Intuition might suggest that plugging the average value of our uncertain inputs (Sales Volume, Selling Price, and Unit Cost) into our model should produce the average value of the output (Net Profit). The Flawed Average Modelīefore we explore how to use simulation to analyze this problem, consider the Excel model pictured below, which calculates Net Profit based on average sales volume, average selling price, and average unit cost. However, Sales Volume, Selling Price and Unit Cost are all uncertain variables, so Net Profit is an uncertain function. Recall that Net Profit is calculated as Net Profit = Sales Volume * (Selling Price - Unit cost) - Fixed costs. Our next step is to identify uncertain functions - also called functions of a random variable. In this case, the most likely cost is also the average cost. Your firm’s production manager advises you that unit costs may be anywhere from $5.50 to $7.50, with a most likely cost of $6.50.
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December 2022
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