CHAPRTER VII

QUANTITATIVE METHODS
FOR PLANNING AND CONTROL

"You can't do anything about the length of your life, but you can do something
about its width and depth."

STUDY OBJECTIVE:
After studying this chapter, you should be able to answer the following:

1. What is quantitative technique and how is it useful in planning and

control?
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?
4. What are PERT and CPM and how is it useful in business planning and
control?

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DEFINITIONS

Management Science (Operations Research) is a collective effort of

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

PROBABILITY

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.
2. Unconditional Probability – it is the probability of some event which is
not conditional (or dependent) on some other event occurring.

GENERAL COMPUTATION OF PROBABILITY OF ANY EVENT

1. Identify each sample point* in the event. *Sample point is a unique

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
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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.

Both PERT and CPM involve determining expected times of completion of

individual events for the entire project.

PERT goes further to include variance analysis while CPM does not. CPM, on the
other hand, goes beyond PERT in another direction. It uses cost data to assess the
financial effects of setting up crash programs in the network’s critical path
segments to ensure completion on schedule.

The essence of PERT is to aid managers in planning and controlling a project.

BAR CHART for a simple PERT network will bring out the pattern of activities and
slack times clearly. A Bar Chart would be unwieldy for use in a more complex
network.

ILLUSTRATIVE EXERCISES
PROBABILITY
It has been observed by the Probe Company over the past 100 weeks that the
weekly demand for Product A was 30 units during 25 of these 100 weeks, 35 units
during 35 of the past 100 weeks, and 40 units during the remaining 40 weeks. The
demand pattern can be expected to remain stable in the future.

The company buys the product from another source at a cost of P30 per unit and
sells it for P50 each. The product is perishable and unsold units become worthless
at the end of the week.

Required:
1. Compute the probability of the demand for Product A weekly at 30 units,
35 units, and 40 units.

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 2. Compute the expected value of the weekly demand.
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:

Demand of Product A Lead Time for Product A

Unit Probability of Lead Time Probability of
Demand Occurrence in Days Occurrence
Per Day
0 .45 1 .40
1 .15 2 .35
2 .30 3 .25
3 .10
1.00 1.00

Leslie is able to deliver Product A to its customers the same day that it is received
from the supplier. All units of product A demanded but not available, due to a
stock-out, are back ordered and filled immediately when a new shipment arrives.

Requirement:
1. Compute for the probability of the demand for Product A being nine (9)
units during a three-day lead time for delivery from the supplier.
2. Compute the number of days during a 360-day year that Leslie will
experience a stock-out of Product A if Leslie reorders 10 units of Product
A when its inventory level is 10 units.

CORELATION ANALYSIS
A. The closeness of the linear relationship between the cost and the activity
is the
a. Correlation c. Deviation
b. Variation d. Standard Error

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 B. Looking at the following scatter diagrams, we can conclude that
P . . . . . P ..
. . . .. ...
. . . . .. . .
. . . . ..

Activity Activity

Cost A Cost B
a. Cost A will be easier to predict than cost B.
b. Cost B will be easier to predict than cost A.
c. Cost A is out of control.
d. Cost B has no variable component.

C. Which of these correlation coefficients represents strongest relationship

between two vaiables?
a. +.50 c. +.05
b. -.80 d. +1.02
D. What is the appropriate range for the coefficient of determination?
a. -1 to +1 c. 0 to +1
b. -1 to 0 d. 0 to infinity

LINEAR PROGRAMMING
Linear Company produces Product A and B which contributes to profit per unit at
P20 and P15 respectively. Product A is processed in Machine X requiring 4 hours
per unit 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 respectively each year.

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 hours available each year.

Required:
1. Formulate the objective function.
2. Determine the basic relationships (Constraints or limitations).

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 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.

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 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 activities or processes. The expected time is based upon
the commonly used, 1-4-1, three-estimate method. For example, the three-
estimate method gives an estimated time of 4.2 to complete event 1.

5.2

7.1

5.0
2 5 3.5
4.2

4.2
S 1 3.0 6
7.3

2.1
3 4
3.6 4.6

5.0
7 8

Required:
Determine the following:
1. Critical path (the path requiring the greatest amount of time.)
2. The slack time on path 1-9-6.
3. The latest time for reaching event 6 via path 1-2-5-6.

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 4. The earliest time for reaching 6 via path 1-2-5-6.

PRACTICE EXERCISES
(Sources: CMA/CIA/RPCPA/AICPA/Various test banks)

1. Which of the following is a useful technique in determining the fixed and

variable elements of a semi-variable expense?
a. Linear Programming c. PERT
b. Queing theory d. Simple
regression analysis

2. Which of the following quantitative methods will separate a semi-variable

costs into its fixed and variable components with the highest degree of
precision under all circumstances.
a. High-low method c. Least-squares method
b. Simplex method d. Scatter-graph
method

3. Simple regression analysis involves the use of

a. One variable c. Three variables
b. Two variables d. More than
three variables

4. Probability (risk) analysis

a. Ignores probability weights under fifty percent
b. Is only for situations in which there are three or fewer possible
outcomes
c. Does not enhance the usefulness of sensitivity analysis data
d. Is an extension of sensitivity analysis

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

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6. A formal diagram of the interrelationships of complex time series of
activities is
a. PERT c. Linear
programming
b. The method of least squares d. Correlation
analysis

7. A quantitative technique used to discover and evaluate possible cause-

and-effect relationship is
a. Linear programming c. Poisson
distribution models
b. PERT d. Correlation
analysis

8. The constraints in a linear programming problem usually model

a. Profits c. Dependent
variables
b. Restrictions d. Goals

9. Linear programming is used most commonly to determine

a. That mix of variables which result in the largest quantity.
b. The best use of scarce resources.
c. The most advantageous prices
d. The fastest timing.

10. Simple regression analysis involves the use of

Dependent Variables Independent Variables

a. One None
b. One One
c. One Two
d. None Two

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 The Carrot, the Egg and the Coffee beans
(An inspiring story)

A carrot, an egg, and a cup of coffee…You will never look at a cup of coffee
the same way again.

A young woman went to her mother and told her about her life and how
things were so hard for her. She did not know how she was going to make
it and wanted to give up. She was tired of fighting and struggling. It
seemed as one problem was solved, a new one arose.

Her mother took her to the kitchen. She filled three pots with water and
placed each on a high fire. Soon the pots came to boil. In the first she
placed carrots, in the second she placed eggs, and in the last she placed
ground coffee beans. She let them sit and boil; without saying a word.

In about twenty minutes she turned off the burners. She fished the carrots
out and placed them in a bowl. She pulled the eggs out and placed them in
a bowl.

Then she ladled the coffee out and placed it in a bowl. Turning to her
daughter, she asked, “Tell me what you see.”

“Carrots, eggs, and coffee,” she replied.

Her mother brought her closer and asked her to feel the carrots. She did
and noted that they were soft. The mother then asked the daughter to take
an egg and break it. After pulling off the shell, she observed the hardboiled
egg.
Finally, the mother asked the daughter to sip the coffee. The daughter
smiled as she tasted its rich aroma. The daughter then asked, “What does
it mean, mother?”

Her mother explained that each of these objects had faced the same
adversity: boiling water. Each reacted differently.

The carrot went in strong, hard, and unrelenting. However, after being
subjected to the boiling water, it softened and became weak.

The egg had been fragile. Its thin outer shell had protected its liquid
interior, but after sitting through the boiling water, its inside became
hardened.
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The ground coffee beans were unique, however. After they were in the
boiling water, they had changed the water.

“Which are you?” she asked her daughter. “When adversity knocks on
your door, how do you respond? Are you a carrot, an egg or a coffee bean?

So think about this story – which one are you?

Are you the carrot that seems strong, but with pain and adversity, do you
wilt and become soft and lose your strength?

Are you the egg that starts with a malleable heart, but changes with the
heat? Did you have a fluid spirit at one time, but after a death, a breakup,
a financial hardship or some other trial, have you become hardened and
stiff?

Does your shell look the same, but on the inside, are you bitter and tough
with a stiff spirit and hardened heart?

Or are you like the coffee bean? The bean actually changes the hot water,
the very circumstance that brings the pain. When the water gets hot, it
releases the fragrance and flavor.

If you are like the bean, when things are at their worst, you get better and
change the situation around you.

When the hour is the darkest and trials are their greatest, do you elevate
yourself to another level? How do you handle adversity? Are you a carrot,
an egg or a coffee bean?

May you have enough happiness to make you sweet, enough trials to make
you strong, enough sorrow to keep you human and enough hope to make
you happy.
The happiest of people don’t necessarily have the best of everything; they
just make the most of everything that comes along their way.
The brightest future will always be based on a forgotten past; you can’t go
forward in life until you let go of your past failures and heartaches.
When you were born, you were crying and everyone around you was
smiling.
Live your life so at the end, you’re the one who is smiling and everyone
around you is crying.

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