3.3 Decision-Making Techniques

Question 1

What are sales forecasts??

Answer 1

Estimation of future sales figures using past data and considering predictable external factors

Question 2

What are the 3 methods of quantitative sales forecasting??

Answer 2

• Moving averages
• Extrapolation
• Correlation

Question 3

What’s a moving average??

Answer 3

A series of averages calculated from a series of data, they smooth data so trends are easier to find

Question 4

How are moving averages calculated??

Answer 4

Moving total / specified number of periods

Moving total = Adding together sales figures from a specified period of time

This is how to fin a centred average. A moving average is a series of centred averages!

Question 5

What’s a positive, negative and no correlation??

Answer 5

Positive -> As one variable increases, so does the other
Negative -> As one increases, the other decreases
No correlation -> No line of best fit can be found

Question 6

What’s extrapolation?

Answer 6

Using historic/previous data to forecast future events.
It assumes that what happened in the past will repeat.

Question 7

What are 3 limitations of quantitative sales forecasting??

Answer 7

• Unreliable in long-term (doesn’t predict external environment)
• Can’t predict new competition
• Can’t predict market changes

Question 8

What are 3 situations where sales forecasts are likely to be inaccurate??

Answer 8

• Business is new (no historical data to go by)
• Product is fashion item
• Demand highly sensitive to changes in price and income

Question 9

What is investment appraisal??

Answer 9

Process of analysing whether investment projects are worthwhile

Question 10

What are the 3 methods of investment appraisal??

Answer 10

• Payback period
• ARR (Average Rate of Return)
• Net Present Value

Question 11

What is the payback period??

Answer 11

The time it takes for a project to repay its initial investment.
Measured in time (e.g. days/years)

Question 12

How is the payback period calculated??

Answer 12

Identify net cash flow for each period, keep a running total of cash flows (so add them on as you go down)

When the total net cash flow becomes positive, that’s the end of the payback period

Question 13

What are 3 benefits of calculating the payback period??

Answer 13

• Easy to calculate
• Numerical so easy to understand
• Focuses on cash flow

Question 14

What are 3 drawbacks of calculating the payback period??

Answer 14

• Ignores cash flows after payback has been reached
• Takes no account of ‘time value of money’
• Ignores qualitative aspects of decision

Question 15

What is the Average Rate of Return??

Answer 15

Annual % return on an investment project based on average returns earned by the project

Question 16

What are the steps to calculating ARR??

Answer 16

1. Find average annual profit from investment project
2. Average annual profit/initial investment
3. Compared with target % return

Question 17

What are 3 benefits of calculating ARR??

Answer 17

• Easy to calculate
• Focuses on overall profitability
• Uses all returns generated by a project

Question 18

What are 3 drawbacks of calculating ARR??

Answer 18

• Ignores timing of returns
• Focuses on profits rather than cash flow
• Doesn’t adjust for time-value of money

Question 19

What’s the Net Present Value (NPV)??

Answer 19

Calculates the monetary value now of a project’s future cash flows

Question 20

What’s discounting??

Answer 20

Method used to reduce the future value of cash flows to reflect the risk that they may not happen

Question 21

What’s the time-value of money?? (TVM)

Answer 21

Better to receive cash now rather than in the future because future cash flows are worth less

Use discount factors to bring cash flows back to ‘present value’.

Question 22

What’s the equation for the present value of a future cash flow??

Answer 22

Cash flow x Discount Factor = Present value

Question 23

What are 3 benefits of Net Present Value??

Answer 23

• Considers all future cash flows
• Reflects the risks that future cash flows will not be as expected
• Considers time-value of money

Question 24

What are 2 drawbacks of Net Present Value??

Answer 24

• Most complicated method
• Results can be influenced/manipulated using the discount rate

Question 25

What are decision-trees??

Answer 25

Mathematical models used for decision-making They use estimates and probabilities to calculate likely incomes They help decide if investment net gain is worthwhile

Question 26

Describe what a typical decision-tree may look like!

Answer 26

Square (decision to be made) -> Option 1 -> outcome A or B -> Option 2 -> outcome A or B -> Do nothing When stating the 'Options', the associated cost is also stated, and on the arrows leading to the outcomes, the probability is stated

Question 27

How do we find the expected value for the specified option??

Answer 27

Probability x outcome

Question 28

What are 4 advantages of decision-trees??

Answer 28

+ Potential options are considered at the same time + Use of probabilities enables the 'risk' of the options to be addressed + Choices are set out in logical way + Easy to understand

Question 29

What are 3 disadvantages of decision-trees??

Answer 29

- Probabilities are estimates so prone to error - Ignore qualitative aspects of decisions - They don't reduce risks, just addresses them.

Question 30

What's CPA??

Answer 30

Critical Path Analysis Project analysis and planning method that allows a project to be completed in the shortest possible time!

Question 31

Why is it important to plan complex projects?? (CPA)

Answer 31

They can have high investment and high risk and as the risk increases, it becomes more important to identify the relationships between the activities involved to work out the most efficient way of completing the project.

Question 32

What are the 3 pieces of information required for CPA (Critical Path Analysis)??

Answer 32

- List of all activities required for completing the project - The duration of each activity - The dependencies between each activity (e.g. activity D can't be completed until activities B & C are done)

Question 33

What are the 3 things that CPA calculates??

Answer 33

- Longest path of planned activities to the end of the project - Earliest start time (EST) - Latest finish time (LFT) - Which activities are 'critical' and which have 'total float' (e.g. can be delayed without making the project longer)

Question 34

What's the Critical Path??

Answer 34

Sequence of project activities which add up to the longest overall duration. Determines the shortest time possible to complete the project

Question 35

What is important to note about the Critical Path??

Answer 35

Any delay of an activity on the critical path directly impacts the planned project's completion date (there's no float on the critical path)

Question 36

Describe a Network diagram used in CPA!

Answer 36

There are lines connecting circles Circles (nodes) are split into three sections The three sections: - Left half = unique node (activity) number, the network draws them in order - Right half, top quarter = EST that an activity can commence based on previous activity - Right half, bottom quarter = LFT by which the previous activity should be completed Lines represent activities. Above the line = description of activity or letter representing activity Below the line = Duration taken to complete activity

Question 37

What is always the EST of the first node in a network diagram for CPA??

Answer 37

Zero!

Question 38

How are ESTs calculated in CPA network diagrams??

Answer 38

From left to right Add the duration of an activity to the EST of the previous node If more than one activity leads to a node, the highest figure becomes the new EST

Question 39

How are LFTs calculated in CPA network diagrams??

Answer 39

Give the last node of the project an LFT = to the EST Work backwards from right to left Subtract the duration of the activity from the LFT

Question 40

How is the float calculated in CPA network diagrams??

Answer 40

Float = duration an activity can be extended or postponed so that the project still finishes within the minimum time LFT - Duration - EST

Question 41

How is the Critical Path identified??

Answer 41

All activities with a float of '0' (meaning they can't be delayed without delaying the entire project) form the critical path On the Critical Path, activities have equal EST and LFT

Question 42

What are 3 uses of CPA??

Answer 42

- Estimate and minimise project time - Plan and organise resources - Prioritise tasks

Question 43

What are 3 advantages of CPA??

Answer 43

- Helps reduce risk and costs of complex projects - Decision-making and planning tool - Helps with cash flow forecasting an budgeting

Question 44

What are 3 disadvantages of CPA??

Answer 44

- Reliability is largely based on estimates and assumptions - Doesn't guarantee success of a project - Too many activities make the project too complicated (could lead to activities having to further be broken down into their own projects!)