Management Science

Chapter 2:
Introduction to Management Science

Fershie D. Yap, Ph.D.

College of Accountancy and Business Administration
 Management Science
 Concerned with developing and applying models
and concepts that help to illuminate management
issues and solve managerial problems
 A scientific approaches to problem solving and
decision making
 Used in variety of organizations to solve many
different types of problems (investment, resource
allocation, production mix, marketing, scheduling,
etc)
 Why Study Management Science?
Gain an appreciation for the relevance and
power of MS
Learn to recognize when MS can and cannot
be fruitfully applied
Learn how to apply the major techniques of MS
to analyze a variety or managerial problems
Develop an understanding of how to interpret
the results of an MS study
 Uses Scientific Approach
Define the problem and gather of data
Formulate a model to represent the problem
Develop a computed-based procedure for
deriving solutions to the problem from the model
Test the model and refine it as needed
Apply the model to analyze the problem and
develop recommendations for management
Help to implement the team’s
recommendations that are adopted by
management
Management Science Process
Observation – identification of
a problem of an organization
Management scientist is a
skilled person in MS
techniques
Management Science Process
Problem Definition – problem
must be clearly and
consistently defined showing
its boundaries and interaction
with the objectives of the
organization
Management Science Process
Model Construction–
development of the
functional relationships that
describe the decision
variables, objective function
and constraints of the
problem
The product costs P5 to
produce and sells for P20
Z=P20x-P5x
Equation as a whole is
functional relationship
Management Science Process
Model Construction–
 The product is made from steel and
that the business firm has 100
pounds of steel available; 4 pounds
of steel to make each product
 4x = 100 lbs
 Z=P20-P5
 Objective function (Z) – profit
equation
 Constraint (Steel) – resource
equation
 maximize Z=P20-P5x, subject to
4x=100lbs
Management Science Process
Model Solution– Model solved
using MS techniques
 maximize Z=P20-P5x, subject to
4x=100lbs
 Simple algebra solution:
 x=100
 x=100/4
 x=25units
 Profit function substitution
 Z=P20x-P5x
 20(25)-5(25)
 P375
Management Science Process
Model Implementation–
actual use of the model or its
solution
 Model Construction: Example
Problem Definition
Information data:
A bakery makes and sells birthday cakes (Cake A & Cake B)
Cake A cost P100 to produce, Cake B costs P120
Cake A sells for P200, while Cake B sells for P250
Cakes A & B require 0.5 and 0.8 pounds of double cream to
make
The bakery has 20 pounds of double cream for each day
Business problem: Assuming all cakes produced can be sold out,
determine the number of different cakes to produce to make the
most profit given the limited amount of double cream available
Model Construction (Mathematical Model): Example
 Decision Variable:
 Information data:  x=number of Cake A to produce
 A bakery makes and sells  y=number of Cake B to produce
birthday cakes (Cake A &
 Z=total profit
Cake B)
 Model:
 Cake A cost P100 to
produce, Cake B costs  Z=P200x+P250y-P100x-P120y (objective function)
P120  0.5x+0.8y <=20lbs of double cream (resource
 Cake A sells for P200, while constraint)
Cake B sells for P250  Parameters:
 Cakes A & B require 0.5  P200, P100, 0.5lbs, 20lbs (known values)
and 0.8 pounds of double
cream to make  Formal specification of model:
 The bakery has 20 pounds  maximize Z=P200x+P250y-P100x-P120y
of double cream for each  Subject to 0.5x+0.8y <=20lbs
day
MS Modeling Techniques
 Problem Solving and Decision Making
Problem Solving – the process of identifying a difference between
the actual and desired state of affairs
7 Steps of Problem Solving
Identify and define the problem
Determine the criteria for evaluating alternatives
Determine the set of alternative solutions
Evaluate the alternatives
Choose an alternative
Implement the selected alternative
Evaluate the results
 Problem Solving and Decision Making
Decision-Making Process

Single-criterion decision problems – the objective is to find

the best solution
Multi-criteria decision problems – involve more than 1
criterion
 Qualitative vs Quantitative Analysis
Analysis Phase of Decision-Making Process
Qualitative Analysis - based largely on the manager’s
judgment and experience
Quantitative Analysis – concentrate on the quantitative
facts with the problem, development of mathematical
expressions to make recommendations.
 Quantitative Analysis
Reasons for Quantitative Analysis Approach to Decision- Making
- The problem is complex
- The problem is very important
- The problem is new
- The problem is repetitive
 Quantitative Analysis Process
- Model development
- Data preparation
- Model solution
- Report generation
 Quantitative Analysis
 Models – representations of real objects or situations
- Iconic models – physical replicas of real objects
- Analog models – physical in form, nut do not physically resemble
the object being modeled
- Mathematical model – represents real world problems through a
system of mathematical formulas and expressions
 Deterministic vs Stochastic Models
 Deterministic Model – if all uncontrollable inputs to the model are
known and cannot vary
 Stochastic (Probabilistic) Model – if any uncontrollable are
uncertain and subject to variation
Transforming Model Inputs into Output
ABC Co.
 Break-Even Analysis

An important type of cost-volume analysis, focuses on

relationships between cost, revenue, and volume of output
Estimates the income of an organization under different
operating conditions
A simple way to determine price levels and to estimate
whether an expansion or cost saving project makes good
business sense
 Break-Even Analysis

Fixed cost - independent of the volume of units produced

and sold
Variable cost - determined on a per-unit basis
Total variable cost – cost that changes based on activities
Total revenue – selling price per unit x sales volume (pQ)
where pis the selling price per unit
Profit – difference between total revenue and total cost

Total Cost = total fixed cost + total variable cost

 Example: BEP analysis of ABC Co.

 The ABC Co. produces expensive and unusual gifts to be sold in stores
that cater to affluent customers who already have everything. The
latest new-product proposal to management from the company’s
research department is limited edition grandfather clock.
Management needs to decide whether to introduce this new product
and, if so, how many of these grandfather clocks to produce?
 Before making this decision, a sales forecast will be obtained to
estimate how many cloaks can be sold. Management wishes to make
the decision that will maximize the company’s profit.
 If the company goes ahead with this product, a fixed cost of $50,000
would be incurred for setting up the production facilities to produce
this product. In addition to this cost, there is a production cost that
varies with the number of clocks produced. The unit variable (marginal)
cost is $400/clock produced
 Each clock sold would generate a revenue of $900 for the company
 Example: BEP analysis of ABC Co.
 Q = #of grandfather clocks to produce (decision variable)
 Cf = $50,000 if Q>0 (Cf=0, if Q=0)
 Cv = $400/unit
 p = $900/unit
 Total variable cost = $400Q
 Total cost = $50,000 + $400Q
 Total revenue = $900Q
 Profit = Total revenue - Total cost
= $900Q – ($50,000 + P$00Q)
Q b/e = FC/(sales price per unit-VC per unit)
= 50,000 (900-400)
= 50,000/500 = 100units
100units, BEP
Example: BEP analysis of ABC Co.
Example: BEP analysis of ABC Co.
Example: Ponderosa Dev Corp
 Example: Ponderosa Dev Corp

Questions:
1. Identify all cost and denote the marginal cost and
marginal revenue for each house
2. Write the monthly cost function c(x), revenue function r(x),
and profit function p(x)
3. What is the BEP for monthly sales of the house?
4. What is the monthly profit if 12 houses per month are built
and sold?
 Example: Ponderosa Dev Corp
 Questions:
1. Identify all cost and denote the marginal cost and
marginal revenue for each house
 Answer:
FC = salaries + lease + supply cost
= $35,000 + $2,000 + $3,000
= $40,000
MC = cost land + materials + labor cost + commission cost
= $55,000 + $28,000 + $20,000+$2,000
=$105,000
MR = $115,000
 Example: Ponderosa Dev Corp

Questions:
2. Write the monthly cost function c(x), revenue function r(x),
and profit function p(x)
Answer:
c(x) = VC + FC = $105,000x + $40,000
r(x) = $115,000x
p(x) = r(x) – c(x) = $10,000x - $40,000
 Example: Ponderosa Dev Corp

Questions:
3. What is the BEP for monthly sales of the house?
Answer:
r(x) = c(x)
$115,000x = $105,000x + $40,000
BEP = FC/SP-VC
= 40,000/(115,000-105,000)
= 40,000/10,000
X = 4 houses
 Example: Ponderosa Dev Corp

Questions:
4. What is the monthly profit if 12 houses per month are built
and sold?
Answer:
p(12) = $10,000 (12) - $40,000 = $80,000 monthly profit