Decision making with risk Flashcards
Cost-Volume-Profit analysis, break-even, expected values
Calculate EV if:
Scenario 1, 0.6 probability for a profit of $50,000
Scenario 2, 0.3 probability of a profit of $12,000
Scenario 3. 0.1 probability of a lossof $25,000
EV = 0.6 x 50 + 0.3 x 12 - 0.1 x 25,000 = +$31,000
Project is acceptable because EV is a positive number.
What concerns are there with using EV?
EV is a long run average when project is a one-off decision
EV cannot happen
Difficult to estimate probabilities with any certainty
EV ignores risk profile of shareholders
Should you prioritize products which the largest gross profit if you have a constraint?
You can but has issues:
Gross profit per batch includes costs which are fixed in nature and will be incurred regardless to what product is produced.
gross profit does not consider we have a constraint resource. If another product uses less labour (and labour is a constraint) it makes sense to use a less time consuming products to prioritize.
Production overheads absorbed into the cost of each batch are based upon budgeted production overheard absorption rates. If we have a reduced level of productions due to the constraint, it’s likely that these will increase overheads and shared over fewer units.
Should you prioritize products with the higher contribution when you have a constraint?
Would have to recalculate the contribution per unit for that constrained resource.
Should you use throughput per house to prioritize a product if you have a constraint?
With throughput you assume labour is fixed.
Method used to rank options and allocate a time.
Would you prioritise the large retailer customers if you had a constraint?
Probably not, could ruin relationships with other customers.
Other factors to consider if you have a constraint?
As we have 14 days of inventory and the short shelf life of bread, we cannot get around the constraint by using up inventory.
Healthy production staff may be trained enough to move up from other departments and we could pay overtime.
Make products as and when orders come in and communicate their may be a delay in delivery.
What is the most ideal option for Halfpenny constraint?
Throughput probably, most staff are fixed costs due to being salaried.
What is risk-neutral?
Not be concerned by the risk of each package, would consider the expected return instead
What is risk adverse?
Seek to get the best trade-off between risk and return, would only accept a higher risk if the additional return is sufficient to compensate.
How is weighted benefit scoring approach carried out?
Decision making technique which applies numerical weightings to the potential benefits available from a range of options.
What is step 1 for a weighted benefit scoring approach?
Make a list of options available as part of a short-term decision.
What is step 2 for a weighted benefit scoring approach?
Identify the potential benefits which can be obtained by each option.
What is step 3 for a weighted benefit scoring approach?
Select weightings for each benefit based on strategic importance. (as a %)
What is step 4 for a weighted benefit scoring approach?
Allocate a score for each potential benefit to each of the options
What is step 5 for a weighted benefit scoring approach?
Identify the option which has the highest weighted average score
Advantages of weighted benefit approach?
Allows the organisation to consider multiple factors e.g. cost and quality
Strategic priorities are taken into consideration when identifying the best option
Provides transparent framework for decision making
Disadvantages of weighted benefit approach?
The choice of weighting will typically be influenced by some degree of managements subjectivity
Identifying a score for each option may also be highly subjective
Stakeholders may challenge the methodology applied if they are not satisfied with the choice.
