Monte-carlo simulation, Financial Management

Assignment Help:

Monte-Carlo Simulation

Let us, for a shortwhile, leave the illustration for determining the price and consider a simpler illustration for understanding the Monte-Carlo method of simulation.

Example 

A dealer in refrigerators wants to use a scientific method to reduce his investment in stock. The daily demand for a refrigerator is random and varies from day to day in an unpredictable pattern. From the past sales records, the dealer has been able to establish a probability distribution of the demand as given below:

Daily demand (units)

2

3

4

5

6

7

8

9

10

Probability

0.06

0.14

0.18

0.17

0.16

0.12

0.08

0.06

0.03 

The dealer also knows from his past experience that the lead time is almost fixed at 5 days. The dealer would like to study the implications of a possible inventory policy of ordering 30 units, whenever the inventory at the end of the day is 20 units. The inventory on hand is 30 units and the simulation can be run for 25 days. Use the following random numbers.

Random Numbers

03

38

17

32

69

24

61

30

03

48

88

71

27

80

33

90

78

55

87

16

34

45

59

20

59

When we conduct simulation runs, we use random numbers to simulate the actual demand. How do we assign, say, two digit random numbers chosen for a particular demand and also take into account the probabilities known? This is done by calculating the cumulative probabilities at each level of demand as shown below:

Daily Demand (units)

Probability

Cumulative Probability

Random numbers allotted

2

3

4

5

6

7

8

9

10

0.06

0.14

0.18

0.17

0.16

0. 2

0.08

0.06

0.03

0.06

0.20

0.38

0.55

0.71

0.83

0.91

0.97

1.00

00 - 05

06 - 19

20 - 37

38 - 54

55 - 70

71 - 82

83 - 90

91 - 96

97 - 99

The random numbers have been allotted on the basis of the following logic. Looking at the cumulative probabilities we can say that a number between 0 and 5, or to be exact, the numbers 0, 1, 2, 3, 4 and 5 (six numbers in all) signify a demand level of 2 units. Similarly, the random numbers 6 to 19 (i.e. 14 numbers) correspond to the demand level of 3 units and so on. The result of simulation trials conducted for 25 days is  tabulated below:

Day

Random no. generated

Inventory at the beginning of the day(units)

Daily demand (units)

Inventory at the end of the day (units)

Lost sales (units)

Stocks received

Qty. ordered

1

2

3

4

5

6

7

8

1

03

30

2

28

-

-

-

2

38

28

5

23

-

-

-

3

17

23

3

20

-

-

30

4

32

20

4

16

-

-

-

5

69

16

6

10

-

-

-

6

24

10

4

6

-

-

-

7

61

6

6

0

-

-

-

8

30

0

4

0

4

30

-

9

03

30

2

28

-

-

-

10

48

28

5

23

-

-

-

11

88

23

8

15

-

-

30

12

71

15

7

8

-

-

-

13

27

8

4

4

-

-

-

14

80

4

7

0

3

-

-

15

33

0

4

0

4

-

-

16

90

0

8

0

8

30

-

17

78

30

7

23

-

-

-

18

55

23

6

17

-

-

30

19

87

17

8

9

-

-

-

20

16

9

3

6

-

-

-

21

34

6

4

2

-

-

-

22

45

2

5

0

3

-

-

23

59

0

6

0

6

30

-

24

20

30

4

26

-

-

-

25

59

26

6

20

-

-

30

Column 2 of the table indicates the series of random numbers drawn from a random number table. The demand corresponding to the random number has been listed in column 4. Though the table contains the stock position, sales lost, quantities received and an order for each trial, how do we evaluate the financial implication of the inventory policy which has fixed the reorder point at 20 units and the ordering quantity at 30 units? To do this, we would have to gather details regarding ordering cost, carrying costs and storage costs and determine the total cost. The policy could then be varied and the total cost determined for alternative policies through simulation. The most acceptable policy would be the one that shows the least total cost (an alternative method would be to compare the average total cost for 25 days). Even without assigning any costs, we can observe from the table that the policy of ordering 30 units whenever stock falls to 20 units is not desirable as quite a number of lost sales units have arisen over a short period of 25 days.


Related Discussions:- Monte-carlo simulation

What is adjusted gross income, Q. What is Adjusted Gross Income? Adjust...

Q. What is Adjusted Gross Income? Adjusted Gross Income - Gross income decreased by business and other specified expenses ofindividual taxpayers. Amount of adjusted gross incom

Public corporations ought to tender audited financial statem, What are some...

What are some of the government requirements imposed on a public corporation that are not imposed on a private, closely held corporation? Public corporations ought to tender au

Pension reforms, Pension Reforms On January 1, 2004, Pension Funds have...

Pension Reforms On January 1, 2004, Pension Funds have come into force in India. Government servants will have to subscribe to them. The new pension fund system is primarily dr

Net present value of the Lease, how to calculate the net present value when...

how to calculate the net present value when there is company tax rate and rate of return assume that lease is for 2 years payable at the begining of the yr, at the end of two yrs t

Wealth maximization, Wealth Maximization :- It is as well termed as value m...

Wealth Maximization :- It is as well termed as value maximization or Net Present worth maximization. This schema is now universally accepted as an appropriate criterion for making

Out of cash, Out of Cash Calculated by taking organization cash on hand...

Out of Cash Calculated by taking organization cash on hand divided by its burn rate, yielding the time period that the organization will have enough cash to cover what it wants

Food and beverage industry averages, #What are the food and beverages indus...

#What are the food and beverages industry financial ratios for 2011,2010,2009? 1. Liquidity(current/quick), Asset Management(Inventory Turnover, total assets turnover),Debt Menagem

What are retained earnings, What are retained earnings?  Why are they impor...

What are retained earnings?  Why are they important? Retained earnings represent the total of all the earnings available to common stockholders of a business during its complet

Explain marginal cost of capital, Q. Explain Marginal cost of capital? ...

Q. Explain Marginal cost of capital? The calculation of cost of capital focused when the firms total financing and its paten of financing is given and remains constant. However

Write Your Message!

Captcha
Free Assignment Quote

Assured A++ Grade

Get guaranteed satisfaction & time on delivery in every assignment order you paid with us! We ensure premium quality solution document along with free turntin report!

All rights reserved! Copyrights ©2019-2020 ExpertsMind IT Educational Pvt Ltd