timing of cash flows,
Therefore values far distant inflows the same as more immediate inflows, which are worth more,
Including forecast data from far in the future may reduce the reliability of the forecasts and therefore results.

Question 23

What are the strengths of using the net present value method?

Answer 23

Takes the opportunity cost of money into account,

Considers both amount and timing of cash flows to indicate profitability.

Question 24

What are the limitations of using the net present value method?

Answer 24

Complex to calculate and communicate,
Meaning is often misunderstood,
Only comparable between different projects if the initial outlay is the same.

Question 25

What other non-financial factors affect investment decisions?

Answer 25

Corporate objectives: does the chosen investment focus on achieving the agreed objectives of the business?
Company finances,
Confidence in the data: could the person who prepared the forecast be biased?
Social responsibilities: if an investment clearly helps to meet a businesses social responsibilities some businesses may be willing to proceed even if the project isn’t the most financially attractive.

Question 26

What is a decision tree?

Answer 26

A decision tree is a diagram showing the options and possible outcomes involved in making a decision along with the probabilities of outcomes occurring.

Question 27

What is the expected value?

Answer 27

The expected value is the average outcome expected following a chance event.

Question 28

What are the advantages of using decision trees?

Answer 28

The technique allows for uncertainty,
Trees force managers to consider all possible options,
Problems are set out clearly encouraging a logical approach,
Quantification of problems is encouraged by the drawing of the tree and subsequent calculations.

Question 29

What are the limitations of using decision trees?

Answer 29

Gathering data required is hard and is likely to involve an element of guesswork,
New problems mean previous occurrences cannot be used to base estimated probabilities and outcomes on, reducing the reliability of the data further,
An element of bias can be introduced by whoever is estimating probabilities and outcomes if they wish to influence the outcome of the decision,
Decision trees can lead to a failure to consider qualitative aspects of decisions.

Question 30

What is critical path analysis?

Answer 30

Critical path analysis is a technique used in planning the most time efficient way to complete complex projects.

Question 31

When a complex project needs to be completed as quickly as possible why is time crucial?

Answer 31

Time can be crucial in order to:
Get a product to market as quickly as possible,
Construct new premises to move into as quickly as possible,
Move offices or production facilities to a new location.

Question 32

What does the network diagram in critical path analysis show?

Answer 32

The order in which tasks must be undertaken,
An estimated length of each task,
The earliest date when each task can begin.

Question 33

What are the two key components of a network diagram in critical path analysis?

Answer 33

Lines which represent activities to be completed as part of the overall project
Nodes placed at the start and end of activities.

Question 34

What is the earliest start time (EST)?

Answer 34

The earliest start time of an activity is the earliest possible date on which it is possible to begin the activity.

Question 35

What is the latest finish time (LFT)?

Answer 35

The latest finish time (LFT) for an activity is the last possible date by which it must be complete to avoid delaying the overall project.

Question 36

What is the earliest start time shown in the first node?

Answer 36

The earliest start time shown in the first node is always zero, showing that any activity not dependent on prior activities can start immediately.

Question 37

Why are EST’s useful?

Answer 37

The earliest date resources specially required for an activity may be needed, preventing wasting money on them before they are needed,
The earliest completion date for the whole project.

Question 38

Why are LFT’s useful?

Answer 38

Deadlines for each activity,
The float time (if any for each activity)
The critical path of the project.

Question 39

What does float time mean?

Answer 39

Float time describes any slack time available attached to an activity. The LFT minus the duration of the activity one is the EST of the activity shows if there is float time.

Question 40

What is the critical path?

Answer 40

The critical path of the project is the sequence of activities on which any delay will delay the whole project: The activities with zero flow time.

Question 41

What is the formula for calculating the float time of an activity?

Answer 41

LFT of the activity - duration of the activity - EST of the activity

Question 42

What are the benefits of critical path analysis?

Answer 42

Identifying activities that can be carried out simultaneously shortens the overall duration of the project.

Resources needed for a given activity can be delivered or hired just in time for the activity to begin. This delays cash outflows and avoids having expensive resources sitting around waiting to be used.

The network diagram shows possible ways of dealing with any unforeseen delays and getting back on track (perhaps by allocating extra resources to subsequent critical activities).

Question 43

What are the limitations of critical path analysis?

Answer 43

The diagram can lull manages into a false sense of security. It shows what can happen. To hit deadlines work must actually be completed, which will need careful monitoring.

Diagrams for really complex projects may become unmanageably large.

Not drawing activity lines to scale could be set to devalue the diagrams visual use.