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 cash credit, Q. What is Cash Credit? A cash credit is an arrang...

Q. What is Cash Credit? A cash credit is an arrangement by which a bank allows his customer to borrow money up to a certain limit against some tangible securities or guarantees

Define capital rationing, What is capital rationing?  Should a firm practic...

What is capital rationing?  Should a firm practice capital rationing?  Why? The term Capital rationing is the practice of setting dollar limits on what will be invested in new ca

Illustrate the term structure of interest rates, Illustrate the term struct...

Illustrate the term structure of interest rates? The term structure of interest rates: The term to maturity affects the interest rate. Bonds along with identical risk may

What is the meaning of leverage, What is meant by Leverage? What are its di...

What is meant by Leverage? What are its different types? With what type of risk is associated with each type of leverage. (Explain with illustration)

Estimate the total rate of return, Question: Explain: (a) the advant...

Question: Explain: (a) the advantages and disadvantages, to a company, of debt finance over equity finance; (b) the reasons why a company may choose to issue preference s

Sole proprietorship, Sole Proprietorship This business form is the lega...

Sole Proprietorship This business form is the legal default form for any person who makes no effort to organize the business otherwise but does business in the United States. T

#title.OPERATING CYCLE, DISCUSS THE APPLICABILITY OF OPERATING CYCLE IN VEG...

DISCUSS THE APPLICABILITY OF OPERATING CYCLE IN VEGETABLE GROWING.

Audit opinion, Clean Opinion - AUDIT opinion not qualified for any material...

Clean Opinion - AUDIT opinion not qualified for any material scope restrictions nor departures from GENERALLY ACCEPTED ACCOUNTING PRINCIPLES (GAAP). Also called UNQUALIFIED OPINION

Cash dividends factors that decided by stockholders, What are some of the f...

What are some of the factors that common stockholders consider when deciding how much, if any, cash dividends they desire from the corporation in which they have invested? Gene

Compare and contrast j''s current style of management, When J was promoted ...

When J was promoted to be the new Sales and Marketing Manager for Company L, after working there in different capacities over the last ten years, it was a popular choice between he

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