M7A2 Monte Carlo Simulations

M7A2 Monte Carlo Simulations

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Problem 1 Outsourcing Decision
Fast can produce a part for their 1000 GB SSD internally or outsource its manufacture. Fast has simplified the decision as much as possible and identified all the costs that would result if they decide to manufacture the part in-house to two components: a fixed cost (FC) of setting up internal production of $50,000 and a unit variable cost (UVC) of $125. Fast has also identified and calculated the unit cost of outsourcing the part– the OUC – of $158. The decision comes down to the difference between the cost to manufacture (TMC) and the cost of outsourcing (TOC).
The key parameter is uncertain – the demand (D). For high demand, the FC can be spread over more sales but for lower demand, the FC becomes a burden and it would be more economical to outsource the production of the part.

M7A2 Monte Carlo Simulations

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Part a:
1.  Build a decision model to help Fast choose a path for production of the part. Demand has been estimated to be 1500 units.
2.  Find the difference (Delta) and recommend a decision as to “Manufacture” or “Outsource.”Note: for all simulations, set the Formulas > Calculation Options to Automatic except for Data Tables.
Part b:
3.  Using your decision model from part a, modify it using the Monte Carlo method assuming the demand (D) follows a normal distribution with mean = 1500 and a standard deviation of 300.
4.  Run the simulation using the Monte Carlo method with 500 trials (the “500 trials simulation”)  and create a properly formatted histogram (20 bins) of the frequency distribution of the difference Delta. The histogram should be dynamic and use color to differentiate between the columns representing bins with a Delta <0 and those with Delta >0.

M7A2 Monte Carlo Simulations

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5.  Calculate the probability of difference Delta < 0 using the sample data from part 4.
a.  Do this using the “exact” simulated sample data.
b.  Do this assuming the distribution of difference Delta is approximately normal, i.e. use the mean and standard deviation of the difference Delta values.
c.  Based on the results of this simulation, what is your recommendation for Fast’s decision to manufacture or outsource?
6.  Using the F9 key to manually recalculate the worksheet, rerun the “500 trials” simulation in
part 1.b.4 ten times, noticing and recording each time the mean difference Delta and the decision to Manufacture or Outsource. Specifically, you should have a table with 10 entries for the mean difference Delta and the associated decision. How do you interpret this additional
data?

M7A2 Monte Carlo Simulations

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7.  Modify and run the simulation again for 10,000 trials using the Monte Carlo method. Does your recommendation for Fast on whether to outsource change? Why or why not? What is your confidence in your recommendation? Hint: calculate a confidence interval around the mean difference Delta.
Part c:
Fast’s data team has discovered that the cost to manufacture the part internally actually varies. Their analysis shows the following discrete probability distribution:
Scenario  Unit Variable Cost  Probability
Best Case  $100.  0.20
Most Likely Case  $120.  0.50
Worst Cast  $150.  0.30
Fast’s supplier has also had a data team working on their bid price (OUC). They have determined their
cost to produce the part depends upon their volume of work (they sell the part to others besides Fast)
and have provided the following discrete probability table of the price they would like to charge:

M7A2 Monte Carlo Simulations

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Price  Probability
$105   0.1
$115   0.15
$125   0.18
$135   0.29
$150   0.18
$165   0.1
The supplier asks Fast to consider paying for the part based on these data. Being generous because of
their long-term relationship to the supplier, Fast agrees to buy the part at the price indicated by use of
the table.
Fast’s data and marketing teams now believe the demand for the part will increase to mean of 10,000
units with a standard deviation of 1000 units, still normally distributed.
Finally, Fast believes keeping the internal production line open would have strategic value and is willing
to “lose” $100,000 to do that.
8.  Based on a simulation of the revised model with 10,000 trials, what is the probability that Fast
will lose more than $100,000 if they choose to keep the internal line operating instead of
outsourcing the part?

M7A2 Monte Carlo Simulations

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By admin in Essays on June 16, 2017