# Bounded Rationality It Is A Concept Of Management Behaviour Accounting Essay

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Tricky Dicky Enterprises is considering the possibility of expanding its factory premises. Local elections will soon take place and the firm assumes that pay-offs will vary as follows depending on the outcome of the election:

## Party A

## wins election

## Party B

## wins election

## Expand capacity

U£50,000

£180,000

## Do not expand capacity

£200,000

£40,000

## Required:

Evaluate the proposed expansion using the following criteria:

maximax

maximin

Laplace

(3 marks)

Construct an opportunity loss matrix and use it to determine the preferred option according to the minimax regret criterion.

(3 marks)

Assume that the probability of Party A winning the election is 0.7 and the probability of Party B winning is 0.3. What is the maximum Tricky Dicky should pay to a firm of consultants, Liddy and Magruder, for information predicting the result of the election with total certainty?

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(4 marks)

Bob Ehrlichman sells two products used in plumbing, the Sturgis and the Krogh. There is a profit of £40 on each unit of Sturgis sold, and £80 on each unit of Krogh. The probability distributions of demand for each product are shown below:

## Demand

## Per Week

## Probability

Sturgis

Krogh

0

0.2

0.4

1

0.5

0.6

2

0.3

## -

## Required:

Set up intervals of random numbers to match the probability distributions.

(2 marks)

Use the random numbers below to produce a Monte Carlo simulation of the demand for the two products over a ten week period

## Random Numbers

Product-Sturgis:

71

82

19

50

67

29

95

48

84

32

Product-Krogh:

36

44

64

92

39

21

18

55

77

73

(5 marks)

Use the results of the simulation to produce a probability distribution of profits for each product.

(3 marks)

A firm, Woodstein, is going to introduce a ranking system for investment projects. The projects will be ranked according to their Profitability Index values. The following table gives details of five projects the firm could invest in.

## Project

## Initial Outlay

## (£m)

## NPV

## (£m)

Sandwedge

11.6

3.6

Sedan Chair

9.4

-1.3

Gemstone

8.7

2.2

Muskie

13.2

2.4

Ruby

14.0

2.0

## Required:

Calculate the Profitability Index for each project and rank the projects accordingly.

(6 marks)

If Woodstein had only £25 million to allocate to capital expenditure, which of the above projects would it invest in?

(4 marks)

## SECTION B: You MUST answer TWO questions from this section. Each question is worth 30 marks.

John Haldeman, a manufacturer of electronic eavesdropping equipment, has developed a new highly sensitive bugging device. There are fears that regulations might be introduced to ban the bug in the EU. Haldeman assumes that there is a probability of 0.6 that such regulations will be introduced, and a probability of 0.4 of no restrictions.

If there are no restrictions, a profit of £160 million is forecast from worldwide sales, but with restrictions profits would fall to £60 million.

There is, however, the option of making campaign contributions to an influential politician, S.P. Agnew, in the hope of eliminating the possibility of restrictions. Investing in Agnew's campaign contributions would cost £55 million, and the probability that this would be successful (ie. lead to no EU ban) is 0.75. The firm must decide today, before knowing whether EU banning restrictions will be introduced, whether to pay the campaign contributions.

## Required:

Draw a decision tree to illustrate the above situation.

(10 marks)

Assuming that Haldeman is risk neutral, what is the preferred course of action? Use EMV analysis.

(8 marks)

Calculate the sensitivity of the finding under (b) (above) to the probability that the campaign contributions would lead to a successful outcome from Haldeman's point of view.

(6 marks)

Define the term "risk aversion" and consider whether the conclusion under (b) (above) would vary if Haldeman were risk averse.

(6 marks)

Anthony Ulasawicz Ltd. is reviewing its pricing policy on one of its products, a brown paper bag (useful for carrying large sums of cash). At the moment the selling price is £1.20 per unit. Total output of the product is 38,000 units per month. Monthly fixed costs are £11,400 and the average cost per unit of labour, materials and other variable inputs is constant at 60p.

## Required:

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Calculate the breakeven level of sales and the profit per month at the present price and output level.

(7 marks)

What price should Ulasawicz charge if it wishes to get a mark-up of 30% on full costs?

(3 marks)

If the price elasticity of demand for the bags is -3 and marginal cost is constant at 60p per unit, what is the profit maximising mark-up and price?

(8 marks)

Assume the demand curve for the brown paper bag is as follows:

P = 160 - 0.002Q

where P and Q are the price per unit and the quantity demanded respectively.

Calculate the sales revenue maximising output and price.

(6 marks)

Explain the term "relevant costs" in the context of pricing.

(6 marks)

Watergate Associates is a firm which assembles two products, the Colson and the Segretti. The following table shows the number of hours required for each unit of each of the products at the three stages of the production process:

## Product

## Assembly

## Quality Control

## Packing

Colson

2

4

6

Segretti

10

5

3

The firm's monthly resources are limited to 8,000 hours of Assembly time, 5,500 hours of Quality Control and 6,000 hours of Packing. Each unit of the Colson makes a profit of £40 and each unit of the Segretti £25.

## Required:

Formulate the above information as a linear programming model where the objective is the maximisation of profits from the production of the two products.

(10 marks)

Solve graphically, determining the optimum number of units of Colsons and Segrettis produced per month. State the amount of profit at the maximum.

(12 marks)

We are told that the dual value of the testing resource is £1.67 and the dual value of Packing is £5.55. Explain the meaning of these values.

(8 marks)

Maurice Stans seeks to evaluate four investment projects. Because there are variations in the perceived riskiness of the projects, Mr. Stans is using a different discount rate for each one:

## PROJECT CODE NAMES

McCord

Barker

Martinez

Hunt

Investment

Outlay

(£000s)

60

30

60

90

Net Cash

Flows in Year: (£000s)

1

20

10

15

(20)

2

40

10

30

30

3

30

20

40

65

4

15

25

40

80

Discount Rate:

8%

9%

7%

10%

## Required:

Calculate the Net Present Value of each project and rank the projects accordingly.

(10 marks)

In the analysis in part (a) (above), the difference in risk between the projects is dealt with by varying the discount rate. Define an alternative method that could be used to incorporate risk analysis into the NPV calculations.

(5 marks)

Some firms use the Internal Rate of Return (IRR) method in investment appraisal. Explain how the IRR is calculated and how it can be used.

(5 marks)

Calculate the Profitability Index for each of the above projects. Which projects would it be most advisable for Maurice Stans to invest in if its capital budget is limited to £150,000?

(5 marks)

## End of Examination Paper

## ANSWERS

## Section A

## Q1)

Bounded Rationality: it is a concept of management behaviour that expresses the decisions should be with limits on information availability and on the people's capacity to think all possibility. It is also known as" limited rationality or subjective rationality".

Principle-agent relationships: It is a relationship that exists in uncertain situation when one party which is called agent act on behalf of another party that is called principal.

Satisficing: It is a business decision making strategy and Herbert Simon believed that it tries to meet criteria for capability, instead of classify best solution.

Satisficing, a "handy blended word combining satisfy with suffice",[1] is a decision-making strategy that attempt to meet criteria for adequacy, rather than to identify an optimal solution. A satisficing strategy may often be (near) optimal if the costs of the decision-making process itself, such as the cost of obtaining complete information, are considered in the outcome calculus.

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Examples of our workThe word satisfice was coined by Herbert Simon in 1956.[2][3] He pointed out that human beings lack the cognitive resources to maximize: we usually do not know the relevant probabilities of outcomes, we can rarely evaluate all outcomes with sufficient precision, and our memories are weak and unreliable. A more realistic approach to rationality takes into account these limitations: This is called bounded rationality.

bounded rationality

A model of management behavior that recognizes decisions must be made with constraints on information availability and on the ability of a person to consider every possibility. In general, individuals do the best they can with the information and decision-making ability that is available.

Satisficing is a decision-making strategy which attempts to meet criteria for adequacy, rather than identify an optimal solution. A satisficing strategy may often, in fact, be (near) optimal if the costs of the decision-making process itself, such as the cost of obtaining complete information, are considered in the outcome calculus.

## Q2)

## a)

Maximax (Do not expand capacity; Party A wins election= £200,000

Maximin (Expand Capacity; Party A wins election= £50,000

Laplace (Expand Capacity = (£50,000+180,000)/2= £115,000

(Do not expand capacity = (£200,000+40,000)/2=£120,000

## b)

OL MATRIX

Party A Wins Election

Party B Wins Election

## Expand Capacity

£150,000

0

## Do not expand capacity

0

£140,000

Minimax Regret::

## c)

P (A) =0.7 EMV (A) =

P (B) =0.3 EMV (B) =

## Q3)

## a)

## Demand

## Per Week

## Probability

## Intervals of Random numbers

## Probability

## Interval Random Numbers

## Sturgis

## Krogh

0

0.2 (20 %)

00-19

0.4 (40 %)

00-39

1

0.5 (50%)

20-69

0.6 (60 %)

40-99

2

0.3 (30%)

70-99

## -

## b)

## Random Numbers

Product- Sturgis

71 82 19 50 67 29 95 48 84 32

## 2 2 0 1 1 1 2 1 2 1

36 44 64 92 39 21 18 55 77 73

## 0 1 1 1 0 0 0 1 1 1

## Monte Carlo Simulation

Product-Krogh