Quantitative Analysis for

Management Decisions
(MBA 662)
Credit Hr=3
Pre request = MBA 621
Menasbo Gebru
E mail : [email protected]
Cell: +251 914 727747
What Is Quantitative Analysis?
• Quantitative analysis is the scientific approach to managerial decision
making. Whim( impulse), emotions, and guesswork are not part of the
quantitative analysis approach.

• The approach starts with data. Like raw material for a factory, these
data are manipulated or processed into information that is valuable to
people making decisions.

• This processing and manipulating of raw data into meaningful

information is the heart of quantitative analysis.
Cont’d

• Computers have been instrumental in the increasing use of quantitative

analysis.

• We can use quantitative analysis to determine how much our investment

will be worth in the future when deposited at a bank at a given interest rate
for a certain number of years.

• Quantitative analysis can also be used in computing financial ratios from

the balance sheets for several companies whose stock we are considering.
• Some real estate companies have developed computer programs that use
quantitative analysis to analyze cash flows and rates of return for
investment property.
Cont’d
• In addition to quantitative analysis, qualitative factors should also be
considered. The weather, state and federal legislation, new
technological breakthroughs, the outcome of an election, and so on
may all be factors that are difficult to quantify
• The Quantitative Analysis Approach
The Quantitative Analysis Approach
Defining the Problem
• The first step in the quantitative approach is to develop a clear, concise
statement of the problem. This statement will give direction and
meaning to the following steps.

• In many cases, defining the problem is the most important and the
most difficult step. It is essential to go beyond the symptoms of the
problem and identify the true causes.
• One problem may be related to other problems;
• When the problem is difficult to quantify, it may be necessary to
develop specific, measurable objectives.
Developing a Model
• Once we select the problem to be analyzed, the next step is to develop a model.
• Simply stated, a model is a representation (usually mathematical) of a situation.

• Even though you might not have been aware of it, you have been using models
most of your life.

• You may have developed models about people’s behavior.

• Your model might be that friendship is based on reciprocity, an exchange of

favors.

• If you need a favor such as a small loan, your model would suggest that you ask a
good friend.
Acquiring Input Data
• Once we have developed a model, we must obtain the data that are used in the model
(input data). Obtaining accurate data for the model is essential; even if the model is a
perfect representation of reality, improper data will result in misleading results.

• Garbage in, garbage out means that improper data will result in misleading results
• Developing a Solution
• Developing a solution involves manipulating the model to arrive at
the best (optimal) solution to the problem.
• In some cases, this requires that an equation be solved for the best
decision.
• In other cases, you can use a trial and error method, trying various
approaches and picking the one that results in the best decision.
Cont’d
• The input data and model determine the accuracy of the
• solution.
• Testing the Solution

• Before a solution can be analyzed and implemented, it needs to be

tested completely.

• Because the solution depends on the input data and the model, both
require testing.

• Testing the data and model is done before the results are analyzed.
Analyzing the Results and Sensitivity Analysis
• Analyzing the results starts with determining the implications of the
solution.
• Sensitivity analysis determines how the solutions will change with a
different model or input data.

• Implementing the Results

• The final step is to implement the results. This is the process of

incorporating the solution into the company
Linear Programming problem/LPP
• Linear programming is a technique that helps in resource allocation decisions
• Many management decisions involve trying to make the most effective use of an
organization’s resources

• These resources may be used to make products (such as machinery, furniture, food, or
clothing) or
• Services (such as schedules for airlines or production, advertising policies, or investment
decisions).

• Linear programming (LP) is a widely used mathematical modeling technique designed

to help managers in planning and decision making relative to resource allocation.

• In the world of management science, programming refers to modeling and solving a

problem mathematically.
Requirements of a Linear Programming Problem

• A. Problems seek to maximize or minimize an objective.

• All problems seek to maximize or minimize some quantity, usually
profit or cost.
• We refer to this property as the objective function of LP problem.
• The major objective of a typical manufacturer is to maximize dollar
profits.
• B:Constraints limit the degree to which the objective can be
Obtained.
• The second property that LP problems have in common is the presence
of restrictions, or constraints, that limit the degree to which we can
pursue our objective.
There must be alternatives available.
• There must be alternative courses of action to choose from.
• For example, if a company produces three different products, management
may use LP to decide how to allocate among them its limited production
resources (of personnel, machinery, and so on).

• C. Mathematical relationships are linear.

• The objective and constraints in LP problems must be expressed in terms of
linear equations or inequalities.

• Linear mathematical relationships just mean that all terms used in the
objective function and constraints are of the first degree (i.e., not squared, or to
the third or higher power, or appearing more than once).
 Cont’d

• The equation 2A+ 5B= 10 is an acceptable linear function.

• While 2A2 +5B3+3AB= 10 is not linear because the variable A and B are power of 2
& 3, respectively.

• The term linear implies both proportionality and additivity

• Proportionality means :if production of 1 unit of a product uses 3 hours, production

of 10 units would use 30 hours.

• Additivity means that the total of all activities equals the sum of the individual
activities.
FORMULATING LP PROBLEMS
• Formulating a linear program involves developing a mathematical model to
represent the managerial problem.

• Thus, in order to formulate a linear program, it is necessary to completely

understand the managerial problem being faced.

• The steps in formulating a linear program follow

1. Completely understand the managerial problem being faced.

2. Identify the objective and the constraints.
3. Define the decision variables.
4. Use the decision variables to write mathematical expressions for the objective
function and the constraints.
Cont’d

• One of the most common LP applications is the product mix problem.

• Product mix problems use LP to decide how much of each product

to make, given a series of resource restrictions.

• Two or more products are usually produced using limited resources such
as personnel, machines, raw materials, and so on.

• The profit that the firm seeks to maximize is based on the profit
contribution per unit of each product.
Cont’d
Cont’d
• Flair Furniture’s problem is to determine the best possible combination of
tables and chairs to manufacture in order to reach the maximum profit.
• The firm would like this production mix situation formulated as an LP
problem.
• The objective is Maximize profit
• The constraints are
• 1. The hours of carpentry time used cannot exceed 240 hours per week.
• 2. The hours of painting and varnishing time used cannot exceed 100
hours per week.
• The decision variables that represent the actual decisions we will make
are defined as
Cont’d

• T = number of tables to be produced per week

• C = number of chairs to be produced per week
• Now we can create the LP objective function in terms of T and C. The
objective function is
• Maximize profit = $70T + $50C.

• Our next step is to develop mathematical relationships to describe the

two constraints in this problem.

• One general relationship is that the amount of a resource used is to be

less than or equal to the amount of resource available.
Cont’d

Carpentry time used Carpentry, varnishing and painting time available

4T + 3C < 240
2 T + 1C < 100
The complete problem may now be restated mathematically as
Maximize profit = $70T + $50C
subject to the constraints
4T + 3C < 240 (Carpenter contraint)
2T + 1C < 100 (painting and varnishing constraint)

T > 0 (first non negativity constraint)

C > 0 (second non negativity constraint)
Graphical Solution to an LP Problem
• The graphical method works only when there are two decision
variables, but it provides valuable insight into how larger problems
are structured.

The graphical procedure is useful only when there are two decision
variables (such as number of tables to produce, T, and number of chairs
to produce, C) in the problem.

When there are more than two variables, it is not possible to plot the
solution on a two-dimensional graph and we must turn to more
complex approaches.
Graphical Representation of Constraints
 To find the optimal solution to an LP problem, we must first identify
a set, or region, of feasible solutions.

 The first step in doing so is to plot each of the problem’s constraints

on a graph. The variable T (tables) is plotted as the horizontal axis of
the graph and the variable C (chairs) is plotted as the vertical axis.

 The notation is used to identify the points on the graph. The non
negativity constraints mean that we are always working in the first
(or northeast) quadrant of a graph
 Non negativity constraints mean T > 0 and C > 0.
Cont’d
 Plotting the first constraint involves finding points at which
the line intersects the T and C axes.
 4T + 3C < 240 . must first graph the equality portion of this, which is
4T + 3C =240
• Quadrant Containing All
Positive Values
Graph of Carpentry Constraint Equation 4T + 3C = 240
Cont’d

For example, choose the point (30, 20), as

4(30) + 3(20) = 180 which is less than 240 . this point satisfies the
constraint, and all points on this side of the line will also satisfy the
constraint
What about this, 4(70) + 3(40) = 400
Region that Satisfies the Carpentry Constraint
Region that Satisfies the Painting and Varnishing
Constraint
2T + 1C = 100
Cont’d

• To find the points that require less than 100 hours, select a point on
either side of this line to see if the inequality portion of the constraint
is satisfied. Selecting (0, 0) give us:

• 2(0) + 1(0) = 0 < 100

 In LP problems we are interested in satisfying all constraints at the

• same time.
The feasible region is the set of points that satisfy all the constraints.
Feasible Solution Region for the Flair Furniture
Company Problem
Cont’d
Carpentry constraint 4T + 3C < 240 hours available
• 4(30) +3(20) = 180 hrs are used.
Painting constraint 2T+1C < 100hrs
2(30)+1(20) = 80 hrs are used.
• Isoprofit Line Solution Method
• The isoprofit method is the first method we introduce for finding the
optimal solution.

• For the Flair Furniture problem we may choose a profit of $2,100.

This is a profit level that can be obtained easily without violating
either of the two constraints. The objective function can be
Cont’d

70T+50C = $2,100
 This expression is just the equation of a line; we call it an isoprofit
line. It represents all combinations of that would yield a total profit of
$2,100.

 To plot the profit line, we proceed exactly as we did to plot a

constraint line.
 First, let and solve for the point at which the line crosses the C axis:
Profit Line of $2,100 Plotted for the Flair Furniture
Company
Four Isoprofit Lines Plotted for the Flair Furniture Company
We can draw a series of parallel isoprofit lines until we find the highest
isoprofit line, that is, the one with the optimal solution.
Basic Feasible Solution
•  Consider a LPP in the standard form that contains n-variables and m
constraints ( assume n>m).
• A baisc solution obtained by setting n-m variables (NMV) Equal to 0
and solving the remaining m variables (BV)

• = = , Number of feasible solutions

• Any basic solution in which all variables are non negative is called BFS.
Cont’d
• Max Z= 3x1+2x2
• S.t 4x1+2x2+s1 <=16
• 2x1+4x2 +s2 <=12
• X1>=7
• xi > 0 ( i= 1,2 ) Si> 0 ( i=1,2)

• We have n= v variables ( x1, x2, s1 s2)

• m= 2 Equations ( constraints)
• X1 and X2 are non Basic variables while s1 and s2 are basic variables( sum equal
to zero)
• Compute the possible Basic Feasible Solutions.
No Feasible Solution
• Lack of a feasible solution region can occur if constraints conflict
with one another.

• When there is no solution to an LP problem that satisfies all of the

constraints given, then no feasible solution exists.

• Graphically, it means that no feasible solution region exists—a

situation that might occur if the problem was formulated with
conflicting constraints.
A Problem with No Feasible Solution
Sensitivity Analysis
• Optimal solutions to LP problems have thus far been found under what
are called deterministic assumptions.

• This means that we assume complete certainty in the data and

relationships of a problem—namely, prices are fixed, resources
known, time needed to produce a unit exactly set.

• But in the real world, conditions are dynamic and changing. How can
we handle this apparent discrepancy?
Cont’d
• How sensitive is the optimal solution to changes in profits, resources, or other input parameters?
• An important function of sensitivity analysis is to allow managers to experiment with values of
the input parameters.

Such analyses are used to examine the effects of changes in three areas:

(1) contribution rates for each variable,

(2) technological coefficients (the numbers in the constraint equations), and

(3) available resources (the right-hand-side quantities in each constraint).

This task is alternatively called sensitivity analysis, post optimality analysis, parametric
programming, or optimality analysis.
Post optimality analysis means examining changes after the optimal
solution has been reached.
• The approach we prefer is the analytic post optimality method.

• After an LP problem has been solved, we attempt to determine a range of

changes in problem parameters that will not affect the optimal solution or
change the variables in the solution.

The firm formulates the following LP problem in order to determine

the best production mix of CD players(X1) and Receivers (X2).
Maximize profit = $50X1 + $120X2.
subject to 2X1 + 4X2 = 80 (hours of electricians’ time available).
3X1 + 1X2 = 60 (hours of audio technicians’ time available).
Changes in contribution rates are examined first
The current solution remains optimal unless an objective function
coefficient is increased to a value above the upper bound or decreased to
a value below the lower bound.

• In general, a change can be made to one (and only one) objective

function coefficient, and the current optimal corner point remains
optimal as long as the change is between the Upper and Lower
Bounds.

• If two or more coefficients are changed simultaneously, then the

problem should be solved with the new coefficients to determine
whether or not this current solution remains optimal.
Cont’d
• X1, X2 > 0.
Changes in the Technological Coefficients
• Changes in technological coefficients affect the shape of the feasible
solution region.

• If fewer or more resources are needed to produce a product such as a

CD player or stereo receiver, coefficients in the constraint equations
will change.

• These changes will have no effect on the objective function of an LP

problem, but they can produce a significant change in the shape of the
feasible solution region, and hence in the optimal profit or cost.
Cont’d
Available resources (the right-hand-side quantities in each constraint).
Big M method

•In operations research, the Big M method is a method of solving 

linear programming problems using the simplex algorithm.

•The Big M method extends the power of the simplex algorithm to

problems that contain "greater-than" constraints.

•The "Big M" refers to a large number associated with the artificial
variables, represented by the letter M.

•The Big M method introduces surplus and artificial variables to convert all
inequalities into that form.
Cont’d
• The steps in the algorithm are as follows:

 Multiply the inequality constraints to ensure that the right hand side
is positive.

 If the problem is of minimization, transform to maximization by

multiplying the objective by -1.

 For any greater-than constraints, introduce surplus and artificial

variables.
Cont’d
 Choose a large positive Value M and introduce a term in the objective
of the form -M multiplying the artificial variables.

 For less-than or equal constraints, introduce slack variables so that all

constraints are equalities.

 Solve the problem using the usual simplex method.

• For example, x + y ≤  100 becomes x + y + s1 = 100,

• whilst x + y ≥ 100 becomes x + y − s1 + a1 = 100.
Cont’d

• The artificial variables must be shown to be 0.

• The function to be maximized is rewritten to include the sum of all the

artificial variables.

• The value of M must be chosen sufficiently large so that the artificial

variable would not be part of any feasible solution.

• For a sufficiently large M, the optimal solution contains any artificial

variables in the basis (i.e. positive values) if and only if the problem is
not feasible.