ENCE 627: Monte Carlo example

FOSM. Snodgrass, Snodgrass, and Davis, LLC is a government contractor providing consulting
services to state and local authorities on the control of feral rodents in public parks. They are
bidding on a new contract and have estimated that completion of the job will require trapping N
animals at a unit cost of C. The mobilization cost is K. Thus, their estimated cost is K+NC.

From past jobs, they estimate that each of the terms is Normally distributed, with the following
means and standard deviation for the three terms in the cost equation:

TERM MEAN SD
K $5,000 $500
N 10,000 2,500
C $11 $2.5

A slight complication is that the unit cost, C, tends to go down as the number of animals, N, goes
up. SS&D models this dependence by assuming that C and N are negatively correlated, with a
correlation coefficient of -0.2.

Use a first-order second-moment approximation to get a best estimate of cost (mean) and an un-
certainty (standard deviation) in the cost.

Cost = K+NC

𝐸 𝐶𝑜𝑠𝑡 ≅ 𝐸 𝐾 + 𝐸 𝑁 𝐸[𝐶]

𝐸 𝐶𝑜𝑠𝑡 ≅ $5,000 + $10,000 ∗ 11 = $115,000

𝑉𝑎𝑟 𝐶𝑜𝑠𝑡 ≅
!"#$% ! !"#$% ! !"#$% ! !"#$% !"#$%
𝑉𝑎𝑟 𝐾 + 𝑉𝑎𝑟 𝑁 + 𝑉𝑎𝑟 𝐶 ( ) +  𝐶𝑂𝑉 𝑁, 𝐶
!" !" !" !" !"

TERM MEAN SD 𝜕𝐶𝑜𝑠𝑡

𝜕𝑇𝑒𝑟𝑚
K $5,000 $500 1
N 10,000 2,500 C
C $11 $2.5 N

The covariance of N and C is

! !
𝐶𝑜𝑣 𝑁, 𝐶 ≅ 𝜌𝑉𝑎𝑟 ! 𝑁 𝑉𝑎𝑟 ! 𝐶 = −0.2 2500 2.5 = −1250

in which ρ is the correlation coefficient.

Covariance matrix

K N C
K 250,000 0 0
N 0 6.25E+6 -1250
C 0 -1250 6.25

𝜕𝐶𝑜𝑠𝑡 ! Variance
TIMES VAR
𝜕𝑇𝑒𝑟𝑚 Contribution
K 250,000 1 250E+3
N 6.25E+6 121 756E+6
C 6.25 100E+6 625E+6
NC -1250 110E+3 -137E+6
TOTAL 1244+6 35,270

So, the estimate is $115,000 ± 35,275.

Simulation of budget. Use Monte Carlo simulation to estimate the expected value and standard
deviation of the total cost in the question 3. How closely do the two approaches (FOSM and
simulation) agree? Why are they not exactly the same?

The two are reasonably close: Here the mean is 114,000 and the Std Dev is 34,000. These val-
ues are more accurate because they are not approximations.