STATES OF NATURE

ALTERNATIVES FAVORABLE MARKET UNFAVORABLE MARKET

PROBABILITIES 0.6 0.4
Construct large plant $200,000 –$180,000
Construct small plant $100,000 –$ 20,000
Do nothing $ 0 $ 0

STATES OF NATURE
ALTERNATIVES FAVORABLE MARKET UNFAVORABLE MARKET

PROBABILITIES 0.6 0.4

Construct large plant $200,000 –$180,000
Construct small plant $100,000 –$ 20,000
Do nothing $ 0 $ 0

Expected Value with (Best outcomes state of

Perfect Information nature 1 x probabilities 1)
STEP 1 (EVwPI)
120000
STEP 2 Maximum EMV
EEXPECTED VALUE OF
PERFECT INFORMATION (EVwPI) - Maximum EMV
(EVPI)
 DECISION MAKING UNDER UNCERTAINTY DECISION MAKING UNDER RISK
MAXIMUM MINIMUM AVERAGE EXPECTED MONETARY VALUE (EMV)
(PROBABILITIES1 x OUTCOMES1) + (PROBABILITIES2 x OUTCOMES2)
$200,00 –$180,000 $ 10,000 $ 120,000 $ -72,000
$100,000 –$ 20,000 $ 40,000 $ 60,000 $ -8,000
$0 $0 $0 0 0
maximax maximin equally likely
= $200,000 =$0 =$40,000
DECISION MAKING UNDER CERTAINTY

1. PATUT KE KITA BAYAR $65000 YANG DIMINTA OLEH MARKETING

FIRM TERSEBUT UNTUK MAKLUMAT ITU?
2. KALAU INFORMATION TU BAGUS, IS IT GOOD TO PAY SUCH
AMOUNT?

Best outcomes
state of nature 2
x probabilities 2
0 120000 EVwPI
$ 52,000
$ 68,000 Maximum value yang boleh dibayar oleh syarikat untuk dapatkan
info tadi
NDER RISK
VALUE (EMV)
LITIES2 x OUTCOMES2)
-72,000 $ 48,000 EMV 1
-8,000 $ 52,000 EMV 2
0 0 EMV 3
TUTORIALS

1. DECISION MAKING UNDER UNCERTAINTY

An operations manager's staff has compiled the information below for four manufacturing alternatives (A, B, C, and D
All choices enable the same level of total production and have the same lifetime. The four states of nature represent fo
Values in the table are net present value of future profits in millions of dollars.

States of Nature
1 2 3 4
Alternative A 50 55 60 65
Alternative B -80 0 180 230
Alternative C 20 70 100 145
Alternative D -100 -10 150 220

(a) Assuming a maximax strategy, which alternative would be chosen?

(b) If maximin were used, which would be chosen?
(c) If the states of nature were equally likely, which alternative should be chosen?

2. DECISION MAKING UNDER RISK

An operations manager's staff has compiled the information below for four manufacturing alternatives (E, F, G, and H
All choices enable the same level of total production and have the same lifetime. The four states of nature represent fo
Values in the table are net present value of future profits in millions of dollars.
Forecasts indicate that there is a 0.1 probability of acceptance level 1, 0.2 chance of acceptance level 2, 0.4 chance of

States of Nature
1 2 3 4
Alternative E 50 50 70 60
Alternative F 30 50 80 130
Alternative G 70 80 70 60
Alternative H -140 -10 150 220

Using the criterion of expected monetary value, which production alternative should be chosen?

3.DECISION MAKING UNDER CERTAINTY

A toy manufacturer has three different mechanisms that can be installed in a doll that it sells.
The different mechanisms have three different setup costs (overheads) and variable costs and, therefore, the profit fro

Light Moderate Heavy

Demand Demand Demand
Probability 0.1 0.3 0.6
Wind-up action $325,000 $190,000 $170,000
Pneumatic
action $300,000 $420,000 $400,000
Electrical
action -$600,000 $240,000 $800,000

(a) What is the EMV of each decision alternative?

(b) Which action should be selected?
(c) What is the expected value with perfect information?
(d) What is the expected value of perfect information?

4. DECISION TREE

Somad owns his own business and lives 30 miles from a beach resort. The sale of his business is highly dependent up
At the resort, he will profit $120 per day in fair weather, $10 per day in bad weather. At home, he will profit $70 in fa
Assume that on any particular day, the weather service suggests a 40% chance of foul weather.
(a) Construct decision tree.
(b) What decision is recommended by the expected value criterion?
natives (A, B, C, and D) that vary by production technology and the capacity of the machinery.
s of nature represent four levels of consumer acceptance of the firm's products.

natives (E, F, G, and H) that vary by production technology and the capacity of the machinery.
s of nature represent four levels of consumer acceptance of the firm's products.

level 2, 0.4 chance of acceptance level 3, and 0.3 change of acceptance level 4.

herefore, the profit from the dolls is dependent on the volume of sales. The anticipated payoffs are as follows.
s highly dependent upon his location and upon the weather.
he will profit $70 in fair weather, $55 in bad weather.
ANSWERS

1) DECISION MAKING UNDER UNCERTAINTY

Decision Making Under Uncertainty

STATES OF NATURE
ALTERNATIVES 1 2 3 4
Alternatives A 50 55 60 65
Alternatives B -80 0 180 230
Alternatives C 20 70 100 145
Alternatives D -100 -10 150 220

a) Maximax Strategy = Alternatives B

b) Maximin Strategy = Alternatives A
c) Equal Likely Strategy = Alternatives C

2) DECISION MAKING UNDER RISK

Decision Making Under Risk

STATES OF NATURE
ALTERNSATIVES 1 2 3 4
Alternative E 50 55 70 60
Alternatice F 30 50 80 130
Alternative G 70 80 70 60
Alternative H -140 -10 150 220
Probabilities 0.1 0.2 0.4 0.3

# The operation manager should choose Alternative H

3) DECISION MAKING UNDER CERTAINTY

a) Decision Making Under Certainty

STATES OF NATURE
ALTERNATIVES Light Demand Moderate Demand Heavy Demand EMV
Wind-up action $325,000 $190,000 $170,000 $191,500
Pneumatic action $300,000 $420,000 $400,000 $396,000
Electrical action $-600,000 $240,000 $800,000 $492,000
Probabilities 0.1 0.3 0.6

b) The toy manufacturer should choose Electrical action Alternative

4) DECISION TREE

a) Fair Weather
($120)
Resort
Bad Weather
($10)
Somad's
Business
Fair Weather
($70)
At Home
Bad Weather
($55)
Maximum Minimum Average
65 50 57.75
230 -80 82.5
145 20 83.75
220 -100 65
230 50 83.75
MAXIMAX MAXIMIN EQUAL LIKELY

Decision Making Under Risk

Expected Monetery Value (EMW)
ALTERNSATIVES 1 2 3 4 EMV
Alternative E 5 11 28 18 62
Alternatice F 3 10 32 39 84
Alternative G 7 16 28 18 69
Alternative H -14 -2 60 66 110
Probabilities 0.1 0.2 0.4 0.3

c) Expected value with

perfect information = ($325,000X0.1) + ($420,000X0.3) + ($800,000X0.6)
(EVwPI)
= $32,500 + $126,000 + $480,000

= $638,500

d) Expected Value
Of Perfect Information = (EVwPI) - Maximum EMV
(EVPI)
= $638,500 - $492,000
 = $146,500

b) Since the weather services has predicted that there is 40% chance of bad weather,
Somad should do business at home only because in bad weather he can also generate
a profit of $55 from doing business at resort with a profit of only $10 in bad weather.
It's because to me it's better for Somad to have a high profit on bad weather than to
take the risk of doing business at the resort with a 40% forecast of bad weather.