Chapter 8 Decision Making Models

Question 1

Scientific decision making

Answer 1

it is based on logic and evidence and should reduce the risk of failure
- decision trees
- critical path analysis
- cost benefit analysis

Question 2

Private cost

Answer 2

These are cost that the business making the investment has to accept
- training
- recruitment
- purchase of new capital equipment

Question 3

Public costs

Answer 3

These are costs external to the business making the investment
- A building company will have an environmental impact as it builds houses – increased traffic, noise etc.
- A farm extracting water from a river to irrigate its crops leaves less water further downstream for fishing.
- A new factory may involve the loss of open space, increased traffic congestion and so on

Question 4

Social costs

Answer 4

Private costs + public costs

Question 5

Social benefits

Answer 5

Private benefits + public benefits

Question 6

Adavantages of cost benefit analysis

Answer 6

• Takes into account a wide range of benefits and costs
  • Impacts on society and the community are included
  • Puts a value to external benefits and costs that would normally be ignored by private sector businesses
  • Can be used to rank possible major projects in order of public cost.

Question 7

Disadvantages of cost benefit analysis

Answer 7

• The valuation of intangibles will be difficult – how do you put a value on the effect of pollution or the improve traffic flow of a new road?
  • Valuations will often include value judgements – one person’s or manager’s calculation of an intangible benefit is likely to differ from another person’s calculation, who has a different set of views on what is important for a business
  • If the social costs and benefits are incorrectly calculated then the wrong choice may be made
  • Will all stakeholders be included in the calculation of social costs and benefits

Question 8

Advantages of CPA

Answer 8

• effective for planning and controlling a complex plan
• allows effective management of resources
• Reduces the need for working capital, parts used in the project can be ordered exactly when they are needed. Allows the use of just-in-time production
• improves cash flow
• can be used to check efficiency of individual activities
• improves management of projects
• competitive advantage

Question 9

Disadvantages of CPA

Answer 9

• information can be distorted
• can’t control sub contractors as they’re external
• supply deliveries can be delayed
• required constant checking
• doesn’t ensure that the activities are done on time

Question 10

Advantages of decision trees

Answer 10

• Clearly lay out the problem so that all options can be considered
  • Allow managers to analyse fully the possible consequences and risks of a decision
  • Provide a framework to quantify the values of outcomes and the probabilities of achieving them

Question 11

Disadvantages of the decision tree

Answer 11

• Use probabilities which only gives an estimate, these may be inaccurate
  • Can oversimplify a decision and focus too much on the financial outcome
  • Don’t include other factors such as manpower considerations, managers’ opinions and marketing issues
  • Can be time consuming to construct and may be interpreted with bias