SORS 2104 OPERATION RESEARCH TECHNIQUES

COURSE OUTLINE
Chapter1
NETWORK MODELS
(a) Shortest route
(b) Minimal Spanning tree
(c) Maximal flow
Chapter 2.

Project Management
(a)
(b)
(c)
(d)
(e)
(f)

Chapter 3

Critical path analysis

Deterministic activity times
Probabilistic activity times
Gantt charts resources scheduling
Cost crashing by observation
Formulation of linear programming

Inventory Models
(a)
(b)
(c)
(d)

Chapter 4

Deterministic and probabilistic demand models

Economic order quantity
Economic production lot size
Economic order quantity with back orders quantity, re order point
model, periodic review model, safety stock

Material requirements planning

(a) Product structure
(b) Gross requirement planning,
(c) product structure and gross requirements, net requirements
(d) Time of order

Chapter 5

Decision Analysis
(a)
(b)
(c)
(d)
(e)

Decision making without probabilities

Optimistic approach conservative approach
Minim ax regret approach
Decision making with probabilities
Decision trees expected monetary values, value of perfect information.
Value of survey information
(f) Bayers posterior probabilities. Expected utilities attitudes of risk,
procedures for obtaining utility function from a decision tree

Chapter 6

Queuing Theory
(a) Single channel,
(b) multi- channel,
(c) cost analysis.

Text books
1 Operations Research by Hamdy A. Taha
2 Introduction to Operations Research By C.W. Churchman, R.L Ackoff and E.L. Arnoff
3 Management Science by David R Anderson Dennis J Sweeney and Thomas A Williams
4 Any other Operations research textbook.

Chapter 1 Network Models

1.1

Shortest Route Problem

The primary objective is to determine the shortest route or path between any pair of
nodes in a network.
Example
Nyamz Construction Company has several construction projects located throughout
Zimbabwe. Some construction sites are sometimes located as for as 400km from their
main offices in Bulawayo. With multiple daily trips carrying personnel, equipment and
supplies to and from the construction locations, the costs associated with transportation
activities are substantial. The network shown below describes the travel alternatives to
and from six of Nyamzs newest construction sites.
The circles, or nodes of the network corresponds to the site locations. The roads, streets,
and highways appear as the arcs in the network.
The company would like to determine the routes or paths that will minimize the total
travel distance ( in tens of km) from the office to each site.
17

2
15
1
Main Office

6
3

5
6

10

6
3

We need to determine the shortest route from the main office (node1) to each of the
other nodes in the network. We are going to perform a labeling procedure by giving
node one the permanent label {0,S}. The first number in the label for a particular node
indicates the distance from node 1 to that node, while the second number indicates the
preceding node on the route from node1 to that node.
[14,5 ]
Preceding node on the route from node1 to this node is node 5
Distance from node 1 to this node is 14.

To perform the first step of the labeling procedure, we must consider every node that can be
reached directly from node 1, ie node 2 & 3.
[15;1]
17

2
15
1
[0;S]

6
3

5
6

10

6
3

[10;1]
We say node 2 & 3 are tentatively or temporally labeled.
We now consider all tentatively labeled nodes and identify the node with the smallest distance
value in its label, thus node 3 with a travel distance of 10 km.
Node 3 can be permanently labeled since there is no any other route to node 3 which has a
distance less or equal to 10.
We can shade node 3 to show that it is now permanently labeled or bold the brackets at node 3.
We now consider all nodes that are not yet permanently labeled that can be reached directly from
node 3, and these are node 2 & 5.
Tentative label at node 2 is revised to [10 + 3] = [13] and that at node 5 is [10+4] = [14].
We next consider all tentatively labeled nodes in order to find the node with the smallest distance
value in its label. Node 2 which has the shortest distance out of all the temporally labeled nodes
is now permanently labeled. We now know that node 2 can be reached from node1 in the shortest
possible distance of 13 km by going through node 3. The next step or iteration begins at node 2 ,
the recently permanently labeled node. Nodes that can be reached from node 2 are node 4 and7.
Node 4 become [4;3] node 7 is [30;2]. From among the tentatively labeled nodes 4,5 &7, we
select the node with the smallest distance value and declare that node permanently labeled node.
Continuing this process summarise the solution as in the following table
Table 1.1 Shortest route from node one to all the other nodes.
Node
2
3
4
5
6
7

Shortest Route from Node1

1-3-2
1-3
1-3-5-4
1-3-5
1-3-5-6
1-3-5-6-7

Distance
13
10
18
14
16
22

Example 1.2
Find the shortest route between nodes 1 and all the other nodes in the following network.
2
14
6

2
2
1

1
4

1.2

10
4
13

3
9

12

5
2

8
11

1
0

10

Minimal Spanning Tree Problem

This involves using the arcs of the network to reach all nodes of the network in such a fashion
that the total length of all the arcs used is minimized.
A spanning tree for an N- node network is a set of N-1arcs that connects every node to every
other node. A minimal spanning tree is the set of arcs that does this at the shortest distance. The
steps of the algorithm of the shortest route problem is as follows:
Step 1 Arbitrarily begin at any node and connect it to the closest node in terms of the criteria
being
used. (eg, time, cost or distance). The two nodes are referred to as connected nodes and
the
remaining as unconnected nodes.
Step 2 Identify the unconnected node that is closest to the set of the connected nodes. Break ties
arbitrarily if two or more nodes quality as the closest node. Add this new node to the set
of
connected nodes.
Repeat this step until all nodes have been connected.
EXAMPLE 1.3
N.U.S.T. I.T computer center must have special computer communications lines installed to
connect five satellite users with a new central computer. A Telephone Company will install the
new communication network. However, the installation is an expensive operation. To reduce

costs, the centers management group wants the total length of the new communication lines to be
as small as possible. While the central computer could be connected directly to each user, it
appears to be more economical to install a direct line to some users and let other users tap into the
system by linking them with users already connected to the system. The network for this problem
with possible connection alternatives and distances (in km) is shown below.
40

20

50

40

30
Computer
Center

40

40

10

30
4
20
6

Solution
Starting at node1, the closest node is node 2 with a distance of 20.
Connect nodes 1&2 using bold lines.
In step 2 we find that the closest unconnected node to one of the connected nodes is node 4 with a
distance of 30.
Repeating the steps the minimal spanning tree solution is as below.
40

20
1

30
10

20
6

The minimal length of the spanning tree is given by the sum of distances on the arcs forming the
spanning tree which is 110 km in this case and this is the optimal solution.

EXAMPLE 1.4

The Bulawayo City Council has recently acquired land in the just ended land redistribution
exercise for a new council park, and park planners have identified the ideal locations for the
lodges, cabins picnic groves, boat dock, and scenic points of interest. These locations are
represented by the nodes of the network below. The arcs of the network represent possible road
alternatives in the park.
If the council designers want to minimize the total road distance (km) that must be constructed in
the park and still permit access to all facilities (nodes), which road alternatives should be
constructed.
6

2
1

5
6

1
0

4
2
5

6
9

1.3

3
1
5

6
4

1
2
7

1
1

8
6

8
11

3
2

12

1
4

7
1
3

MAXIMAL FLOW PROBLEM

This involves a network with one input or source node and one output or one sink node.
The problem tries to answer the maximum amount of flow (vehicles, messages, fluids etc) that
can enter and exit the network system in a given period of time.
The amount of flow in any arc is limited due to capacity restrictions on the various arcs of the
network.
Flow capacities are based on the direction of the flow.
eg
1

This indicates that a flow of 6 in the direction of 1-2 and no flow from 2-1.
On roads this can be interpreted as a one way road.
7

Steps of the maximal flow algorithm

Step1 Find any path from the source (input) node to the sink (output) node that has flow
capacities in
the direction of flow greater than zero for all arcs on the path. If no path is available, then
an optimal solution has been reached.
Step 2 Find the smallest arc capacity Pf on the path selected in step 1. Increase the flow through
the
network by sending an amount Pf over the path selected in step1.
Step 3 For the path selected in step 1, reduce all arc flow capacities in the direction of flow by Pf
and increase all arc flow capacities in the reverse direction by Pf . Go to step1.
EXAMPLES 1.5
The West to East flow of vehicles moving in Rusape town reaches a level of 1500 vehicles per
hour at peak times. Due to some maintenance program, which calls for the temporary closing of
lanes and lower speed limits a network of alternative routes through the high way has been
proposed by a transport planning committee. The alternative routes include other highways as
well as city streets.
Due to differences in speed limits and traffic patterns, flow capacities vary, depending on the
particular streets or roads used. The proposed network with arc capacities is shown below.
No of vehicles(00) passing
per hour

0
5

5
8
1

0
7

3
4

0
0

7
6

Applying step 1 to step 3 the total number of vehicles that can pass through the network is 1400
per hour using the following path.
Path

Pf
1.3.6.7
8

1-2-5-7
1.2.3.5.7
1.4.6.7
1.4.6.5.7
1-4-6-3-5-7

3
2
1
1
1

Total 14

Consider the 3-6 arc with initial and final flow capacities shown below
Initial Capacities
3

Final Capacities
3

The arc has a flow of 7-2 = 5 in the 3-6 and the flow is summarized as follows

The complete network will be as below

2
9

7
3

7
6

4
Example 1.6

BP Oil Company ours a pipeline network that is used to transmit oil from its source to several
storage locations. A portion of the network is as follows.
Due to varying pipe sizes, the flow capacities also vary. By selectively opening and closing
sections of the pipeline network, the firm can supply any of the storage locations
(a) if the firm wants to supply storage location 7 (node 7) and fully utilize
the system capacity how long will it take to satisfy a location 7
demand of 100, 000 gallons. What is the maximal flow for this
pipeline system.
(b) If a break occurs on time 2-3 and it is closed down, what is the
maximal flow for the system. How long will take to transmit 100,000
gallows location 7.
3

2
1

6
6

2 6
1

2
0

1
4

0
2

Exercises

Chapter 2

10

PROJECT SCHEDULING: PERT/CPM

2.1

Introduction

PERT - Program Evaluation and Review Technique.

CPM Critical Path Method
Uses of Pert and CPM
1
2
3
4

Construction of plants, buildings and highways.

Research and development of new products and processes.
Maintenance of large and complex equipment.
Design and installation of new systems.

A complicating factor in carrying out scheduling of various jobs or activities using

PERT/ CPM is the interdependence of the activities ie same activities depend on
the completion of other activities before they can be started.

2.2
PERT/CPM Network
The first step in the PERT/CPM project scheduling process is the determination of
the specific activities that will make up the project.
As a simple example consider the table below which involves the building of a
daga hut by a new resettled farmer.

Activity
A
B
C
D
E

Activity Description
Cutting of poles
Clearing of the ground
Digging of holes
Erection of poles
Roofing

Immediate Predecessor
B
A,C
D

The immediate predecessors for a particular activity are the activities that when
completed, enable the start of the activity in question eg. Activity A and B can
start anytime since they do not depend on the completion of any prior activity, but
activity D cannot start until activity A and C have been completed.

11

A network that shows the activities and also shows the predecessor relationships
among the activities is shown below.
Arcs indicate project activities
11111
1

B
C

22222

Nodes correspond to the beginning and ending of activities.

The completion of all the activities that lead into the node is referred to as an
event. For example node 2 corresponds to the event that activity B has been
completed and node 3 corresponds to the event that both activity A and C have
been completed.
Example 2.1
Develop the network for the project having the following activities and immediate
predecessors.
Activity
A
B
C
D
E
F
G

Immediate Predecessor
B
A,C
C
C
D,E,F

Activity E should not start at node 3 as this will imply that A and C are the
immediate predecessors for activity E, which is not. E has only C as the immediate
predecessor.
12

We insert a dummy activity, which is rather fictitious activity used to show proper
precedence among the activities.

D
4

E
2

Note: Activity E and F both starts at node 5 and end at node 4. This situation
causes problem for certain computer programs that use starting and ending nodes,
and they recognize activities E and F as the same activity. Dummy activities can
be added to make sure that no two or more activities have the same starting and
ending nodes.

D
4

E
2

5
F

2.3

PROJECT SCHEDULING WITH PERT/CPM

Example2:
The owner of Bulawayo Shopping Center is considering modernizing and
expanding the current 32 business Shopping complex. If the expansion project is

13

undertaken, the ower hopes to add 8 to 10 new business or tenants to the Shopping
complex. The specific activities that make up the expansion project are listed
below. The objective is to try and finish the project as quickly as possible. How
long will it take to finish the project?
Activity

Activity Description

Prepare architectural
drawings
Identity potential
new tenants
Develop prospectus
for tenants
Select Contractor
Prepare building
permits
Obtain approval for
buildings permits
Perform construction
Finalize contracts
with tenants
Tenants move in

B
C
D
E
F
G
H
I

Immediate Predecessor Completion

Time(weeks)
5

6
A

A
A

3
1

D,F
B,C

14
12

GH
Total

2
51

Pert/CPM Network

2
A

D3

E1

4 F

1
C 4
B

14

6
3

H 12

2 I

NB: Total time to complete the project is 51 weeks. However several activities can be
conducted simultaneously eg A and B and this will reduce the total completion time for
the whole project.
2.4

THE CRITICAL PATH

14

To determine the project completion time we must identify the critical path.
A path is a sequence of connected activities that leads from the starting node (1) to the end
node.
The longest path through the network determines the total time required to complete the
whole project, and is called the critical path. The longest path activities are called critical
path activities of the project.
If managers wish to reduce the project completion time they will have to reduce the length
of the critical path by shortening the duration of the critical path activities
To get the critical path we must compute an earliest start and earliest finish time ES and
EF respectively.
ES = earliest start time for a particular activity
EF = earliest finish time for a particular activity
t = expected activity time for the activity
EF ES t

For activity A. ES 0

t 5

EF 0 5 5

On the network this will be written as

ES
A
1

[0;5]
5

2
EF

RULE 1
The earliest start time for an activity leaving a particular node is equal to the largest of the earliest
finish times for all the activities entering that node.
Proceeding in a forward pass through the network we can establish the ES and EF for each
activity

2
A[0;5]

D [5;8]
E[5;6]

F [6;10]

1
C [5;9]

15

G [10;24]

B [0;6]
H [9;12]

I[24;26]

The latest finish time for activity I is 26 weeks so the total time required to complete the project is
26
weeks. The critical path is obtained by making a backward pass calculation.
Starting at the completion point (node7) and using a latest finish time of 26 for activity 1 we trace
back through the network, computing a latest start and latest finish time for each activity.
LS = Latest start time for a particular activity.
LF = Latest finish time for a particular activity.
LS LF t

eg LS for activity I = 26 - 2 = 24

Rule 2
The latest finish time for an activity entering a particular node is equal to the smallest of the latest
start times for all activities leaving that node.
Calculating backwards the LF and LS times are as below.

{7;10}

2
A[0;5]

{0;5}

{5;6}

D [5;8]
E[5;6]
4
{6;10]

F [6;10]

C [5;9]
{8;12}

16

G [10;24]
{10;24}

B [0;6]
{6;12}

I[24;26]
{12;24}

H [9;12]
{24;26}

Slack is defined as the length of time an activity can be delayed without affecting the total time
required to complete the whole project.
ie Slack = LS ES LF EF
eg For activity C Slack = LS ES = 8 5 = 3 weeks
This means activity C can be delayed up to 3 week (staring anywhere between week 5 and 8)
without changing the completion time of the whole project of 26 weeks.
The activity C is not a critical path activities.
For critical path activities slack = 0 ie Activities A, E, F, G and I form the critical path.
The critical path is A-E-F-G-I
Activity

ES

LS

EF

LF

A
B
C
D
E
F
G
H
I

0
0
5
5
5
6
10
9
24

0
6
8
7
5
6
10
12
24

5
6
9
8
6
10
24
21
26

5
12
12
10
6
10
24
24
26

2.5

Slack LSES
0
6
3
2
0
0
0
3
0

Critical
path
YES

YES
YES
YES
YES

PROJECT SCHEDULING WITH UNCERTIAN ACTIVITY

This involves the scheduling of a new product with the activities in this project never been
previously attempted.
Examples 2.3
The H and S Company have been manufacturing industrial vacuum cleaning system for a number
of years. A member of the companys new- product research team submitted a report suggesting
that the company considers manufacturing a cordless vacuum cleaner. The companys

17

management would like to study the feasibility of manufacturing the new product. The researcher
suggests the activity list of the new product as below.
Activity
A
B
C
D
E
F
G
H
I
J

Description
Develop product design
Plan market research
Prepare manufacturing engineering
Build prototype model
Prepare marketing brochure
Prepare marketing brochure
Prepare cost estimates
Preliminary product testing
Complete pricing and forecast report
Prepare final report

Immediate Predecessor
A
A
A
C
D
B,E
H
F.G.I.

Network diagram for the New product

C

5
F

A
G
E

4
3

2.5.1

D
7
6

UNCERTIAN ACTIVITY TIMES

Accurate activity time estimates are important in the development of an activity schedule.
When activity times are uncertain, three time estimate (1) optimistic time, (ii) Most probable
time and
(iii) pessimistic time allow the project manager to take uncertainty into consideration in
determining the critical path and the activity schedule.
Optimistic time a = the activity time if everything progressed in an ideal manner.
Most probable time m = Most probable activity time under normal conditions
Pessimistic time b = the activity time if significant delays are encountered.
The average or expected time (t) for any activity is determined by the formula
18

a 4m b

eg for activity A the manager estimates the most probable time to be 5 weeks with a range of 4
weeks (optimistic) to 12weeks (pessimistic) therefore;
tA

4 4(5) 12 36

6 weeks
6
6

Also with uncertain activity times the variance or variation in the activity time is given by
ba

The difference between the pessimistic (b) and optimistic (a) time estimates greatly affects the
value of the variance.
So

12 4

A2

1.78

NB The variance equation is based on the notion that a standard deviation is approximately
the difference between the extreme values of the distribution. Variance is the square of the
standard deviation.

Activity

Optimistic

A
B
C
D
E
F
G
H
I
J

4
1
2
3
2
1,5
1,5
2,5
1,5
1

19

Most
Probable (m)
5
1,5
3
4
3
2
3
3,5
2
2

Pessimistic
(b)
12
5
4
11
4
2.5
4.5
7.5
2.5
3

Expected
(t)
6
2
3
5
3
2
3
4
2
2

Variance
2
1.78
0.44
0.11
1.78
0.11
0.03
0.25
0.69
0.03
0.11

1
of
6

32

2.5.2

CRITICAL PATH

To get the critical path we treat the expected activity times as the fixed length or duration of each
activity.
The critical path calculations will only determine the expected or average time to complete the
project.

C[6;9] {13;15}

2
{10;13}
F[9;11]
A[0;6]
D[6;11]
{0;6}
{6;9}
{7;13}
G[11;14]
1
4
E[6;9] {12;15}
{15;17}
B[0;2] I
{7;9} {13;15}
[13;15]
H[9;13]

5
J[15;17]
7
6

8
{9;13}

The expected completion time for the entire project is 17 weeks and the critical A-E-H- I-J.
2.5.3

VARIABILITY IN THE PROJECT COMPLETION TIME

Variation in critical path activities can cause variation in the project completion time .If a noncritical path activity is delayed longer enough than its slack time, then if becomes part of a new
critical path and may affect the project completion time. Let T denote the total time required to
complete the project. The expect value of T which is determined by the critical activities A- EH- I-J is
E T t a t E t H t I t J
6 3 4 2 2 17

20

The variance of T is given by

2 A2 E2 H2 I2 J2
1.78 0.11 0.69 0.03 0.11
2.72
Stdev

2 1.65

The normal distribution tends to be the better approximation of the distribution of total time for
larger projects where the critical path has many activities. Suppose that management has allocated
20 weeks for the project. What is the probability that the 20 weeks deadline will be meet.
Using the normal distribution shown below we want P[T 20]
The Z- value for the normal distribution at T = 20 is given by
20 17
1.65
1.87

Using Z = 1.82

P[T 20] 0.4656 0.5

0.9656

There is an excellent (96.6%) chance that the project will be completed before the 20 week
deadline.
2.6

CONDISERING TIME-COST TRADE OFFS

Use of more resources (such as more workers, overtime and so on) generally increase project
costs, and reduce activity times.
A manager has to make a decision that involves trading decreased activity time for increased
project costs.
In the previous example the 17- week completion time could be reduced if management were
willing to add more resources to shorten any of the critical path activities
Consider the following example
Activity

Description
21

Immediate

Expected

Predecessor
A

Overhaul machine I

B
C
D
E

Adjust machine 1
Overhaul machine II
Adjust machine II
Test machine II

Time(days)
7
3
6
3
2

C
B,D

The network diagram and the critical path is as below;

2
A

D
3

The critical path is A-B-E and the project is taking 12 days.

2.6

CRASHING ACTIVIY TIMES

Suppose the above project was declared to last for 10 days. This can be achieved by shortening
selected activity times by adding resources such as labor or overtime and is referred to as
crashing. Crashing results in added project costs.
We have to identify activities, which cost less to crash and then crash on them to meet the desired
project completion time.
We need information like
1. Estimated activity cost under normal or expected activity time.
2. Estimated time to complete the activity under maximum crashing (ie,
the shortest possible activity time)
3. Estimated activity cost under maximum crashing.
22

Let

= normal time for activity j.

= time for activity j under maximum crashing
M j = maximum possible reduction in time for activity j due to maximum crashing.
C j =estimated cost for activity j under normal time
C 'j = estimated cost for activity j under maximum crashing
j

'
j

M j j 'j

The per unit time basis crashing cost K j is given by

Kj

C 'j C j
Mj

Eg If the normal time for activity A is 7 days at CA = $500 and the time under maximum crashing
is 4 days at CA = $800, then
M A 7 4 3 days and
KA

C A' C A 800 500

$100 per day

MA
3

So if we decide to crash activity A by 1

1
1
days the added cost is 1 ($100) $150
2
2

Total cost for activity A will be $500+150 = $650

Activity

Time
normal

(Days)
Crash

Total
Normal
(cj)

Cost
Crash (cj)

A
B
C
D
E

7
3
6
3
2

4
2
4
1
1

$500
$200
$500
$200
$300

800
350
900
500
550

23

Maximum
reduction
in time
(mj)
3
1
2
2
1

Crash cost
per day Kj
= Insert
formulae
100
150
200
150
250

Which activities must be crashed and by how much.

As one crash the current critical path activities other paths may become critical as well.
2.7

A LINEAR PROGRAMMING MODEL FOR CRASHING DECISIONS

Since we have 5 nodes or events in the above example we need five decisions variables to
identify the time of occurrence for each event.
We also need 5 decision variables to represent the amount of crash time used for each of the five
activities. So let
x i = time of occurrence of event i for i 1, 2,....5
y j = amount of crash time used for activity j = A,B,C,D and E
Since the total cost for a normal completion time is fixed at $1 700, we can minimize total project
cost (normal cost plus crash cost) by minimizing the total crashing cost.
The objection function became
E

Minimise Z k j y j

kj

j A

crash cost coefficient.

Constraints are based on;

1. The time of occurrence of event i ( x i ) must be greater than or equal to
the activity completion time for all activities leading into a node.
2. An activity start time is equal to the occurrence time of its preceding
node.
3. The time to complete an activity time is equal to its normal time less
the length is crashed.

Chapter 3
Inventory Models
Introduction
Inventory refers to idle goods or materials that are held by an organizations for use
in the future. While inventory serves as a buffer against uncertain and fluctuating
usage and keeps a supply of items available in case the items are needed by the
organization or its customers, the expense associated with financing and
maintaining inventories is so high.
Two important questions that need to be addressed in inventory management are;
(i)
how much to order when the level of inventory drops,
(ii)
and when to order a given item,
should be answered to effectively manage inventories.
3.2
Economic Order Quality (EOQ) model
This is the best known and must fundamental inventory model and is applied when
the demand for an item has a constant, or nearly constant rate.
Also the entire ordered quantity arrives in inventory at one point in time.
24

To illustrate the use of the EOQ model let us consider the following example.
Examples 3.1
National Breweries is a distributor of beer, wine and soft drink products. From a
main warehouse located in Bulawayo the company supplies nearly 1000 retail
stores with its beverage products. The beer inventory which constitutes about 40%
of the companys total inventory, averages around 50 000 crates. With an average
cost per crate of approximately $8, the company estimates the value of its beer
inventory to be $400 000. The warehouse manager has decided to do a detailed
study of the inventory costs associated with castle beer the number one selling beer
for the company. The purpose of the study is to establish the how much to- order
and the when to order decisions. The manager has obtained the following
historical demand data for the past 10 weeks.
Week
1
2
3
4
5
6
7
8
9
10

Demand (crates)
2000
2025
1950
2000
2100
2050
2000
1975
1900
2000
Total Demand 20 000

Average per week 2000

Holding Costs
These are costs associated with maintaining or carrying a given level of inventory
and they depend on the size of the inventory.
First there is the cost of financing the inventory investment. This cost of capital is
usually expressed as a % of the amount invested. Netbrew estimates its cost of
capital at an annual rate of 18%. Other holding costs includes, insurance, taxes,
breakages and warehouse overhead. Net brew estimates these other costs at an
annual rate of approximately 7% of the value of its inventory.
Total holding costs for the beer inventory is 25% (18% + 7%) of the value of the
inventory. Assume the cost of 1 crate of castle beer is $8. The cost of holding one
crate of beer in inventory for 1 year is 0,25 ($8) = $2
Ordering Costs
This costs is considered fixed regardless of the order quantity. It covers the
preparation of the voucher, the processing of the order including payment, postage,
telephone, transportation, invoice verification, salaries of the purchasers etc. The
manager estimates its ordering costs are $32 per order regardless of the quantity
requested in the order.

25

3.2.2 Formulation of the EOQ Model

The holding costs, ordering costs and demand information are the 3 data items that
must be known before the use of the EOQ model.
Let Q be the order quantity, the how much to order decision involves finding the
value of Q that will minimize the sum of holding and ordering costs.
Assume that Natbrew opens 5 days each week and has a constant demand rate of
2000 crates per week or 400 crates per day.
The graph of the level of beer over one order cycle of length T is as shown below.
Q

1
Q
2

Average Inventory level

T
Time
Inventory level over many cycles is as below.

Q
Average Inventory Level
0
Time
Let I = annual holding cost rate.

26

C = Unit cost of the inventory item

C h = annual cost of holding one unit in inventory

Annual cost of holding one unit in inventory is

C h IC

Cost of one crate of castle is C = $8

with I = 225%

Annual holding cost for one crate is

C h IC = 0,25 (8)

= $2
Annual holding cost = (Average inventory level ) (annual holding cost per unit)
=

1
QC h
2

Let D be the annual demand for the product.

for Natbrew D = 52 (2000 crates per week)
= 104,000 crates per year.
D

By ordering Q units every time we order we have to place Q orders per year.
If C o is the cost of placing one order,
Annual ordering cost = (Number of orders per year) (cost per order)
D

= Q Co
Total annual costs TC = Annual holding costs + Annual ordering cost
1

ie TC 2 QC h Q C o
For castle beer
( C h = $2, C o = $32
TC

104 000
1
Q ( 2)
(32)
2
Q
3 328 000
= Q
Q

3.3 The how much to order decision

Find Q that will minimize the total annual costs (TC).

27

D = 104,000

3 328 000
Q

For the castle beer

TC Q

Using Q = 8000,
When Q = 5000,

TC = 8000 + 3,328 00/8000 = $ 8 416

TC = 5000 + 3,328,00/500 = $5 666

Several other values of Q gives the graph below

Diagram
600

TC
Annual holding

cost
400
Cost ($)
Annual ordering cost
200
Q*
Order Quantity (Q)

3.3.1 Derivative of Q* Using Calculus

1

Since TC 2 QC h Q C o
Differentiating the above equation with respect to Q gives
DC o
d (TC ) 1
Ch
dQ
2
Q2

at minimum

ie

d (TC )
0
dQ

DC
1
C h 20 0
2
Q
Q*

For the castle beer;

28

2 DC 0
Ch

Q2

2 DC 0
Ch

2(104000)32
2
1824 cases

Q*

NB

Q*

will always balance the holding costs and the ordering costs

3.4 When to Order Decisions

The inventory position for an item is defined as the amount of inventory on hand
plus the amount of inventory on order. The when to order decision is expressed in
terms of a reorder point, which is the inventory position at which a new order
should be placed.
The manufacturer of castle beer guarantees a 2 day delivery on any order placed.
Assuming a constant demand rate of 400 crates per day we expect 2( 400) = 800
crates to be sold during the 2 days it takes a new order to reach the company.
The two day period is called the lead time and the 800 crates demand during this
period is called lead time demand.
So they had to order when the inventory level reaches 800 crates. The reorder
point is the same as the lead time demand.
The reorder point r is given by
r dm
where
r = reorder point
d = demand per day
m = lead time for a new order in days
Period between orders is called cycle time(T) and is given by:
T

Q*
D

( in years)

12Q *
( in months )
D
250Q *
or T
(in days )
D
or T

3.5 Economic Production lot size model

In this model, instead of assuming that goods arrive in a shipment of size Q as in
the EOQ model, we will assume that units are supplied to inventory at a constant
rate over several days or week.
The constant supply rate assumption implies that the same number of units is
supplied to inventory over a period of time eg 10 units every day. Once an order is
placed production begins and a constant number of units is added to inventory
each day until the production run has been completed.
In this model production rate should be greater than demand rate.

29

The inventory pattern is as below

Production phase
Inventory
Level

Non production phase

Average inventory level

Time
This model assume two cost; holding costs and production set up costs.
Production set up costs include labor, material etc and is a fixed cost that occurs
for every production run regardless of the production lot size.
The total cost model
Let Q be the production lot size ie the total number of units produced during the
production period.
Let d = daily demand rate for the product
p = daily production rate for the product
t = number of days for a production run.
Since p d, the daily inventory build up rate during production phase is p - d.
After t days the level of inventory will be ( p d )t .
Max inventory level = ( p d )t
Since Q is the production lot size it means
Q pt
Q
t
p

days (length of a production run)

Maximun inventory level ( p d )t

Q
( p d)
p
d
(1 )Q
p

30

1
max imum inventory level
2
1
d
(1 )Q
2
p

Average inventory level

Therefore

Annual holding cos ts Ave. Inventory level Annual holding cos ts

1
d
1 QC h
2
p

If D is the annual demand for the product and C o is the set up cost for
a production run then,

No of production runs Set up cost

An ual set up cost
per year per un
D
Co
Q
TC

1
D
D
1 QC h C o
2
P
Q

P is the annual production for the year.

d

NB p P

31

DC o
d (TC ) 1
D
(1 )C h
dQ
2
P
Q2

Q*

2 DC 0
D
(1 )C h
P

Example 3.2
The New Green Key Bar Soap is produced on a production line that has an annual
capacity of 60 000 bars. The annual demand is estimated at 26 000 bars with the
demand rate essentially constant throughout the year. The cleaning, preparation
and set up of the production line cost approximately $135.00. The manufacturing
cost per bar is $4.50 and the annual holding cost is figured at a 24% rate.
(a)What is the recommended production lot size.
(b) Find
(i)Total cost
(ii) the reorder point and cycle time between production runs given that
the lead time is 1 week.
Solution

C h IC 0.24($4.50) $1.08

(a)
2( 26000)135
26000
(1
)1.08
60000

Q*

3 387

(b) (i)
TC

1
D
D
1 QC h C o
2
P
Q

$2 073

(ii)

r dm
( weekly demand )(1 week lead time)
26000
(1)
52
500 bars

32

and
250Q
D
250(3387)

26000
33 working days

So a production of 3387 bars had to be planned every 33 days

3.6
Quantity Discounts for the EOQ Model
In this model the cost per unit varies depending on the quantity ordered.
Example 3.3
The data and cost analyses below show an annual holding cost of 20%, an ordering
cost of $49 per order, and an annual demand of 5000 units. What quantity should
be ordered?
Discount
Category
1
2
3

Order size

Discount %

Unit Cost

0-999
1000-2499
2500 +

0
3
5

$5
$4,85
$4,75

Solution
Let Q1 , Q2 and Q3
respectively.
*
Since Q

2 DC o
Ch

represent the order quantity for discount category 1,2,3

and C h IC (0.20)C

The following steps should be followed

Solution
Step 1 Calculate Q* based on the unit cost associated with the discount category 1,
2, 3 respectively.

33

Q1*

2(5000) 49
700
0.2(5)

Q2*

2(5000) 49
711
0.2(4.85)

Q3*

2(5000) 49
718
0.2(4.75)

Step 2 For the Q* that is too small to qualify for the assumed discount price adjust
the order quantity upward to the nearest order quantity that will allow the product
to be purchased at the assumed price.
Purchase cost = annual demand x unit cost
affected by the inventory order b4)
Q

(which was constant and never

So the Total Cost TC 2 C h Q C o DC

(i)
N.B if a calculated Q for a given discount price is large enough to qualify for a
bigger discount, that value of Q cannot lead to an optimal solution.
Step 3 For each of the order quantities resulting from steps 1& 2, compute the
total
annual cost using the unit price from the appropriate discount category and the
order
quantity yielding the minimum total annual costs is the optimal order quantity.
The results after step 3 are summarized below

Discount
category
1
2
3

Unit
cost
5
4.85
4.75

Order
quantity
700
1000
2500

Holding
Cost
350
485
1188

Ordering
Cost
350
245
98

Purchase
Cost
25000
24.250
23.700

Total
Cost TC
25 700
24 980
25 036

So a decision to order 1000 units at the 3% discount rate yields the minimum cost
solution Q* = 1000
3.7
A Single Period Inventory Model with Probabilistic Demand
This single- period inventory model treat demand as probabilistic and best
described by probability distribution.

34

In situations where the demand rate is not deterministic models have been
developed that treat demand as probabilistic and best described by a probability
distribution.
The single- period inventory model refers to inventory situations in which one
order is placed for the product; at the end of the period, the product has either sold
out, or there is a surplus of unsold items that will be sold for a salvage value.
The single- period inventory model is applicable in situations involving seasonal
or perishable items that cannot be carried in inventory and sold in future periods.
Eg newspapers, winter coats and the single period inventory problem is sometimes
referred to as the news boy problem.
Incremental analysis is a method that can be used to determine the optimal order
quantity for a single- period inventory model.
Incremental analysis addresses the how- much to order question by comparing
the cost or loss of ordering one additional unit with the cost or loss of not ordering
one additional unit.
Co = cost per unit of overestimating demand (this cost represent the loss of
ordering one additional unit and finding it cannot be sold).
Cu = cost per unit of underestimating demand (this cost represents the
opportunity loss of not ordering one additional and finding that it could have
been sold
The general expressions for the expected loss for overestimating and
underestimating order quantity are:
EL(Q * 1) C o P(demand Q*)

(1)

EL(Q*) C u P( Demand Q*)

(2)

But P(demand Q*) P(demand Q*) 1

(3)

P( demand Q*) 1 P ( demand Q*) ( 4)

Substituting (4) into (2) yields

EL(Q * 1) C u [1 P (demand Q *

(5)

(6)
When EL(Q * 1) EL(Q*)
there is no economic advantage to increasing the order quantity by one
additional unit. Substituting (1) and (5) into (6);

C o P(demand Q*) C u [1 P(demand Q*)

Solving for P(demand Q*) we have

P(demand Q*)

35

Cu
Co Cu

(8)

( 7)

and this states the general condition for the optimal order quantity Q in the single
period inventory model.
Thus to establish an optimal order quantity for single- period models we must
identify the probability distribution that describes the demand for the item and the
costs of overestimation and underestimation.
EXAMPLE 3.4
The J & B shop sells calendars with different colonial picture for each month.
The once a year order for each years calendar arrives in September.
From past experience, the Sept- Jul demand for the calendars can be
approximated by a N (500,1202 ).
The calendars cost $1 500 each and J&B sells them for $3 000 each.
(a) If J &B throws out all unsold calendars at the end of July (ie salvage value
is zero) how many calendars should be ordered?
(b) If J & B reduces the calendar price to $ 1000 at the end of July and can sell
all surplus calendars at this price, how many calendars should be ordered?
solution
(a)

C 0 1500

Q ~ N (500,120 2 )

P (demand Q*)

1500
3000

Normalising this equation yields

Q * 500
1

P Z

120
2

Q * 500
0 ( from normal tables )
120

36

Q* 500

C u 3000 1500 1500

P demand Q *

(b)

1500
2000

Q * 500

P Z
0.75
120

Q * 500
0.675
120
Q* 581

Example 3.
An Air- Conditioning Company is considering the purchase of a special
shipment of portable air conditioners manufactured in Japan. Each unit will
cost the company
$80 000 and it will be sold for $ 125 000.
The company does not want to carry surplus air conditioners over to next year.
Thus all surplus air conditioners will be sold to a wholesaler for $50 000 per
unit.
Assume that the air conditioners demand follows a N (20, 82)
(a) what is the recommended order quantity?
(b) What is the probability that the company will sell all the units it orders?
solutions
(a)

C u 45 000

P demand Q *

C 0 30 000

Cu 45

C0 Cu 75

Q * 20
P Z
0.6
8

Q * 20
0.253
8
Q* 22

37

P Sell all Pdemand Q *

(b)

1 Pdemand Q *
1 .0 60
.0 40

3.8

An Order Quantity, Re order Point Model with Probabilistic

Demand
(Multi Period)

Reorder point
Order placed

Time

Stock out

The inventory level decreases at a non-constant rate based on probabilistic

demand.
A new order is placed whenever the reorder point is reached.
At times, the order quantity of Q units will arrive before inventory reaches
zero.
However at times, higher demand will cause a stock out before a new order is
received. As with other order quantity, reorder point models, the manager
must determine the order quantity Q and the re- order point for the inventory
system.
3.8.1 How much to order decision
The how much to order question is answered by the following equation.
38

Q*

3.8.2

2 DC 0
Ch

The when to order decision

If a normal distribution is used for lead-time demand, the general equation for r
is
r t Z where Z is the number of std deviation necessary to obtain the
acceptable stockout probability.
EXAMPLES 3.
Barons Inc provides a variety of auto parts to small local garages. Barons purchase
parts from manufacturers according to the EOQ mode and then ship the parts from
a regional warehouse directly to its customers. For a particular type of springs,
Barons EOQ analysis recommends orders with Q* = 25 to satisfy an annual
demand of 200 mufflers.
There are 250 working days and the lead-time averages 15 days.
(a) What is the re order point if Barons assumes a constant demand rate?
(b) Suppose that an analysis shows that the lead time demand follow N (12,
2,52). If the management can tolerate one stock out per year, what is the
revised re- order point?
(c) What is the safety stock for part (b) if C n = $5 / year. What is the extra cost
due to the uncertainty demand?
solution
200
15 12
250

(a)

r dm

(b)

D 200

8 orders per year

Q
25

P1 stockout per cycle

1
0.125
8

P(stockout) = 0.125

39

For area in tail = 0.125, z = 1.15

Z

r 12
1.15
2.5
r 12 1.15( 2.5) 14.875 15

(c) Safety stock = 15 13 = 3

Added cost = 3($5) = $15 per year

Chapter 4
DECISION ANALYSIS
4.1

Introduction
Decision analysis is used to determine optimal strategies when a decision
maker is faced with several decisions alternatives of future events.

40

For example a manufacturer of seasonal clothing would like to

manufacture more if consumer acceptance and demand for the product is
high and manufacture less if demand is low.
Selection of the best production- volume decision from among several
alternatives when the decision maker is faced with the uncertainty of future
demand is a problem suited for decision analysis.
4.2

STRUCTURING THE DECISIN PROBLEM

EXAMPLES 4.1
Alfa computer systems is a newly formed computer service firm that
specializes in information services such as surveys and data analysis.
The company is in the final stages of selecting a computer system for one of its
branches.
The company is currently attempting to determine the size of the computer
system that would be most economical, between one of three computer
systems which differ in size and capacity.
The three decision alternatives, denoted by d1, d2, d3, are as follows:
d1 = large computer system
d2 = medium computer system
d3 = small computer system

The second step is to identify the future events that might occur, and these events,
which are not under the control of the decision maker, are referred to as the state of
nature.
The states of nature for the company are as follows:
S1 = high customer acceptance of the companys services
S2 = low customer acceptance of the companys services
Given the 3 decision alternatives and two states of nature, which computer system
should the company select.
4.2.1

Payoff Tables

In decision analysis terminology, the outcome resulting from a certain decision and
the occurrence of a particular state of nature is a referred to as the payoff. The
profit and loss that the company will make for taking a certain decision and the
occurrence of a state of nature is shown below.
STATES OF NATURE

41

Decision Alternatives
Large system
Medium system
Small system

High Acceptance (s1)

$200 000
$150 000
$100 000

Low Acceptance (s2)

- $20,000
$20,000
$60,000

Payoff (profit in $) of Alfa C.S

The notation used in the payoff table is V (d i, Sj) which is the payoff associated
with decision alternative di and state of nature Sj.
eg V (d1, S2) = $ - 20 000
DECISION TREES
A decision tree provides a graphical representatives of the decision making
process. For ACS
High (S1)

Large(d1)

Medium (d2)

Small (d3)

$200 000

2
Low(S2)
High(S1)

$-20 000
$150 000

Low(S2)

$20 000

High(S1)

$100 000

4
Low(S1)

$60 000

Note node1 (which is a Square) is called a decision node whereas 2,3 and 4 are
state of nature nodes.
4.3

DECISION MAKING WITHOUT PROBABILITIES

4.3.1

Optimistic Approach

The optimistic evaluates each decision alternatives in term of the best payoff that
can occur.
In the above example, the optimistic approach would lead the decision maker to
choose the alternative corresponding to the largest profit.
42

For problems involving minimization, this approach leads to choosing the

alternative with the smallest payoff.
For the above problem the decision is to buy the large systems.
For maximization the approach is referred to as the maximax approach and for a
minimization it is referred to as the minimin approach.
Decision alternative
d1
d2
d3
4.3.2

Maximum payoff
200 000
150 000
100 000

Conservative Approach

This evaluates each decision alternative in terms of the worst payoff that can occur.
The decision alternative recommended is the one that provides the best of the
worst possible payoff.
For a maximizations problem this approach is referred to as the maximin and for
minimization problem it is referred to as the minmax.
For A.C.S.
Decision alternatives
d1
d2
d2

4.3.3

Minimum payoff
- 20 000
20 000
60 000

MINIMAX REGRET APPROACH

This approach is neither purely optimistic nor purely conservative.

Suppose that d3 was chosen and it happens that service is high, the resulting profit
would be $100 000.
Since S1 occurred we see that d1 yielding a profit of $20 000 would have the best
decision.
Opportunity loss or regret = difference between best payoff (200 000) and payoff
experienced 100 000
= 200 000 100 000
= $100 000
If we choose d2 and state S1 occurred
Opportunity loss or regret = 200 000 150 000 = 50 000
In general for a maximization problem.

43

Opportunity loss or regret R(di, Sj) = V* (Sj) V (di, Sj) where;

R (di, Sj) = regret associated with decision alternative with decision alternative di
and
state of nature sj
V* (sj) = best payoff value under state of nature sj
V(di, Sj) = payoff associated with decision alternative di and state of nature sj
In minimization problems V* (sj) will be the smallest entry in column j, and
R (di,Sj) = V(di, Sj ) V*(Sj)
Regret or opportunity loss of A.C.S. is as below,
State of nature
Decision alternatives
d1
d2
d3

S1
0
50 000
100 000

Decision alternatives
d1
d2
d3

S2
80 000
40 000
0
Maximum regret or opportunity loss
80 000
50 000minimum of the maxim regret
100 000

NB Although the 3 approach have provided different recommendations,

ultimately, the decision maker will have to choose the most appropriate opproach
and then make the final decision accordingly.

4.4

DECISION MAKING WITH PROBABILITIES

In many decision making situation, it is possible to obtain probability estimates for

each of the states of nature.
When these probabilities are available, the expected value approach can be used
to identify the best decision alternatives, after evaluates each decision alternative
in terms of its expected value.
Consider the Alfa computer system (A.C.S)
Let N = the number of states of nature. P(Sj) = probability of state of nature Sj
Conditions
P (sj) 0 for all states of nature.
44

P( S
j 1

) P ( S1 ) P( S 2 ) .........P ( S N ) 1

Expected Value (EV) of decision alternative di is;

N

EV (d i ) P( S j )V (d i , S j )
j 1

For A.C.S. Let P(S1) = 0.3 and P(S2) = 0.7

EV (d1 ) 0.3(200 000) 0.7( 20 000) $46 000
EV (d 2 ) 0.3(150 000) 0.7( 20 000) $59 000
EV (d 3 ) 0.3(100 000) 0.7(60 000) $72 000

P (S1) = 0.3

Large(d1)

Medium (d2)

Small (d3)

2
P(S2) = 0.7
P(S1) = 0.3

$-20 000
$150 000

P(S2) = 0.7

$20 000

P(S1) = 0.3

$100 000

4
P(S1) = 0.7

Large(d1)

Medium (d2)

Small (d3)

45

$200 000

EV = $46 000

EV = $59 000

$60 000

EV = $72 000

4.4.1

SENSITIVITY ANALYSIS

For A.C.S P(S1) = 0.3 and P(S2) = 0.7 these probabilities might change and such
changes is referred to as sensitivity analysis.
For example Let P(S1) = 0.6 and P(S2) = 0.4
EV ( d 1 ) 0.6( 200 000) 0.4(20 000) $112 000
EV ( d 2 ) 0.6(150 000) 0.4(20 000) $98 000
EV ( d 3 ) 0.6(100 000) 0.4(60 000) $84 000

For cases
To get p equal any two equation
220 000p 20000 = 40 000 + 60 000
180 000p = 80 000
p = 0,44
ie when p = 0,44 all the decision alternatives will provide the same EV for p
0,44 d3 provides the largest EV.
sensitivity analysis can assist management in deciding when it is worth investing
more time and money to obtain better probability estimates .
NB Similar sensitivity analysis with 3 d a and two S on should not be expected to
result in the same type of graph.
In cases where s o n are more than 3 a computer software package can be used to
assist with the computations
4.5

EXPECTED VALUE OF PERFECT INFORMATION (EV PT)

A.C.S. should conduct a market research study that would evaluate consumer
needs and such a study could help by improving the probability assessments for
the states of nature.
If the cost of obtaining the market research information exceeds its value then
the company should not conduct the research study.
If perfect information were available the decision strategy will be as follows:
If s1 occurs then select d1
s2 select d3

46

since P (s1) = 0,3 & P (s2) = 0,7, we see that there is a 0,3 probability that ACS
will make $200 000 and 0,7 probability that ACS will make $60 000.
So the expected value of the decision strategy that uses perfect information is
0,3 ( 200 000) + 0,7 (60 0000) = $102 000.
$102 000 is referred to as the expected value with perfect information (EV w PT)
When perfect information was not available, the expected value of approach
resulted in d3 with an expected value of $72 000
$72 00 is the expected value without perfect information (EV W 0 P1)
The expected value of perfect information (EVP1) EV wo P1
= 102 000 72000
= $30 000
In other words $30 000 represents the additional expected value that can be
obtained of perfect information were available about the states of nature.
So ACS should not pay more than $30 000 for any information no matter how
good.
4.6

DECISION ANALYSIS WITH SAMPLE INFORMATION

To make the best possible decision, the decision maker may want to seek
additional information about the states of nature.
This new information can be used to revise or update the prior probabilities so that
the final decision is based on better probability estimates for the states if nature.
In the ACS example, P (s1) = 0,3 and P (S2) = 0,7 and these probabilities are
referred to as prior probabilities
for the states of nature.
Suppose ACS has decided to carry a market research, which will provide new
information that can be combined with the prior probabilities by using Bayes
theorem.
The revised probabilities are called posterior probabilities and the new information
obtained through research or experiments is referred to as indicator.
The marketing research study outcome was as follows.
I1 = favorable market research report (ie the individually contacted express interest
in ACS services)
I1 = favorable market research report ( ie the individually contacted express little
interest in ACS)
Insert a diagram
The end result of the Bayesian revision process depicted above is a set of posterior
probabilities of the form P(sj/ Ik) ie sj will occur given what market research
study was indicator Ik
Assume that in the ACS problem the following are available
MARKET RESEARCH REPORT
Insert a table

47

Developing a Decision Strategy

Insert diagram

4.6.1

Computing Branch Probabilities

Prior probabilities in the ACS problem were given as P (S1) = 0,3 & P (S2) = 0,7
Also insert the solutions
To calculate the probabilities P (Ik) and P (sj / Ik) , Bayesian procedure is applied.
First note that:
The market research report is favorable (I1) and the state of nature turns to be high
acceptance (S1), is written as (I1 S1)
Also I1 and son turns to be S2 is written (I1 S2)
The probabilities of these two are written P (I1 S2) and P (I1 S2)
Insert the formulae
The indicator probabilities are:
Insert the solutions
4.6.2

COMPUTING BRANCH PROBABILITIES A TABULAR

PROCEDURE

First for each indicator Ik we form a table consisting of the following 5 columns
1
States of nature Sj
2
Prior probabilities P(sj)
3
Conditional probabilities
4
Joint probabilities
5
Posterior probabilities
Then given any indicator Ik the following procedure can be used to calculate

48

Insert the solution

Step 1
In column 1, the states onto the problem being analyzed.
Step 2
In column 2, enter the prior probability to each of state of nature.
Step 3
In column 3 enter the appropriate value of ( I k sj ) for each s o n specified in
column 1
Step 4
To compute each entry in column 4 multiply column 2 x corresponding c 3
Step 5
Add the entries in column 4. The sum is the value of P (I k)
Step 6
To compute each entry in column 5, divide the corresponding entry in column 4 by
P (Ik)
Do for P (T2)
4.6.3

An Optimal Strategy

After computing the branch probabilities, we can use the expected value approach
to determine the decision strategy.
Working backward through the decision tree in use to calculate the expected value
at each s-o n mode.
Enter formulaes
So since d1 leads to an expected value of $150,324 the optimal decision at node 2
is d1.
Similarly at node 3 optimal decisions at this branch is d3. ($63, 480)
Finally EV (node 1) inserts the formulae
the value $90,402 is viewed as the expected value of the optimal decision strategy
when the market research study is used.
We will need to know the results of the market research study before deciding on
any system.
The results of the decision analysis at this point, however, have provided the
following optimal strategy.

49

IF
Report favorable
Report unfavorable

4.7

Then
Select large system (d1)
Select small system (d3)

EXPECTED VALUE OF SAMPLE INFORMATION

Since the additional information provided by the market research firm will result
in an added cost, in terms of the fee paid to the research firm, management may
question the value of this market research information.
The value of sample information is often measured by calculating what is referred
to as the expected value of sample information
For maximization problems insert the format and diagram.
So ACS should be willing to pay up to $18,402 for the market research.
Insert format
NB Higher efficiency ratings indicate that the sample information is almost as
good as perfect information, and additional sources of information should not be
worthwhile.
Lower efficiency ratings for sample information lead the decision maker to look
for other types of information

Chapter 5
WAITING LINE MODELS (QUEUING THEORY)
5.1

Introduction

The study of waiting lines is referred to as the queuing theory.

Waiting line models consist of Mathematics formulas and relationships that can be
used to determine the operating characteristics (performance measures) for a
waiting line. Some of the operating characteristics that are of interest are:
(1) The probability that there are no units in the system.
(2) The average number of units in the waiting line.
(3) The average number of units in the system (the number of units in the
waiting line + number of units being served).

50

(4)
(5)
(6)
(7)

5.2

The average time a unit spends in the waiting line.

The average time a unit spends in the system. (line plus service)
The probability that an arriving unit has to wait for service.
The probability that of n in the system ( n 0 ).

THE STRUCTURE OF A WAITING LINE SYSTEM

Example 5.1
Hefilis fast- food restaurant, sells hamburgers, cheeseburgers, French fries, soft
drinks, milk shakes, pizas and Chinese food and a lot more dessert selections.
Although Hefilis would like to serve each customer immediately at times more
customers arrive than can be handled by the food- service staff. Thus customers
wait in the line to place and receive their orders.
Hefilis is concerned that the methods they are currently using to serve customers
are resulting in excessive waiting times. Management has asked that a waiting line
study be performed to help determine the best approach to reducing waiting times
and improving services.
SINGLE CHANNEL WAITING LINE

Order taking
and order
filling

5.2.1

The Process of Arrivals

For many waiting line situation, the arrivals occur in a random fashion, ie each
arrival is independent of other arrivals, and we cannot predict when the next
arrival will occur.
It was found out that the Poisson probability distribution provides a good
description of the arrival pattern.
The probability of x arrivals in a specified time period is defined as;
P( x)

where

51

x e
x!

for x = 0, 1, 2 ,

x = the number of arrivals in the period.

= the average or mean number of arrivals per period.

Suppose that Hefilis has analyzed data on customer arrivals and has concluded that
mean arrival rate is 45 customers per hour ie
45 arrivals per hour or

45
arrivals per minuate
60

Probability of x arrivals per minute is;

P ( x)

x e
(0.75) x e 0.75

x!
x!

Probability of 0, 1, 2 arrivals during a in minute period is

5.2.2

P ( 0)

(0.75) 0 e 0.75
0.4724
0!

P (1)

(0.75)1 e 0.75
0.3543
1!

The Distribution of Service Times

The service time is the time the customer spends at the service facility once the
service has started.
It has been determined that the exponential probability distribution often provides
a good approximation of service times in waiting line situations.
P[ service time t ] 1 e t

where
= the average or mean number of units that can be served per time period.
Hefilis has found out that a single food server can process an average of 60
customer orders per hour.
Or 6060 = 1 customer per minute.
So = 1 customer minute
P[ service time 0.5] 1 e 1( 0.5)
1 0.6065

5.2.3 Queue Discipline

Most waiting line system assume a FIFO Basis (first in first out)

52

Other are FILO basis eg in an elevator

LILO
LIFO
5.3

The Single Channel Waiting Line Model with Poisson Arrivals and
Exponential Service Times

The following Assumptions regarding the waiting line are applicable.

(1)
(2)
(3)
(4)

the waiting line has a single channel.

The pattern of arrivals follows a Poisson probability distribution
The service times arrivals follows an exponential probability distribution
The queue discipline is FIFO.

Operating Characteristic
= the mean or average number of arrivals per time period (mean Arrival
Rate)
= the mean or average number of services per time period (mean service
rate)
(1) the probability that there are no units in the system is
P (0) 1

(2) the average number of units in the waiting line

Lq

2
( )

(3) The average number of units in the system

L Lq

(4) The average time a unit spends in the waiting line

Wq

Lq

(5) The average time a unit spends in the system

W Wq

53

(6) Probability that an arriving unit has to wait for service

Pw

(7) Probability of n units in the system

Pn

P0

The above formulas are applicable only when the mean service rate is

greater than the mean arrival rate . ie when 1

For Hefilis problem since = 0,75 customers per minute and = 1 customer
per minute.
P0 1

0.25

2
2.25
( )
L 3 customers
Wq 3 min
Lq

W 4 min
Pw 0.75

Managers Use Of Waiting

Looking at the results of the single- channel waiting line for Hefilis
Customers wait for 3 minutes before service.
75% of the arriving customers have to wait.
There is probability of 0,1335 that seven or more customers are in the system

at one time P7 P0

Hefilis should consider alternative designs or plans for improving the waiting
line operation.
Improving the Waiting Line Operation
Generally service improvements are made along the following lines .
(1) Increase the mean service rate m by making a creative design charge or by
employing new technology.

54

(2) Add parallel service channels so that more units can be serviced at a time.
Assume Hefilis had considered employing an order filler who will assist the order
taker at the cash register.With this new deign management has estimated the mean
service rate to increase from 60 customers per hour to 75 customer per hour.
Or from 1 customer per min to 1,25 customer/min
Using = 0,75 and = 1,25 the following results were obtained.
Probability of no units in the system = 0,400
Average number of units in the waiting line = 0,900
Average number of units in the system = 1,500
Average time in the waiting line = 1,2 minuets
Average time in the system = 2.00
Probability on arriving unit has to wait = 0,600
Probability that 7 more are in system = 0,028

Example5.
The reference desk at NUST library receives requests for assistance.Assume
that a poisons probability distribution with a mean of 10 requests per hour can
be used to describe the arrival pattern and that service times follow the
exponential probability distribution with mean service rate of 12 requests per
hour.
(1) What is the probability that there are no requests for assistance in the
system?
(2) What is the average number of request that will be waiting for service.
(3) What is the probability waiting time in minutes before services begins.
(4) What is the average time at the reference deist in minutes (wait t service).
(5) What is the probability that a new arrival has to wait for service?
5.4

THE MULTIPLE- CHANNEL WAITING LINE MODEL WITH

POISSON ARRIVALS AND EXPONENTIAL
This model consists of two or more channels or service locations that are
assumed to be identical in terms of service capability.
Formulas used in this model use the following assumptions;
(1) The waiting line has two or more service channels.
(2) Arrivals follows a Poisson probability distribution.
(3) Service time for each channel follows an experimental probability
distribution.
(4) (mean service rate) is the same for each channel.

55

(5) Arrivals wait in a single line and then move to the first open channel for
services.
(6) Queue discipline is FIFO
Operating Characteristics
= the mean arrival rate for the system
= the mean service rate for each channel
k = No of channels
k = mean service rate for the multiple- channel system.
The formulas following apply if k >
1 The probability that there are no units in the system.
P0

k 1

n!
n 0

k!

The average number of units in the waiting line.

k

Lq

k 1! k 2

P0

(3) The average number of units in the system

L Lq

(4) The average time a unit spends in the waiting line

Wq

Lq

(5) The average time a unit spends in the system

W Wq

(6) Probability that an arriving unit has to wait for service

Pw

k!

k
P0
k

(7) Probability of n units in the system

56

Pn
n!

P0

for n k

Pn n k P0
k! k

for n > k

Assume that Hefilis wishes to open another cash register and order processing
station so that two customers can be served simultaneously.
We will assume that k= 2, = 0,75 and = 1

P0 1

0.4545

2
0.1227
( )
L 0.8727customers
Wq 0.16 min
Lq

W 1.16 min
Pw 0.2045

It can be observed that;

1. The average time required between when you customer enters, the waiting
line and when the customer receivers the order (waiting time + service
time) is reduced from w = 4 min to w = 1,16 min.
2. Length of waiting line is reduced from Lq = 2,25 customer to Lq = 0,1227
customer.
3. Wq from Wq = 3 min to Wq = 0,16
4. The % of customers having to wait for service is reduced from Pw = 0,75
or 75% to Pw = 0,2045 or 20,45%.
ECONOMIC ANALYSIS OF WAITING LINES
To develop a total-cost model for awaiting line, we begin by defining the
following notation.
Cw = the waiting cost per time period for each unit.
L = the average number of units in the system
57

Cs = the service cost per time period for each channel.

k = No of channels.
TC = total cost per time period.
TC = Cw + Cs k
In the Hefilis problem , the waiting cost per period would be the cost per minute
for a customer waiting for services.
Although the cost is not a direct cost to Hefilis but of Hefilis ignores this cost and
allows long waitng lines customers will ultimately take their business elsewhere,
thus experiencing lost sale and incur a cost.
Service cost include serverss wages, benefits, and any other direct costs associated
with operating the service channel.
Lets suppose that Hefilis is willing to assign a cost of $10 per hour for customer
waiting time and service cost is estimated to be $7 per hour.
For single channel system where L = 3 customers
TC Cw L + Cs K
= $10 (3) + $7 (1)
= $37.00 per hour
for Two channel system (where L = 0,8727 customer
TC = 10(0,8727 ) + 7(2)
= $22,73 per hour

Diagram
600

TC
Service cost

400
Cost ($)
Waiting cost
200
k
Number of service channels

58

59