Page 3 - CIMA OCS Workbook May 2019 - Day 1 Tasks

CIMA MAY 2019 – OPERATIONAL CASE STUDY

EXERCISE TWO (DECISION MAKING)
To: Juliette Goh (Finance Director)
From: You
Subject: RE: New product range
The branches of the decision tree:

A decision tree is used in situations where there are multiple decisions (marked by squares) to be
made which follow on from each other. This is exactly the situation here; the first decision is
whether to accept the exclusivity contract with the new customer or to undertake a marketing
campaign instead and the second is the scale of the marketing campaign at E$10,000 or E$4,000.
Each branch of the tree considers each of these decisions. The top branch relates to the first
decision. The branch shows that if the contract is accepted there is a 50% chance of making
contribution of E$130,000 and a 50% chance that it will be E$90,000. The circles on the tree
signify that a range of future outcomes may then occur.

The bottom branch considers the second decision assuming that the first decision is to undertake
a marketing campaign rather than accept the contract. This branch shows that if marketing spend
is E$10,000 then there is an 80% chance of contribution of B$150,000 and a 20% chance of
E$90,000. If the marketing spend is only E$4,000 then the chance of making the higher
contribution of E$150,000 falls to 60%.
Points A, B, C and D and the overall optimum decision:
The value at point A of E$110,000 is the expected value of the decision to accept the contract,
calculated as the sum of each possible outcome multiplied by its probability of occurrence:
110 = 0.5 × 130 + 0.5 × 90

Point B is the expected value of the decision to spend E$10,000 on a marketing campaign.
Point C is the expected value of the decision to spend E$4,000 on a marketing campaign.

Point D represents the optimum position relating to the second decision. From point B when we
deduct the marketing spend of E$10,000, this gives an expected value of E$128,000.

From point C when we deduct the marketing spend of E$4,000 this gives an expected value of
E$122,000. Given this is lower that E$128,000, the optimum decision if a marketing campaign is
chosen is therefore to spend E$10,000 as it has the highest expected value.

Moving to the left of the diagram we can see that comparing points A and D, that the optimum
decision on an expected value basis is therefore the marketing campaign, because this gives the
highest value.
Other factors to consider

The analysis only includes figures for the first six months. Does the exclusivity contract then allow
for VitaMine to sell to other channels as well?
The analysis does not take into account the wider knock-on implications of boosting brand
awareness on sales of other products should this range be sold under the VitaMine brand.
The approach uses expected values (EV), which can be criticised as follows:
o EV is a long run average when the project is a one-off decision
o EV cannot happen
o Difficult to estimate probabilities with any certainty
o EV ignores risk profile of shareholders

56 KAPLAN PUBLISHING