Business Decision Making
Tolkien Transport is currently based in Leeds but has plans to expand its operations by setting up another depot in the south of England. The management team has identified four possible locations for the depot and these are listed in the decision matrix below. As a first step they have decided to use a multi-criteria analysis (MCA) to rank the options. After much discussion, the team have decided on three key criteria (Cost, Accessibility and Environmental Impact) against which to judge the options and have agreed on the ratings shown in the matrix, below (running from 4 for the best to 1 for worst under each criterion). The criteria have been weighted as follows: Cost (0.45), Accessibility (0.35) and Environmental Impact (0.2).
- Explain to Tolkien Transport the limitations of a multi-criteria analysis for a decision problem of this kind.
(Total: 10 marks)
Tolkien’s marketing manager has been asked to develop a new promotional strategy for the company, which has been facing stiff competition from some new transport companies. After much research she has narrowed down the choice to three strategies and has constructed the decision tree shown below – which includes the payoffs and probabilities she has managed to estimate – but it is incomplete. She has identified three alternative promotional strategies (and their upfront cost): customer referral programme (£35,000); causes and charity (£30,000); branded gifts (£50,000). The impact on turnover in each case depends on the ‘reach’ of the promotional campaigns which could be high, medium or low. The payoffs represent the increase in annual sales turnover in £000s over a one-year period (excluding up-front costs).
- Complete the decision tree by providing the value of all missing elements (shown as A, B, C, D, all marked with a *).
- Use the decision tree to advise the marketing manager on the best option to choose, assuming the company wishes to maximize expected annual sales turnover, net of upfront costs.
(Total: 10 marks)
Tolkien Transport has a small facility adjacent to its Leeds depot which it uses to manufacture tarpaulins for its lorries. The facility currently produces 3000 tarpaulins a year. The company’s Finance Manager has estimated the cost per tarpaulin at this level of output to be:
|Cost per unit|
|Direct Labour (cutting, trimming and sewing)||£45|
|Variable manufacturing overhead||£37|
|Fixed manufacturing overhead||£43|
An outside supplier has offered to supply all the tarpaulins required by Tolkien for £145 each. If Tolkien decided not to make the tarpaulins, there would be no other use for the production facilities and none of the fixed manufacturing overhead cost could be avoided.
- Calculate how much higher or lower Tolkien’s net operating income would be if it purchased the tarpaulins from the outside supplier, showing all calculations. Would you advise Tolkien to accept the offer?
- Clearly explain to Tolkien’s Finance Manager how opportunity cost might affect the make or buy decision. Illustrate with a numerical example.
[END OF SECTION A]
[SECTION B STARTS ON THE NEXT PAGE]
SECTION B: Answer only TWO questions from this section.
The business manager of Tolkien Transport wishes to analyse three strategic options available to the company (Cost-cutting; Diversification; Expansion) under four possible UK macroeconomic conditions: Recession, Low Growth, Medium Growth and High Growth. He has summarised available information in the following pay-off matrix (with impact on company profits in the next year in £000s).
|Recession||Low Growth||Medium Growth||High Growth|
- What is the difference between risk and uncertainty? Illustrate with examples of business decisions.
- Which option should Tolkien Transport choose based on of the following criteria? Indicate what attitude to risk each represents.
- Maximax (3 marks)
- Minimax (3 marks)
- Construct a potential regret matrix and use it to determine the best option according to the minimax regret criterion.
- The business manager decides to access the latest macroeconomic predictions from the Bank of England. This provides him with the following probabilities: Recession (15%), Low Growth (30%), Medium Growth (35%), and High Growth (20%). Which option is preferred according to the expected monetary value (EMV) criterion? What attitude to risk does this represent?
- Tom Tolkien, the CEO, is not happy with the quality of information being presented by his business manager. He asks the best economic consultancy firm in the country to provide an accurate macroeconomic forecast, which they guarantee would be 100% accurate. What is the most that Tolkien Transport should be willing to pay the research firm for this information (in other words what is the value of perfect information concerning the state of the economy)?
[Question 4 continues on the next page]
- Tolkien Transport is facing increasing price competition from its big local rival in Yorkshire, Lewis Lorries. Tolkien’s CEO is interested in using game theory (in particular, the ‘prisoners’ dilemma’ game) to model decision making in this duopoly market. Explain and illustrate the key aspects of the ‘prisoners’ dilemma’ game, its key assumptions and how the CEO might use it to model his rivalry with Lewis Lorries.
(Total: 35 marks)
Assume that the income statement for Tolkien Transport last month is as follows:
|Revenue (500 customers*£2000)||£1,000,000|
|Less variable expenses||£410,000|
Note: The revenue given is calculated by multiplying number of customers last month (500) by £2,000 the average price for transportation services
- Calculate the break-even point in units and in pounds last month.
- How many customers would Tolkien Transport need to generate a profit of £119,000?
- Compute the company’s margin of safety last month in both £ pound and percentage terms.
- If revenue increases by £300,000 this month and there is no change in fixed costs, by how much would you expect profit to increase? (Do not prepare a profit and loss account; use the CM ratio to compute your answer.)
- Refer to the original data. Tolkien Transport’s marketing team is convinced that a 15% reduction in the selling price would cause customer numbers this month to increase by 150 units. Calculate the impact on monthly profit.
- Using the data from part (e), calculate the price elasticity of demand for its transportation service (based on a 15% reduction from the current selling price).
- Calculate the profit-maximising mark-up on variable costs and use this to estimate the profit-maximising price for the transportation service. Based on this, what advice would you give Tolkien?