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Chapter 1:

Introduction to Managerial
Decision Modeling

© 2007 Pearson Education


What is Decision Modeling?
A scientific approach to managerial
decision making

• The development of a (mathematical) model


of a real-world scenario

• The model provides insight into the solution of


the managerial problem
Types of Decision Models
• Deterministic Models
Where all the input data value are known with
complete certainty

• Probabilistic Models
Where some input data values are uncertain
Quantitative vs. Qualitative Data
The modeling process begins with data

• Quantitative Data
Numerical factors such as costs and revenues

• Qualitative Data
Factors that effect the environment which are
difficult to quantify
Spreadsheets in Decision Making
• Computers are used to create and solve
models

• Spreadsheets are a convenient alternative


to specialized software

• Microsoft Excel has extensive modeling


capability via the use “add-ins”
Steps in Decision Modeling
1. Formulation
Translating a problem scenario from
words to a mathematical model
2. Solution
Solving the model to obtain the optimal
solution
3. Interpretation and Sensitivity Analysis
Analyzing results and implementing a
solution
Steps in
Modeling
Example Model: Tax Computation
Self employed couple must estimate and
pay quarterly income tax (joint return)
• Income amount is uncertain
• 5% of income to retirement account, up to
$4000 max
• Personal exemption = 2 x $3200 = $6400
• Standard deduction = $10,000
• No other deductions
Tax Brackets

Percent of
Taxable Income Taxable Income
up to $14,600 10%
$14,601 to $59,400 15%
$59,401 to $119,950 25%
Example Model: Break-Even Analysis

Profit = Revenue – Costs

Revenue = (Selling price) x (Num. units)

Costs = (Fixed cost) +


(Cost per unit) x (Num. units)
The Break Even Point (BEP) is the
number of units where;

Profit = 0, so
Revenue = Costs

BEP = Fixed cost


(Selling price) – (Cost per unit)
Possible Problems in
Developing Decision Models
Defining the Problem

• Conflicting viewpoints

• Impact on other departments

• Beginning assumptions

• Solution outdated
Possible Problems in
Developing Decision Models
Developing a Model
• Fitting the textbook models
• Understanding the model

Acquiring Input Data


• Using accounting data

• Validity of data
Possible Problems in
Developing Decision Models
Developing a Solution
• Hard to understand mathematics

• Limitations of only one answer

Testing the Solution

Analyzing the Results

Implementation