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Supplement ASpreadsheet Modeling: An Introduction

Operations Managementby

R. Dan Reid & Nada R. Sanders4th Edition © Wiley 2010

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Learning Objectives

Explain what models are and why they are used.

Identify the main types of models. Describe the different components of

mathematical models. Identify the recommended steps in the

spreadsheet modeling process. Explain the importance of model correctness,

flexibility and documentation.

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Learning Objectives con’t

Construct spreadsheet models applying sound modeling principles.

Enter key Excel formulas and functions in models.

Use the Goal Seek and Data Table features of Excel to perform meaningful analysis.

Develop meaningful charts representing the results of analysis.

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What are Models?

Mental Models Visual Models Physical Models Mathematical Models Spreadsheet Models

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What is a model?

Some model commonalities consist of Motivated by a decision need A model has inputs A model has outputs A model transforms inputs to outputs A model is defined as:

A purposeful representation of the key factors in a situation and the relationships between them

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Model Characteristics

Inputs: quantities or factors that affect a decision Controllable Inputs (decision

variables) Uncontrollable Inputs (parameters)

Outputs: Primary & secondary, calculated from inputs and is of interest to the decision maker

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Model Definition

A model is a purposeful representation of the key factors in a situation and the relationships among them. So, it: is an abstraction of a real situation provides enough detail so results

meet current needs omits unnecessary details

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Model Schematic

Uncontrollable Inputs

(Parameters)

Controllable Inputs (Decision Variables)

Mathematical Model: set of relationships

(spreadsheet formulas)

Outputs

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Spreadsheet Modeling Process

1. Turn off the computer. Draw a picture/diagram, identify controllable & uncontrollable inputs, outputs.

2. Sketch out overall plan for spreadsheet model. Determine where inputs, intermediate calculations, and outputs will go.

3. Develop the base case spreadsheet model.4. Test the model using trial values.5. Use the model to perform the needed analysis.6. Document the model so others can understand

it.

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Evaluating Spreadsheet Models

Correct Correct numerical answer for base case (i.e., “given”

information) Flexible

Accurate results if any legitimate values of input are used . Each input value entered only once in the model. Formulas contain only cell references, not numerical values.

Good: =B1+C1 Bad: =B1+55

Documented Descriptive labels, units of measure, numerical formatting,

cell formatting, cell comments Printouts: include row/column headings, gridlines, footer

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Example 1 Sports Feet

Company considering a new line of footwear Variable Cost: $9.00 Selling Cost: $25.00 Fixed Cost: $52,000/year

Develop flexible spreadsheet model, perform sensitivity analysis, find breakeven point

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Sports Feet: “Black Box” Determine inputs & outputs

Model:

Set of relationships

(formulas) to translate the inputs

into the outputs

Unit Sales Price

Annual Fixed Cost

Unit Variable Cost

Quantity Made and Sold

Annual Revenue

Annual Total Cost

Annual Profit (Loss)

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Sports Feet: Key Relationships Annual Profit = Annual Revenue –

Annual Total Cost Annual Revenue = Unit Selling Price *

Quantity Made and Sold Annual Total Cost = Annual Fixed Cost

+ Annual Variable Cost Annual Variable Cost = Unit Variable

Cost * Quantity Made and Sold

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Sports Feet: Excel ModelTrial value entered for “quantity made and sold.” At this trial value, Profit = ($12,000).

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Sports Feet: Find Breakeven Point

What Quantity results in a Profit of $0? We have a flexible model. Can do

“what-if” analysis on cell B9 to determine when the Profit becomes $0.

However, Excel has Goal Seek tool which can automate this what-if analysis.

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Excel: Goal Seek Goal Seek works backwards to find the

value of an input quantity that causes an output quantity to have a particular value.

Excel: ToolsGoal Seek Set Cell: Output Cell (cell must contain a

formula) To Value: Specify the numerical value you

want the output cell to have (e.g., 0 for a breakeven analysis).

By Changing Cell: Input Cell (cell must contain a value)

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Example 1: Goal Seek

ToolsGoal Seek

After Solving

Goal Seek changes the value of the Quantity Cell (B9) to 3250. This results in the Profit Cell (B16) having a value of $0. Therefore, the breakeven point is 3250 pairs of shoes.

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Goal Seek Comments Sometimes critical values (e.g., breakeven points) can be found

using algebraic methods. However, many real-world problems are quite complex and an algebraic approach is difficult, if not impossible. This is where Goal Seek is particularly useful.

There is nothing special about choosing $0 for profit. We used this because it is common to find a breakeven point. However, in a particular situation we may be interested in some other critical value (e.g., How much do we need to sell in order to make a $2000 profit?).

Goal Seek can be used to find a series of critical values for each of the input quantities. For example, we could find the variable cost, the fixed cost, and the selling price for which profit equals $0 (for a specified quantity made and sold).

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Excel: Data Table Feature Spreadsheets are a great “what-if” tool.

But, what-if analysis can be tedious. Excel has a feature called a Data Table

Data Table allows one to systematically vary one or two input quantities, and keep track of a resulting input value.

For example, vary “quantity made and sold” and keep track of “profit.”

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Example 1: Data Table

2223242526272829303132333435363738394041

A B CData Table to Show Profit as Function of Quantity

Sales Quantity Profit($12,000)

0 ($52,000)500 ($44,000)

1000 ($36,000)1500 ($28,000)2000 ($20,000)2500 ($12,000)3000 ($4,000)3500 $4,0004000 $12,0004500 $20,0005000 $28,0005500 $36,0006000 $44,0006500 $52,0007000 $60,0007500 $68,0008000 $76,000

B24: =B16

This is a completed Data Table

Excel automatically calculates the profit for each of the sales quantities in the left column.

The results are dynamic. If we change, for example, the variable cost, this data table will be automatically re-calculated.

Powerful tool for sensitivity analysis!

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Great Feet: Data Table “How To”

1. Enter labels in Rows 22 & 23 as shown in previous slide.

2. Cells A25:A41. Enter 0,500,…,8000 (use EditFill or write a formula to add 500 to the above quantity).

3. Cell B24: Enter “=B16”. This is the “output” that Excel will compute each time.

4. Select A24:B41. Keep this range selected.5. From menu, DataTable. For the “column input cell,”

select Cell B9.6. Click OK. If all the profit values are the same, press

the F9 key (F9 forces Excel to recalculate the spreadsheet).

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Antonio’s Italian Restaurant: Multi-Criteria Decision Making

Three possible locations for new restaurant.

Seven different factors that are important in the decision.

How to decide which location is “best?”

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Multi-Criteria Model: Basic Ideas Develop weights for each factor. Sum of

weights to equal 100. Higher weights imply more important factors.

For each location and factor, assign a score representing how well that location scores with respect to that factor. Here we use a 1-5 scale, with higher values indicating a better score.

Overall score for each location is a weighted sum of the factor weights and the scores for that location.

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Antonio’s: Constructing Model in Excel

Cells B18:B24. Compute weighted scores for each factor/location combination.

Cells B25:D25. Compute overall scores.

Result: Location 1 has highest weighted score.

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Antonio’s: Visualization (Stacked Column Chart)

Weighted Factor and Overall Scores of Alternate Restaurant Locations

0

50

100

150

200

250

300

350

400

Location 1 Location 2 Location 3

Labor supply

Competition

Access

Customer parking

Proximity to market

Ease of expansion

Appearance

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Antonio’s Completed Model w/best score/location

Completed model with enhancement to automatically show best score and best alternative.

Uses Excel’s MAX, INDEX, and MATCH functions. See Excel Help system for more information.

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Useful Spreadsheet Tips1. Lay out data and the model in a logical and

consistent way.2. Name each worksheet of the workbook.3. Learn to use Relative and Absolute References.4. Use Cut (Ctrl-x) and Paste (Ctrl-V) to move

formulas, Not Copy (Ctrl-C).5. Use Shift + Arrow keys will select cells in a

range.6. Learn to use keyboard shortcuts to select cells

and menu items.7. Set up printouts to print with “Row and column

headings” and “Gridlines.”

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Useful Spreadsheet Tips con’t

8. Use Print Preview, Page Setup, and Page Break Preview to get your model to print exactly the way you want.

9. Create and use a standard footer for all your spreadsheet printouts.

10. Print a copy of the spreadsheet formulas in addition to the regular printout.

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Important Excel Formulas

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Important Excel Formulas con’t

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Spreadsheet Modeling within OM: How it all fits together

The models in this chapter have been fairly basic, but you should begin to see some of the powerful uses of models and quantitative analysis.

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Supplement A Highlights

A model is a purposeful representation of the key factors in a situation, and the relationships among them. It abstracts the real situation, incorporating those factors that are important to the decision it was designed to address.

The main types of models are mental models, visual models, physical models, and mathematical models. Spreadsheet models (essentially mathematical models) are the focus of this supplement.

Mathematical models translate inputs into outputs through a set of relationships. Inputs consist of uncontrollable inputs and controllable inputs, sometimes called decision variables.

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Supplement A Highlights con’t

The recommended spreadsheet modeling process consists of understanding the problem, drawing a sketch of the model, developing a base case spreadsheet, testing the spreadsheet, using the model to perform analysis, and documenting the model.

Models should be correct, flexible, and documented. This supplement focused on the construction of

models by applying sound modeling principles. You should invest time applying the principles to problems in this supplement as well as other problems in the test.

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Supplement A Highlights con’t

Key Excel formulas and functions were addressed in this supplement. A critical skill is the correct use of Relative and Absolute References. Mastery allows you to develop a model in a fraction of the time it would take otherwise.

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Supplement A Highlights con’t

Two useful Excel analysis tools, Goal Seek and Data Table, were illustrated. Goal Seeks allows you to find the value of an input that causes an output to be equal to a value you specify. A Data Table allows you to vary one (or two) inputs, and automatically calculate the value of an output for each of the input values in the range. We covered data tables where one input was varying.

Several different chart types were used to illustrate model results. These were the XY chart, the Column chart, and the Stacked Column chart. Excel has many other chart types.

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The EndCopyright © 2010 John Wiley & Sons, Inc. All

rights reserved. Reproduction or translation of this work beyond that permitted in Section 117 of the 1976 United State Copyright Act without the express written permission of the copyright owner is unlawful. Request for further information should be addressed to the Permissions Department, John Wiley & Sons, Inc. The purchaser may make back-up copies for his/her own use only and not for distribution or resale. The Publisher assumes no responsibility for errors, omissions, or damages, caused by the use of these programs or from the use of the information contained herein.