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

State the several goals for the organisation, State the several goals for t...

State the several goals for the organisation As there could be several goals for the organisation, we must try and summarise theorganisational goals in financial terms so that

Operating cycle, #question application of an operating.cycle in vegetable g...

#question application of an operating.cycle in vegetable growing business.

Delivery and credit risk, When a borrower uses repo market for fund f...

When a borrower uses repo market for fund financing, he has to deliver the securities to the lender. One way to do this is to deliver the collateral to the lender

Calculate amount of first coupon payment your organization, Your firm has p...

Your firm has presently issued five year floating-rate notes indexed to six-month U.S. dollar LIBOR plus 1/4%.  What is the amount of first coupon payment your organization will pa

Financial projections, A total of $426,000 seed-funding would be ideal to s...

A total of $426,000 seed-funding would be ideal to start the project on a local basis. The cost analysis done above is for the material required to perform the work, and as the wor

What is the exit strategy for equity stake venture, What is the Exit strate...

What is the Exit strategy for equity stake venture Exit strategy for equity stake venture capitalists and other financiers may include: (i) Selling their shares to the publ

Highest earnings-per-share, McGovern Company is comparing two disimilar cap...

McGovern Company is comparing two disimilar capital structures - an all-equity plan (Plan I) and a levered plan (Plan II).  Under Plan I, the Company would have 700,000 shares of s

Price-output determination under monopoly, The potato chip industry in the ...

The potato chip industry in the Northwest in 2007 was competitively structured and in long-run competitive equilibrium; firms were earning a normal rate of return and were competin

#title.operating cycle., discuss the applicability of an operation cycle in...

discuss the applicability of an operation cycle in a vegetation business

Interest rate risk for floating-rate securities, In a fixed-rate coup...

In a fixed-rate coupon bond, the change in the price can be attributed to the change in the market interest rates. This change is due to the difference in the pre

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