Applying Expected Values and Sensitivity to Decision-Making Problems 3 / 6

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MC Question 18

The following scenario relates to questions 16–20.

Mylo runs a cafeteria situated on the ground floor of a large corporate office block. Each of the five floors of the building are occupied and there are in total 1,240 employees.

Mylo sells lunches and snacks in the cafeteria. The lunch menu is freshly prepared each morning and Mylo has to decide how many meals to make each day. As the office block is located in the city centre, there are several other places situated around the building where staff can buy their lunch, so the level of demand for lunches in the cafeteria is uncertain.

Mylo has analysed daily sales over the previous six months and established four possible demand levels and their associated probabilities. He has produced the following payoff table to show the daily profits which could be earned from the lunch sales in the cafeteria:

Demand level Probability Supply level
450 620 775 960
$ $ $ $
450 0·15 1,170 980 810 740
620 0·30 1,170 1,612 1,395 1,290
775 0·40 1,170 1,612 2,015 1,785
960 0·15 1,170 1,612 2,015 2,496

18. Which of the following statements is/are true if Mylo chooses to use expected values to assist in his decision-making regarding the number of lunches to be provided?

(1) Mylo would be considered to be taking a defensive and conservative approach to his decision
(2) Expected values will ignore any variability which could occur across the range of possible outcomes
(3) Expected values will not take into account the likelihood of the different outcomes occurring
(4) Expected values can be applied by Mylo as he is evaluating a decision which occurs many times over

A    1, 2 and 3
B    2 and 4
C    1 and 3 only
D    4 only

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MC Question 20

The following scenario relates to questions 16–20.

Mylo runs a cafeteria situated on the ground floor of a large corporate office block. Each of the five floors of the building are occupied and there are in total 1,240 employees.

Mylo sells lunches and snacks in the cafeteria. The lunch menu is freshly prepared each morning and Mylo has to decide how many meals to make each day. As the office block is located in the city centre, there are several other places situated around the building where staff can buy their lunch, so the level of demand for lunches in the cafeteria is uncertain.

Mylo has analysed daily sales over the previous six months and established four possible demand levels and their associated probabilities. He has produced the following payoff table to show the daily profits which could be earned from the lunch sales in the cafeteria:

Demand level Probability Supply level
450 620 775 960
$ $ $ $
450 0·15 1,170 980 810 740
620 0·30 1,170 1,612 1,395 1,290
775 0·40 1,170 1,612 2,015 1,785
960 0·15 1,170 1,612 2,015 2,496

Mylo is now considering investing in a speciality coffee machine. He has estimated the following daily results for the new machine:

$
Sales (650 units)1,300
Variable costs(845)
Contribution 455
Incremental fixed costs (70)
Profit
385

20. Which of the following statements are true regarding the sensitivity of this investment?

(1) The investment is more sensitive to a change in sales volume than sales price
(2) If variable costs increase by 44% the investment will make a loss
(3) The investment’s sensitivity to incremental fixed costs is 550%
(4) The margin of safety is 84·6%

A    1, 2 and 3
B    2 and 4
C    1, 3 and 4
D    3 and 4 only

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MC Question 17

Tree Co is considering employing a sales manager. Market research has shown that a good sales manager can increase profit by 30%, an average one by 20% and a poor one by 10%. Experience has shown that the company has attracted a good sales manager 35% of the time, an average one 45% of the time and a poor one 20% of the time.

The company’s normal profits are $180,000 per annum and the sales manager’s salary would be $40,000 per annum.

Based on the expected value criterion, which of the following represents the correct advice which Tree Co should be given?

A. Do not employ a sales manager as profits would be expected to fall by $1,300
B. Employ a sales manager as profits will increase by $38,700
C. Employ a sales manager as profits are expected to increase by $100
D. Do not employ a sales manager as profits are expected to fall by $39,900

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