Decision Theory and the Normal Distribution l CD-ROM MODULE 3

TRUE/FALSE

M3.1 Examples of fixed costs are insurance, rent, equipment, etc.

ANSWER: TRUE

M3.2 Examples of variable costs are labor and material costs related to production volume.

ANSWER: TRUE

M3.3 The break-even point is the volume where revenues equal costs.

ANSWER: TRUE

M3.4 EMV typically is not useful in break-even analysis.

ANSWER: FALSE

M3.5 EOL typically is not useful in break-even analysis.

ANSWER: FALSE

M3.6 A large number of possible volume values need to be assumed to enable one to use a unit normal
loss integral.

ANSWER: TRUE

M3.7 Using EOL requires one to identify the loss per unit when sales are below the break-even point.

ANSWER: TRUE

M3.8 In determining the EOL with the normal distribution, as D increases, the unit normal loss integral,
N(D), also increases.

ANSWER: FALSE

M3.9 When computing Z for a break-even analysis: as  increases, Z decreases.

ANSWER: TRUE

M3.10  describes the dispersion or spread of the normal distribution.

ANSWER: TRUE

*M3.11 In breakeven analysis, we will use the normal distribution even if such use is not warranted.

ANSWER: FALSE

*M3.12 If a variable other than demand is random (price, fixed or variable cost, etc.) the problem of
breakeven-analysis becomes much more complex.

ANSWER: TRUE

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Decision Theory and the Normal Distribution l CD-ROM MODULE 3

*M3.13 The unit normal loss integral can be used to compute EOL.

ANSWER: TRUE

*M3.14 EVPI and EOL are equivalent.

ANSWER: FALSE

*M3.15 Even if demand appears as sketched below, we can use the normal distribution to represent it.

ANSWER: FALSE

MULTIPLE CHOICE

M3.16 The price/unit minus the fixed cost is

(a) loss/unit when sales are below the break-even point.

(b) the break-even point.
(c) the Z value.
(d) EOL.
(e) none of the above

ANSWER: e

M3.17 If fixed costs were to double unexpectedly, the break-even point would be

(a) unaffected.
(b) doubled.
(c) halved.
(d) increased by a factor of 4.
(e) none of the above

ANSWER: b

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M3.18 If the price/unit were doubled at the same time that the variable cost/unit doubled, the break-even
point would be

(a) unaffected.
(b) doubled.
(c) halved.
(d) increased by a factor of 4.
(e) none of the above

ANSWER: c

M3.19 For volumes greater than the break-even point, the opportunity loss function is

(a) a function of K, the loss per unit.

(b) 0.
(c) dependent on how much the volume is greater than the break-even point.
(d) Z2.
(e) none of the above

ANSWER: b

M3.20 When using the normal distribution to estimate demand, one assumes

(a) symmetry of demand around a mean.

(b)  twice the value of 
(c)  half the value of 
(d) Z.
(e) none of the above

ANSWER: a

M3.21 EOL can be approximated by

(a) K  N(D).
(b) K 
(c) ( -break-even point)/
(d) K2 D.
(e) none of the above

ANSWER: a

M3.22 In determining the EOL with the normal distribution, as D increases, N(D)

(a) increases by a factor of D.

(b) increases.
(c) decreases.
(d) is unaffected.
(e) none of the above

ANSWER: c
M3.23 If D = 1.00, then N(1.00) is approximately

(a) 0.

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(b) 1.00000.
(c) 0.08332.
(d) 0.35090.
(e) none of the above

ANSWER: c

M3.24 Demand is estimated to be 1600 units. If Z is taken to be 1.5, when the estimated average
demand is 2000 units, determine  for this data.

(a) 71,111
(b) 71,111
(c) 266
(d) 266
(e) none of the above

ANSWER: c

M3.25 The computed EVPI will be the same as the computed

(a) EMV.
(b) LOE.
(c) break-even point.
(d) EOL.
(e) none of the above

ANSWER: d

M3.26 Given the following opportunity loss function, determine the loss when 400 units are sold.
Opportunity loss = 3 (1000  X) for X  1000, otherwise 0.

(a) 0
(b) 1200
(c) 1800
(d) 3
(e) 600

ANSWER: c

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M3.27 Given the following opportunity loss function, determine the loss when 600 units are sold.
Opportunity loss = 3 (1000  X) for X  1000, otherwise 0.

(a) 0
(b) 800
(c) 1200
(d) 3
(e) 600

ANSWER: c

M3.28 Given the following opportunity loss function, determine the loss when 1000 units are sold.
Opportunity loss = 3 (1000  X) for X  1000, otherwise 0.

(a) 3
(b) 600
(c) 800
(d) 0
(e) 1200

ANSWER: d

M3.29 Given the following opportunity loss function, determine the loss when 1200 units are sold.
Opportunity loss = 3 (1000  X) for X  1000, otherwise 0.

(a) 1200
(b) 0
(c) 600
(d) 3
(e) 800

ANSWER: b

M3.30 Fixed costs include

(a) insurance.
(b) lighting.
(c) labor.
(d) materials.
(e) (a) & (b)

ANSWER: e

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M3.31 If fixed costs are $25,000, variable costs/unit are $5, and the selling price per unit is $10, the
break-even point is

(a) 36,000 units.

(b) 250,000 units.
(c) 25,000 units.
(d) 5,000 units.
(e) none of the above

ANSWER: d

M3.32 If variable cost/unit rises, the fixed cost falls, and the selling price/unit remains constant, the
break-even point

(a) stays the same.

(b) decreases.
(c) increases.
(d) none of the above
(e) unable to say without more information

ANSWER: e

M3.33 If the variable cost/unit doubles, while the fixed cost and selling price/unit remain constant, the
break-even point

(a) doubles.
(b) increases by fifty percent.
(c) remains the same.
(d) none of the above
(e) unable to say without more information

ANSWER: e

M3.34 If the selling price/unit rises, while the fixed cost remains at $50,000 and variable cost/unit
remains at $5/unit, the break-even point

(a) increases proportional to the fractional increase in selling price.

(b) decreases proportional to the fractional increase in selling price.
(c) decreases.
(d) none of the above
(e) unable to say without more information

ANSWER: c

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M3.35 Loss/unit when sales are below the break-even point is equal to

(a) (total revenue - total cost)/number of units.

(b) selling price.
(c) price/unit minus variable cost per unit.
(d) EOL.
(e) none of the above

ANSWER: c

*M3.36 If the break-even volume doubles, this suggests that

(a) variable cost has increased.

(b) fixed cost has increase.
(c) selling price has decreased.
(d) any one of (a), (b), or (c)
(e) none of the above

ANSWER: d

*M3.37 Break-even analysis gives us information about

(a) the variable costs we should expect to incur.

(b) cost and revenues as a function of demand.
(c) the number of products we should expect to sell.
(d) all of the above
(e) none of the above

ANSWER: b

*M3.38 Tony B. is attempting to start up a new landscaping business. He estimates that to break-even, he
will need about 150 customers. He believes that he will lose approximately $500 per customer
for each customer fewer than the 150. At the moment, he believes that there is an 80%
probability that he will be able to secure between 130 and 170 customers, and that there is a
50/50 chance that demand will be greater than 160 customers. What is the mean or expected
number of sales?

(a) 130
(b) 150
(c) 160
(d) 170
(e) none of the above

ANSWER: c

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*M3.39 Tony B. is attempting to start up a new landscaping business. He estimates that to break-even, he
will need about 150 customers. He believes that he will lose approximately $500 per customer
for each customer fewer than the 150. At the moment, he believes that there is an 80%
probability that he will be able to secure between 130 and 170 customers, and that there is a
50/50 chance that demand will be greater than 160 customers. He has several marketing research
firms offering (for a price, of course) to conduct a survey that will provide additional information
regarding the probability of demand. How much should he be willing to spend if he decides to
have a survey made?

(a)  $7,000
(b)  $3,000
(c)  $5,000
(d)  $2,000
(e) none of the above

ANSWER: b

*M3.40 The URU Company manufactures traditional wooden toothpicks. They have determined their
variable cost/unit to be $0.0001 /toothpick. Fixed costs, however, are quite high due to the old
equipment that is employed in the process and the costly packaging needed to market the
toothpicks. The fixed costs are estimated at $11,000 /month. IRU sells their toothpicks at a
price of $2.75/gross of 100 toothpick packages. How many gross of packages of toothpicks must
be sold annually to break even?

(a)  7,000 packages

(b)  8,700 packages
(c)  8,100 packages
(d)  8,400 packages
(e) none of the above

ANSWER: d

*M3.41 The break-even point is 3000 units/month. Next month begins an increase in advertising cost of
$5,000 per month. The overall effect will be to increase the fixed costs by 5%. How will the
break-even point be affected?

(a) break-even will rise to 3,500 units per month

(b) break-even will fall to 2,800 units per month
(c) break-even will rise by 5%
(d) break-even will rise by 3%
(e) none of the above

ANSWER: c

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*M3.42 If D = 1.37, s = 1100, K= 12, and the selling price/unit = 7, the EOL is:

(a)  12345
(b)  24315
(c)  15019
(d)  16518
(e) none of the above

ANSWER: e

*M3.43 Given the following opportunity loss function, determine the loss when 7000 units are sold.
Opportunity loss: 3(10500 - X) for X  9000.

(a) 10500
(b) 13500
(c) 9000
(d) 11000
(e) none of the above

ANSWER: a

*M3.44 Harry Sprague makes custom bowling balls. His fixed cost is $255,000, variable cost is $45.50,
and selling price is $55.50. To what value must he reduce his variable cost if he wants a break-
even point of 10000 units?

(a) $39
(b) $37
(c) $35
(d) $30
(e) none of the above

ANSWER: d

*M3.45 Harry Sprague makes custom bowling balls. His fixed cost is $255,000, variable cost is $45.50,
and selling price, $55.50. To what value must he reduce his fixed cost if he wants a break-even
point of 10000 units?

(a) $110,000
(b) $100,000
(c) $105,000
(d) $80,000
(e) none of the above

ANSWER: b

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PROBLEMS

M3.46 The IRU Company manufactures traditional wooden pencils. They have determined their
variable cost/unit to be $0.012 /pencil. Fixed costs, however, are quite high due to the old
equipment that is employed in the process and the costly packaging needed to market the pencils.
The fixed costs are estimated at $140,000 /month. IRU sells their pencils at a price of
$13.248/gross. How many gross of pencils must be sold annually to break even?

ANSWER: selling price/pencil = 13.248/144 = 0.092 $/pencil

break-even point = 140,000/(0.092-0.012) = 1,750,000 pencils/month = 145,833 gross/year

M3.47 The break-even point was determined to be 3000 units/month. Next month begins an increased
lease payment for the production facility. The overall effect will be to increase the fixed costs by
10%. How will the break-even point be affected?

ANSWER: break-even point(NEW) = break-even point(OLD) (1.1) = 3,300

M3.48 If the break-even point was estimated to be 500 units when fixed costs are estimated at
$1200/month, what would the EMV be if average demand is estimated at 750?

ANSWER: 500 = 1200/(P  V), therefore (P  V) = 2.4 EMV = (2.4)(750)  (1200) = 600

M3.49 Average demand is estimated at 1200 units/month. It is believed there is a 20% chance for for
demand to be higher than 1800. Determine the  and  of a normal distribution that estimates
demand.

ANSWER:  = 1200,  = (1800  1200)/ (0.84) = 714

M3.50 Given the following opportunity loss function, determine the loss when 3000 units are sold.
Opportunity loss = 10 (7000  X) for X  7000, otherwise 0.

ANSWER: 40000

M3.51 Determine N(D) for the following D values: 0.01, 0.21, 0.77, and 1.20.

ANSWER:

N(D) = 0.3940, 0.3027, 0.1267, 0.05610

M3.52 If D = 1.00, s = 1000, K= 10, and the selling price/unit = 4, determine the EOL.

ANSWER:

EOL = 10 (1000) (0.08332) = 833

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M3.53 Jack Spratt is producing candlesticks. His fixed cost is $5,000, variable cost/unit, $3.50, and
selling price, $8.50. At what number of units does he break even?

ANSWER:

Break-even (units) = 5000/(8.50 - 3.50) = 1000 units

M3.54 Given the following opportunity loss function, determine the loss when 7000 units are sold.
Opportunity loss: 6(9000 - X) for X  9000.

ANSWER:

OL = 6(9000 - 7000) = 12000

M3.55 If D = 0.75, s = 500, K = 6, and the selling price/unit = 5, determine EOL.

ANSWER:

EOL = K N(D) = 6 (500) N(0.75) = 6 (500)(0.1312) = 394

M3.56 Jack Spratt makes candlesticks. His fixed cost is $5,000, variable cost is $3.50, and selling
price, $8.50. To what value must he reduce his variable cost if he wants a break-even point of
900 units?

ANSWER:

Variable cost = (900*8.50 - 5000)/900 = $2.94

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SHORT ANSWER/FILL IN THE BLANK

M3.57 Break-even analysis answers what common management question?

ANSWER: At what point do revenues equal costs?

M3.58 Briefly describe the opportunity loss function.

ANSWER: a function that relates opportunity loss in dollars to sales in units

M3.59 In terms of fixed costs, variable cost/unit, and the selling price/unit, what is the break-even point?

ANSWER: break-even point = fixed cost / (selling price/unit  variable cost/unit)

M3.60 At break-even, _______ revenues equal _________ costs.

ANSWER: total, total

M3.61 Expected opportunity loss has the same value as ________.

ANSWER: EVPI

M3.62 As  increases, the spread of a distribution ________.

ANSWER: increases

M3.63 In decision-making, we use the normal distribution when there are ________.

ANSWER: very many alternatives and the distribution is bell-shaped

M3.64 The mean of a distribution locates the _________ of the distribution.

ANSWER: center or expected value

M3.65 EMV tells us the _________ if a decision was __________.

ANSWER: average monetary value of a decision, made many times

M3.66 EOL and EVPI are the _________ one would be willing to spend to gather additional
information.

ANSWER: maximum amount

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