CHAPRTER VII DEFINITIONS

QUANTITATIVE METHODS Management Science (Operations Research) is a collective effort of interdisciplinary

FOR PLANNING AND CONTROL talent concentrating on the development and application of models (usually
mathematical) to aid management in solving executive problems.

PROBABILITY

"You can't do anything about the length of your life, but you can do something about
its width and depth."
Probability is the numerical measurement of the likelihood that an event will occur. It
is a number between 0 and 1 and it may be expressed as a percentage (e.g., 90%) or as
a fraction (9/10).
Expected Value is an arithmetic mean, a weighted average using the probabilities as
weights. It is merely a sum of products, each product representing a weighted
observation. Each weight is the probability of the observation occurring.

Pay-off-table shows the actions, outcomes with their probabilities and the monetary
values of all possible action/outcome combinations.

TYPES OF PROBABILITIES

1. Conditional Probability – that probability of some event which is conditioned

(or predicated) on some other event.
STUDY OBJECTIVE: 2. Unconditional Probability – it is the probability of some event which is not
After studying this chapter, you should be able to answer the following: conditional (or dependent) on some other event occurring.

1. What is quantitative technique and how is it useful in planning and control? GENERAL COMPUTATION OF PROBABILITY OF ANY EVENT
2. What is probability and how is it useful in planning and control?
3. What are regression and correlation analysis and how is it useful in business? 1. Identify each sample point* in the event. *Sample point is a unique
4. What are PERT and CPM and how is it useful in business planning and control? representation of the possible outcomes of the experiment. Thus, in a coin,
there two (2) sample points, head and tail, and in a dice there are six.
2. Obtain the probability of each sample point.
3. Add all these probabilities together.

Mutually Exclusive Events – Events are mutually exclusive if one and only one
outcome can take place at time. An example is tossing a coin.

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REGRESSION AND CORRELATION ANALYSIS
REGRESSION ANALYSIS – tries to estimate the relationship between a dependent
variable (cost) and one or more independent variables (volume) from a set of actual
observations on these variables.
SIMPLE LINEAR EQUATIONS
a. SIMPLE: Only two variables are involved, i.e., the data set consist of paired
observations of two variables of interest. One dependent variable (cost) and
one independent variable (volume).
b. LINEAR: The underlying relationship between the two variables, if plotted,
would resemble a straight line, e.g. Y = a +bx
SCATTERGRAM (Scatter Diagram) – is obtained by plotting the data set on an ordinary
two axis graph, this diagram gives a fair indication of the nature between the
dependent and independent variables.
LINE OF REGRESSION – is the line of average for costs that are influenced by a factor
such as hours or activity. It is a method frequently used in computing an average rate
of variability. The average is the point at which the sum of the deviations above the
point (line) is equal to the sum of the deviations below that point. The line drawn at
this point is the Line of Regression.
CORRELATION ANALYSIS – In contrast to simple regression analysis, the objective of
simple linear correlation analysis is to measure the degree of relationship between the
two variables X and Y. Thus, the terms dependent variable and independent variable
have no meaning in correlation analysis.
1. The coefficient of correlation (r) is a measure of the degree of linearity in the
relationship between X and Y. A perfectly linear relationship means r = 1
(positive slope line) or r = -1 (negative slope line); r can only lie between +1
and -1.
2. The square of r is called the coefficient of determination. It is equal to the
proportion of the total variation in Y that can be explained by the regression of
Y and X. r² = Explained Variation ÷ Total Variation
If the regression line gives a good fit to the data, a high proportion of the variation can
be explained by the relationship and r² tends to be high.
LINEAR RELATIONSHIP
HIGH-LOW POINT METHOD – It is a crude technique to fit a linear relationship to a
scatter of points, e.g., Volume (X) and Cost (Y) data. It uses only two data points, those
corresponding to the highest and lowest values.
LEAST-SQUARES METHOD – It minimizes the sum of squares of the vertical deviations
of the points from the straight line.
LINEAR PROGRAMMING – Linear Programming is a mathematical technique for
optimum allocation of scarce resources.
Linear Programming involves:
1. Constructing a set of simultaneous linear equations which represent the model
of the problem and which include many variables; and
2. Solving the equations with the help of a computer.
Steps applied in Linear Programming:
1. Formulate the objective function. This objective is usually to maximize profit or
minimize cost.
2. Determine the basic relationships particularly the constraints.
3. Determine the feasible alternatives.
4. Compute the optimum solution.
PERT and CPM
PERT (Program Evaluation and Review Technique) is based on what is called a
Network Plan. A flow chart – the network – is used to show how the individual parts of
a project (the activities and the starting events) depend on one another and which
tasks must be finished before others can be started.
Estimates derived from PERT Analysis:
1. The earliest expected time for completion of each activity, or task.
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2. The latest allowable time for each completion event.
3. The critical path of the network; that is, the path through the flow chart that has the
least total amount of slack. (Slack is the difference between the latest allowable time
and the expected time of completion.)
4. The probabilities that events will occur on schedule.
CPM (Critical Path Method) or Project Management is closely related to PERT.
3. -Prepare a Pay-off Table that will show the expected monetary value of each
outcome.
PROBABILITY
As the accounting consultant for Leslie Company, you have compiled data on the day-
to-day demand rate from Leslie’s customers for Product A and the lead-time to receive
Product A from its supplier. The data are summarized in the following probability table:

Both PERT and CPM involve determining expected times of completion of individual Demand of Product A Lead Time for Product A
events for the entire project. Unit Demand Probability of Lead Time Probability of
Per Day Occurrence in Days Occurrence
PERT goes further to include variance analysis while CPM does not. CPM, on the other 0 .45 1 .40
hand, goes beyond PERT in another direction. It uses cost data to assess the financial 1 .15 2 .35
effects of setting up crash programs in the network’s critical path segments to ensure 2 .30 3 .25
completion on schedule. 3 .10
1.00 1.00
The essence of PERT is to aid managers in planning and controlling a project.
Leslie is able to deliver Product A to its customers the same day that it is received from
BAR CHART for a simple PERT network will bring out the pattern of activities and slack the supplier. All units of product A demanded but not available, due to a stock-out, are
times clearly. A Bar Chart would be unwieldy for use in a more complex network. back ordered and filled immediately when a new shipment arrives.

Requirement:
ILLUSTRATIVE EXERCISES 1. Compute for the probability of the demand for Product A being nine (9) units
PROBABILITY during a three-day lead time for delivery from the supplier.
It has been observed by the Probe Company over the past 100 weeks that the weekly 2. Compute the number of days during a 360-day year that Leslie will experience
demand for Product A was 30 units during 25 of these 100 weeks, 35 units during 35 of a stock-out of Product A if Leslie reorders 10 units of Product A when its
the past 100 weeks, and 40 units during the remaining 40 weeks. The demand pattern inventory level is 10 units.
can be expected to remain stable in the future.
CORELATION ANALYSIS
The company buys the product from another source at a cost of P30 per unit and sells A. The closeness of the linear relationship between the cost and the activity is the
it for P50 each. The product is perishable and unsold units become worthless at the a. Correlation c. Deviation
end of the week. b. Variation d. Standard Error

Required:
1. Compute the probability of the demand for Product A weekly at 30 units, 35 B. Looking at the following scatter diagrams, we can conclude that
units, and 40 units.
2. Compute the expected value of the weekly demand.

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 P . . . . . P ..
. . . .. ... PERT and CPM
. . . . .. . . A construction company has contracted to complete a new building and has asked for
. . . . .. assistance in analyzing the project. Using the Program Evaluation Review Technique
(PERT), the network has been developed. All paths from the start point to the finish
Activity Activity point, event 6, represent activities or processes that must be completed. The numbers
above the paths or line segments represent expected completion times for the
Cost A Cost B activities or processes. The expected time is based upon the commonly used, 1-4-1,
a. Cost A will be easier to predict than cost B. three-estimate method. For example, the three-estimate method gives an estimated
b. Cost B will be easier to predict than cost A. time of 4.2 to complete event 1.
c. Cost A is out of control.
d. Cost B has no variable component. 9

C. Which of these correlation coefficients represents strongest relationship

5.2
between two vaiables?
a. +.50 c. +.05 7.1
b. -.80 d. +1.02 5.0
D. What is the appropriate range for the coefficient of determination? 2 5 3.5
a. -1 to +1 c. 0 to +1 4.2

b. -1 to 0 d. 0 to infinity 4.2
S 1 3.0 6
7.3
LINEAR PROGRAMMING
2.1
Linear Company produces Product A and B which contributes to profit per unit at P20
3 4
and P15 respectively. Product A is processed in Machine X requiring 4 hours per unit 3.6 4.6
and Machine Y requiring 3 hours per unit. Product B is processed only in Machine Y
using 4 hours per unit. Machine X and Y could provide 4,000 hours and 4,800 hours
5.0
respectively each year.
7 8

Product A and B passes the Polishing Department requiring 2 hours per unit each
product before it is considered a finished product. The polishing department has 2,600 Required:
hours available each year. Determine the following:
1. Critical path (the path requiring the greatest amount of time.)
Required: 2. The slack time on path 1-9-6.
1. Formulate the objective function. 3. The latest time for reaching event 6 via path 1-2-5-6.
2. Determine the basic relationships (Constraints or limitations). 4. The earliest time for reaching 6 via path 1-2-5-6.
3. Determine the number of Product A and Product B that the company should
manufacture using the graphic method.
4. Formulate the problem under the Simplex Method.
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PRACTICE EXERCISES b. The method of least squares d. Correlation analysis
(Sources: CMA/CIA/RPCPA/AICPA/Various test banks)
7. A quantitative technique used to discover and evaluate possible cause-and-
1. Which of the following is a useful technique in determining the fixed and effect relationship is
variable elements of a semi-variable expense? a. Linear programming c. Poisson distribution
a. Linear Programming c. PERT models
b. Queing theory d. Simple regression b. PERT d. Correlation analysis
analysis
8. The constraints in a linear programming problem usually model
2. Which of the following quantitative methods will separate a semi-variable a. Profits c. Dependent
costs into its fixed and variable components with the highest degree of variables
precision under all circumstances. b. Restrictions d. Goals
a. High-low method c. Least-squares method
b. Simplex method d. Scatter-graph 9. Linear programming is used most commonly to determine
method a. That mix of variables which result in the largest quantity.
b. The best use of scarce resources.
3. Simple regression analysis involves the use of c. The most advantageous prices
a. One variable c. Three variables d. The fastest timing.
b. Two variables d. More than three
variables 10. Simple regression analysis involves the use of

4. Probability (risk) analysis Dependent Variables Independent Variables

a. Ignores probability weights under fifty percent a. One None
b. Is only for situations in which there are three or fewer possible outcomes b. One One
c. Does not enhance the usefulness of sensitivity analysis data c. One Two
d. Is an extension of sensitivity analysis d. None Two

5. Regression analysis is superior to other cost behavior analysis techniques

because it
a. Produces measures of probable error.
b. Examines only one variable
c. Proves a cause and effect relationship
d. It is not a sampling technique

6. A formal diagram of the interrelationships of complex time series of activities

is
a. PERT c. Linear programming