Quantitative Analysis for Management

Fourteenth Edition

Chapter 1
Introduction to
Quantitative Analysis

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 What is Quantitative Analysis?
Quantitative analysis is a scientific approach to
managerial decision making in which raw data are
processed and manipulated(control) to produce meaningful
information

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 What is Quantitative Analysis?
Quantitative factors are data that can be accurately
calculated
 Different investment alternatives
 Interest rates
 Financial ratios
 Cash flows and rates of return
 Flow of materials through a supply chain

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 What is Quantitative Analysis?
Qualitative factors are more difficult to quantify but
affect the decision process
 The weather
 State and federal legislation
 Technological breakthroughs (step forward)
 The outcome of an election

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 Business Analytics
 Descriptive analytics: The study and consolidation of
historical data for a business and an industry.
 Predictive analytics: Forecasting future outcomes
based on patterns in the past data.
 Prescriptive analytics: The use of optimization
methods to provide new and better ways to operate
based on specific business objectives.

Pick any organization and provide examples of how

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 Defining the Problem
 Develop a clear and concise statement of the problem to
provide direction and meaning
 This may be the most important and difficult step
 Go beyond symptoms, and identify true causes
 Concentrate on only a few of the problems—selecting
the right problems is very important
 Specific and measurable objectives may have to be
developed

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 Developing a Model
 Models are realistic, Mathematical models
solvable, and
understandable X=independent variable
Y=dependent variable
mathematical bo=intercept (x and y=0)
b1=slope
representations of a Y=b0​+b1​X (linear
situation equation)

 Different types of models

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 Developing a Model
 Mathematical model—a set of mathematical
relationships
 Models generally contain variables and parameters
 Controllable variables, decision variables, are
generally unknown
 How many items should be ordered for
inventory?
 Parameters are known quantities that are a part of
the model
 What is the cost of placing an order?
 Required input data must be available
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 Acquiring Input Data
 Input data must be accurate—GIGO rule
 Data may come from a variety of sources—company
reports, documents, employee interviews, direct
measurement, or statistical sampling

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 Developing a Solution
 Manipulating (control) the model to arrive at the best
(optimal) solution
 Common techniques are
 Solving equations
 Trial and error: trying various approaches and
picking the best result
 Complete enumeration: trying all possible values
 Using an algorithm: a series of repeating steps to
reach a solution

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 Testing the Solution
 Both input data and the model should be tested for
accuracy and completeness before analysis and
implementation
 New data can be collected to test the model
 Results should be logical, consistent (reliable), and
represent the real situation

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 Analyzing the Results
 Determine the implications of the solution
 Implementing results often requires change in an
organization
 The impact of actions or changes needs to be studied
and understood before implementation
 Sensitivity analysis determines how much the results
will change if the model or input data changes
 Sensitive models should be thoroughly (carefully)
tested

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 Implementing the Results
 Implementation incorporates (integrates) the solution into
the company
 Implementation can be very difficult
 People may be resistant to changes
 Many quantitative analysis efforts have failed
because a good, workable solution was not properly
implemented
 Changes occur over time, so even successful
implementations must be monitored to determine if
modifications are necessary

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 How to Develop a Quantitative Analysis
Model
A mathematical model of profit:
Profit  Revenue  Expenses

 Revenue and expenses can be expressed in different

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 How to Develop a Quantitative Analysis
Model
Profit Revenue  (Fixed cost  Variable cost)
Profit Selling price per unit Number of units sold 
 Fixed cost  Variable costs per unit Number of
units sold

Profit  sX   f + vX 
Profit  sX  f  vX
Where:
s = selling price per unit v = variable cost per unit
f = fixed cost X = number of units sold

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 Mathematical Models Categorized by
Risk
 Deterministic models do not involve risk or chance
 All in the model are known with complete certainty
 Probabilistic models involve risk or chance
 Values used in the model are estimates based on
probabilities

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 Possible Problems in the Quantitative
Analysis Approach
 Defining the problem
 Conflicting viewpoints
 Impact on other departments
 Beginning assumptions
 Solution outdated
 Developing a model
 Fitting the textbook models
 Understanding the model

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 Possible Problems in the Quantitative
Analysis Approach
 Acquiring accurate input data
 Using accounting data
 Validity of the data
 Developing a solution
 Hard-to-understand mathematics
 Only one answer is limiting
 Testing the solution
 Solutions not always intuitively obvious
 Analyzing the results
 How will it affect the total organization

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Implementation—Not Just the Final Step
 Lack of commitment by end users
 Loss of power
 Resistance to change
 Modeling slows down process
 Lack of commitment by quantitative analysts
 Analysis doesn’t end when the model is done
 Work with end-users and consider feelings

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Quantitative Analysis for Management
Fourteenth Edition

Chapter 3
Decision Analysis

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 Introduction
 Decision theory is an analytic and systematic
approach to the study of decision making
 What is involved in making a good decision?
 A good decision is one that is based on logic, considers
all available data and possible alternatives, and applies a
quantitative approach.

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 The Six Steps in Decision Making
1. Clearly define the problem at hand
2. List the possible alternatives
3. Identify the possible outcomes or states of nature
4. List the payoff (typically profit) of each combination of
alternatives and outcomes
5. Select one of the mathematical decision theory models
6. Apply the model and make your decision

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Types of Decision-Making Environments
 Decision making under certainty
 The decision maker knows with certainty the
consequences of every alternative or decision choice
 Decision making under uncertainty
 The decision maker does not know the probabilities
of the various outcomes
 Decision making under risk
 The decision maker knows the probabilities of the
various outcomes

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 Decision Making Under Uncertainty
Criteria for making decisions under uncertainty
1. Maximax (optimistic)(decision-makers who want to
maximize the best possible outcome)
2. Maximin (pessimistic)(decision-makers who want to
maximize the worst possible outcome)
3. Criterion of realism (Hurwicz) (A decision-making tool
used in operations research and economics)
4. Equally likely (Laplace) (Averages payoffs and chooses
the alternative with the highest average)
5. Minimax regret (Minimizes the maximum possible regret
by choosing the alternative with the smallest worst-case
regret)
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 Minimax Regret
 Based on opportunity loss or regret
 The difference between the optimal profit and actual
payoff for a decision
Step 1—Create an opportunity loss table by determining
the opportunity loss from not choosing the best alternative
Step 2—Calculate opportunity loss by subtracting each
payoff in the column from the best payoff in the column
Step 3—Find the maximum opportunity loss for each
alternative, and pick the alternative with the minimum
number

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 Expected Value of Perfect Information
(EVPI)
 E V P I places an upper bound on what you should pay for
additional information
 E V w P I is the long-run average return if we have perfect
information before a decision is made
EVwPI (best payoff in state of nature i )
(probability of state of nature i )

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 Decision Trees
 A decision tree is a flowchart-like structure used for decision-making and
predictive modeling.
 Any problem presented in a decision table can be graphically represented in a
decision tree.

 Most beneficial with a sequence of decisions

 All decision trees contain decision points/nodes and state-of-nature

 At state-of-nature nodes (the circles), one state of nature will occur

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Five Steps of Decision Tree Analysis
1. Define the problem
2. Structure or draw the decision tree
3. Assign probabilities to the states of nature
4. Estimate payoffs for each possible combination of
alternatives and states of nature
5. Solve the problem by computing expected monetary
values (EMVs) for each state of nature node

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Quantitative Analysis for Management
Fourteenth Edition

Chapter 4
Regression Models

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 Introduction
 Regression analysis—a very valuable tool for managers
 Understand the relationship between variables
 Predict the value of one variable based on another
variable
 Simple linear regression models have only two variables,
a dependent and an independent variable
 Multiple regression models have three or more variables,
one dependent variable, and two or more independent
variables

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 Introduction
 The variable to be predicted is called the dependent
variable or response variable
 Value depends on the value of the independent
variable(s)
 Explanatory or predictor variable
 A scatter diagram or scatter plot is often used to
investigate the relationship between variables
 Independent variable is normally plotted on the X axis
 Dependent variable is normally plotted on the Y axis

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Assumptions of the Regression Model
 With certain assumptions about the errors, statistical
tests can be performed to determine the model’s
usefulness
1. Errors are independent
2. Errors are normally distributed
3. Errors have a mean of zero
4. Errors have a constant variance
 A plot of the residuals (errors) often highlights glaring
violations of assumptions

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 Binary or Dummy Variables
1. Binary (or dummy or indicator) variables are special
variables created for qualitative data
2. A dummy variable is assigned a value of 1 if a particular
condition is met and a value of 0 otherwise
3. The number of dummy variables must equal one less
than the number of categories of the qualitative variable

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Quantitative Analysis for Management
Fourteenth Edition

Chapter 5
Forecasting

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 Exponential Smoothing With Trend
 The equation for the trend correction uses a new smoothing constant 

 Ft and Tt must be given or estimated

 Three steps in developing FITt

Step 1: Compute smoothed forecast Ft+1

Smoothed forecast  Previous forecast

Ft 1 FITt   (Yt  FITt )

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 Exponential Smoothing With Trend
Step 2: Update the trend (Tt +1 ) using
Smoothed forecast  Previous forecast including
trend  b(Error or excess in
trend)
Tt 1 Tt   (Ft 1  FITt )

Step 3: Calculate the trend-adjusted exponential smoothing forecast

Forecast including trend (FITt 1 )  Smoothed forecast (Ft 1 )

FITt 1 Ft 1  Tt 1

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