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Applying simulation to a decision problem 187
Thus, if variable costs are at their lowest possible value of $8 and
the remaining factors are at their most likely value we have:
Profit = ($25 − $8) × 22 000 − $175 000 = $199 000
(iii) Repeat (ii), but with the first factor at its highest possible value.
Thus we have:
Profit = ($25 − $18) × 22 000 − $175 000 =−$21 000
(iv) Repeat stages (ii) and (iii) by varying, in turn, each of the other
factors between their lowest and highest possible values while the
remaining factors remain at their most likely values.
Figure 7.2 shows the results of the preliminary sensitivity analysis.
This diagram, which is often referred to as a tornado diagram, indicates
that each of the factors is crucial to our analysis in that a change from its
lowest to its highest possible value will have a major effect on profit. It is
therefore well worth spending time in the careful elicitation of probability
distributions for all these factors. (Note that some software packages
also produce tornado diagrams after the simulation has been run to
identify where the major sources of uncertainty are. These packages
Highest value
Variable costs
Lowest value Sales
Highest value
Highest value
−$60
$0
Fixed costs
$100
PROFIT ($000)
Lowest value
Lowest value
$200
Figure 7.2 – Tornado diagram showing the effect on profit if each factor changes from
its lowest to its highest possible value