BASIC PROFIT MODEL
Chapter 2
Introduction
Influence Diagrams
Introduction
In building spreadsheets for deterministic
models, we will look at:
ways to translate the black box representation
into a spreadsheet model.
recommendations for good spreadsheet model
design and layout
suggestions for documenting your models
useful features of Excel for modeling and
analysis
Price
Total Revenue
Fixed Cost
Variable Costs
Overhead
Costs
Sunk Costs
Total Costs
Revenue received from selling units
Profit
Breakeven Point
Crossover Point
Examples
Example 1: Simon Pie
Two ingredients combine to make Apple Pies:
Fruit and frozen dough
The Pies are then processed and sold to local grocery
stores in order to generate a profit.
Follow the three steps of model building.
Step 1: Study the Environment and Frame the
Situation
Critical Decision: Setting the wholesale pie price
Decision Variable: Price of the apple pies
(this plus cost parameters will determine profits)
Step 2: Formulation
Using “Black Box” diagram, specify cost parameters
Pie Price
Unit Cost, Filling
Unit Cost, Dough
Unit Pie Processing Cost
Fixed Cost
Model
Profit
The next step is to develop the logic inside the black box.
A good way to approach this is to create an Influence
Diagram.
An Influence Diagram pictures the connections between the
model’s exogenous variables and a performance measure
(e.g., profit).
Black Box View of Simon Pie
Model
Pie Price
Unit Cost, Filling
Unit Cost, Dough
Unit Pie Processing Cost
Fixed Cost
MODEL
Profit
Influence Diagram
To create an Influence Diagram:
start with a performance measure variable.
Decompose this variable into two or more intermediate
variables that combine mathematically to define the
value of the performance measure.
Further decompose each of the intermediate variables
into more related intermediate variables.
Continue this process until an exogenous variable is
defined (i.e., until you define an input decision variable
or a parameter).
Start here:
Profit
performance
measure
variable
Decompose this variable into the intermediate variables
Revenue and Total Cost
Profit
Revenue
Total Cost
Now, further decompose each of these intermediate
variables into more related intermediate variables ...
Profit
Total Cost
Revenue
Processing
Cost
Ingredient
Cost
Required
Ingredient
Quantities
Pies Demanded
Pie Price
Unit Pie
Processing Cost
Unit Cost
Filling
Unit Cost
Dough
Fixed Cost
Step 3: Model Construction
Based on the previous Influence Diagram, create the
equations relating the variables to be specified in the
spreadsheet.
Profit
Revenue
Total Cost
Profit = Revenue – Total Cost
Profit
Revenue
Revenue = Pie Price * Pies Demanded
Pies Demanded
Pie Price
Profit
Total Cost
Processing
Cost
Ingredient
Cost
Total Cost =
Processing Cost + Ingredients Cost + Fixed Cost
Fixed Cost
Profit
Total Cost
Processing
Cost
Pies Demanded
Unit Pie
Processing Cost
Processing Cost =
Pies Demanded *
Unit Pie Processing Cost
Profit
Total Cost
Ingredients Cost =
Qty Filling * Unit Cost Filling +
Qty Dough * Unit Cost Dough
Ingredient
Cost
Required
Ingredient
Quantities
Unit Cost
Filling
Unit Cost
Dough
Examples