Frequent Asked Questions (MGT302) Prepared by Dr. X.

Huang

Chapter 12

Q: Explain the slide which discusses in which environment a level strategy (or a chase
strategy) is more appropriate.

A: A level strategy maintains a constant level of regular workforce (and hence a constant
level of regular production output level) and uses inventory to absorb fluctuations in
demand. On the other hand, a chase strategy varies the level of regular workforce to
absorb fluctuations in demand.

Suppose the cost of recruiting/layoff one person is X. The total cost associated with
recruiting/layoff for each strategy = X* the number of recruiting/layoff.

For a level strategy, the number of recruiting/layoff is close to 0 (In a level strategy, the
only time you will hire or layoff person is at the beginning of the first month). Hence
even if X is very high, the total cost associated with recruiting/layoff for a level strategy
is very low. On the contrary, the number of recruiting/layoff in a chase strategy is much
higher. Hence, the total cost associated with recruiting/layoff for a chase strategy when X
is high will be very high. This is why we conclude firms should adopt a level strategy
when the recruiting/layoff cost required is high.

Same logic applies to other market and resource-related characteristics. For instance the
discussion on shut down and restarting cost.

The total cost associated with shut down and restarting for each strategy = shut down and
restart cost required each time * the number of times of shut down and restart. Since a
level strategy has a constant level of production, and hence the number of times of shut
down and restart is zero. Hence even when the shut down and restart cast required each
time is high, a level strategy will not be affected. On the other hand, a chase strategy
changes the production volume to chase the demand. Hence it constantly varies the level
of production, and therefore constantly experiences shut down and restart. Under this
condition, when the shut down and restart cast required each time is high, a chase
strategy will have to pay higher total cost associated with shut down and restart. This is
why we conclude firms should adopt a level strategy when shut down and restart cost
required is high.

1
Frequent Asked Questions (MGT302) Prepared by Dr. X. Huang

Additional Exercise on the Decision Tree Technique:

Problem:
A builder has located a piece of property that she would like to consider buying and
eventually building on. The land is currently zoned for four homes per acre, but she is
planning to request new zoning if she decides to buy. Whether she buys and what she
builds depend on approval of zoning requests and your analysis of this problem to advise
her. The probability of rezoning is .60. The cost of land is $2million. If the land is
rezoned, there will be additional cost for new roads, lighting, and so on, of $1 million.

If the land is rezoned, the contractor must decide whether to build a shopping center or
1,500 apartments that the tentative plan shows would be possible. If she builds a
shopping center, there is a 70 percent chance that she can sell the shopping center to a
large department chain for $4 million over her construction cost, which excludes the land
cost; and there is a 30 percent chance that she can sell it to an insurance company for $5
million over her construction cost (also excluding the land). If, instead of the shopping
center, she decides to build the 1,500 apartments, she places probabilities on the profits as
follows: There is a 60 percent chance that she can sell the apartments to a real estate
investment corporation for $3,000 each over her construction cost; there is a 40 percent
chance that she can get only $2,000 each over her construction cost. (Both exclude the
land cost).

If the land is not rezoned, she will comply with the existing zoning restrictions and
simply build 600 homes, on which she expects to make $4,000 over the construction cost
on each one (excluding the cost of land).

Questions:
1. Draw a complete decision tree using the right symbols.
2. Compute the values for all possible events
3. Calculate the expected values for the options and make your
recommendation.

2
Frequent Asked Questions (MGT302) Prepared by Dr. X. Huang

Answers:

1. Decision Tree
Shopping Sell to a department chain
Center A
0.7

Rezoned 0.3
Sell to an insurance company B
0.6
Apt 0.6
Sell to a real state corporation C
Buy Not
Rezoned 0.4
0.4 No Sell to a real state corporation D

Not E
Buy

2. Compute the values for all events (events A-F)

A: Buy, rezoned, build a shopping center and sell it to a department chain: 4-2-1=$1mil

B: Buy, rezoned, build a shopping center and sell it to an insurance company: 5-2-1=2
mil

C: Buy, rezoned, build 1,500 apartments and sell them to a real state corporation:
$3,000*1,500-$2mil-$1mil=$1.5mil

C: Buy, rezoned, build 1,500 apartments and no sell to a real state corporation:
$2,000*1,500-$2mil-$1mil=$0mil

E: Buy, not rezoned: $4000*600 - $2 mil=$0.4mil

F: No buy: 0

3. Computed the expected values for the options

Decision point 2:

Rezoned shopping center:

Expected value = .70($1 Million) + .30($2 Million) = $1.3 Million

3
Frequent Asked Questions (MGT302) Prepared by Dr. X. Huang

Rezoned apartments:

Expected value = .60($1.5 Million) + .40($0 Million) = $0.9 Million

Since a shopping center has more value, prune the apartment choice. In
other words, if rezoned, build a shopping center with a net profit of $1.3
Million.

Decision point 1:

If buy:

Expected value = .60($1.3 Million) + .40($.4 Million) = $.94 Million

Since the expected value for buying the property is $.94 million, which is better than not buying it
(i.e., net profit = 0), the builder should decide to buy the property.

4
Frequent Asked Questions (MGT302) Prepared by Dr. X. Huang

Exercise on Aggregate Planning:

A plant produces to a seasonal demand, with the forecast for the next 12 months as given
below. Currently the plant has 50 regular time workers. Each worker can produce 10
units per month and is paid $1,000 per month. Inventory carrying cost is computed based
on the ending inventory in each month. The cost of carrying inventory is $5 per unit
every month. It costs $1000 to hire a worker and $1000 to layoff a worker as well. The
starting inventory is 200 units and the desired ending inventory a year from now is also
200 units. Assuming all forecast demand must be met and no stock outs are allowed.
a. Please use the level workforce strategy to develop an aggregate plan for this plant and
compute the cost for this strategy.
b. Please use the chase strategy to develop an aggregate plan for this plant and compute
the cost for this strategy.
c. Suggest one strategy for this plant based on your calculation.
Month J F M A M J J A S O N D
Demand 580 680 800 700 600 500 600 700 800 900 700 600

Answers:

Part A
Level Workforce Strategy
Month: Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Total
Demand
Forcast: 580 680 800 700 600 500 600 700 800 900 700 600 8160
Starting
Inventory: 200 300 300 180 160 240 420 500 480 360 140 120
Regular
Workers: 68 68 68 68 68 68 68 68 68 68 68 68
Units
Produced: 680 680 680 680 680 680 680 680 680 680 680 680 8160
Ending
Inventory: 300 300 180 160 240 420 500 480 360 140 120 200
Costs (Thousands)
Regular
Time: 68 68 68 68 68 68 68 68 68 68 68 68
Hire /
Layoff: 18 0 0 0 0 0 0 0 0 0 0 0
Inventory
Carrying: 1.5 1.5 0.9 0.8 1.2 2.1 2.5 2.4 1.8 0.7 0.6 1
Total
Cost: 87.5 69.5 68.9 68.8 69.2 70.1 70.5 70.4 69.8 68.7 68.6 69 $851.00
(in
thousands)

Part B

5
Frequent Asked Questions (MGT302) Prepared by Dr. X. Huang

Chase Strategy
Month: Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Total
Demand
Forcast: 580 680 800 700 600 500 600 700 800 900 700 600 8160
Starting
Inventory: 200 200 200 200 200 200 200 200 200 200 200 200
Regular
Workers: 58 68 80 70 60 50 60 70 80 90 70 60
Units
Produced: 580 680 800 700 600 500 600 700 800 900 700 600 8160
Ending
Inventory: 200 200 200 200 200 200 200 200 200 200 200 200
Costs (Thousands)
Regular
Time: 58 68 80 70 60 50 60 70 80 90 70 60
Hire /
Layoff: 8 10 12 10 10 10 10 10 10 10 20 10
Iventory
Carrying: 1 1 1 1 1 1 1 1 1 1 1 1
Total
Cost: 67 79 93 81 71 61 71 81 91 101 91 71 $958.00
(in
thousands)
Analysis:
In this case, the plant is set up such that a "Level Workforce" strategy would be wiser than a "Chase" strategy.
The firm would save about $107 thousand due to the fact that inventory costs less than hiring/firing people.

Exercise on decision tree:

E-Education is a new start-up that develops and markets MBA courses offered over the Internet.
The company is currently located in Chicago and employs 150 people. Due to strong growth the
company needs additional office space. The company has the option of leasing additional space at
its current location in Chicago for the next two years, but after that will need to move to a new
building. Another option the company is considering is moving the entire operation to a small
Midwest town immediately. A third option is for the company to lease a new building in Chicago
immediately. If the company chooses the first option and leases new space at its current location,
it can at the end of two years either lease a new building in Chicago or move to the small
Midwest town.

The following are some additional facts about the alternatives and current situation:

1. The company has a 75 percent chance of surviving the next two years (In other words, at
the end of 2nd year, the company either fails or survives).
2. Leasing the new space for two years at the current location in Chicago would cost
$750,000 per year.
3. Moving the entire operation to a Midwest town would cost $1 million (one time cost). In
addition, leasing space would run only $500, 000 per year.

6
 Frequent Asked Questions (MGT302) Prepared by Dr. X. Huang

4. Moving to a new building in Chicago would cost $200,000, and leasing the new building’s space would cost $650,000 per year.
5. Assume all other costs and revenues are the same no matter where the company is located.
What would E-Education do? Please develop a decision and make a recommendation based on the 5-year window (Note: if the
company does not survive, you only need to calculate for 2 years instead of 5 years).

Answer: Decision Tree Lease a new building in Chicago

Year 3 A
75% Company Survives

Tree

Move to a small Midwest town

B
25% Company Fails
C
Lease additional space in Chicago
for two years

75% Company Survives

D
Move to a small
Midwest town
Year 1

25% Company Fails

E

Lease a new building in

Chicago
75% Company Survives
F

7
25% Company Fails G
Frequent Asked Questions (MGT302) Prepared by Dr. X. Huang

COSTS for all seven events described in the decision tree:

A: (750,000 * 2) + 200,000 + (650,000 * 3) = $3,650,000

B: (750,000 * 2) + 1,000,000 + (500,000 * 3) = $4,000,000

C: (750,000 * 2) = $1,500,000

D: 1,000,000 + (500,000 * 5) = $3,500,000

E: 1,000,000 + (500,000 * 2) = $2,000,000

F: 200,000 + (650,000 * 5) = $3,450,000

G: 200,000 + (650,000 * 2) = $1,500,000

(Note: Hence you will cut the option of B: see the tree)

Expected value for the three options:

Lease a New Building in Chicago:

($3,450,000 * .75) + ($1,500,000 * .25) = $2,962,500

Move to a Small Midwest Town:

($3,500,000 * .75) + ($2,000,000 * .25) = $3,125,000

Lease additional space in Chicago for two years and then lease a new building in Chicago:
($3,650,000 * .75) + ($1,500,000 * .25) = $3,112,500

Decision: Lease a New Building in Chicago since the expected cost is lowest among three.