DECISION ANALYSIS ASSIGNMENT

(Show and describe your steps of calculation)

1) Barbour Electric is considering the introduction of a new product. This product can be produced
in one of several ways: (a) using the present assembly line at a cost of $25 per unit, (b) using the
current assembly line after it has been overhauled (at a cost of $10,000) with a cost of $22 per unit;
and (c) on an entirely new assembly line (costing $30,000) designed especially for the new product
with a per unit cost of $20. Barbour is worried, however, about the impact of competition. If no
competition occurs, they expect to sell 15,000 units the first year. With competition, the number of
units sold is expected to drop to 9,000. At the moment, their best estimate is that there is a 40%
chance of competition. They have decided to make their decision based on the first year sales.
a. Develop the decision table (EMV).
b. Develop a decision table (EOL).
c. What should they do?

2) The following is a payoff table giving costs for various situations.

State 1 State 2 State 3

Alternative 1 45 37 83
Alternative 2 16 59 72
Alternative 3 23 65 91
Alternative 4 44 33 55

a. What decision would an optimist make?

b. What decision would a pessimist make?
c. What decision should be made based on the Hurwicz criterion?
d. What decision should be made based on the Laplace criterion?
e. What decision should be made based on the minimax regret criterion?

3) David has plans to open some pizza restaurants, but he is not sure how many to open. He has
prepared a payoff table to help analyze the situation.

States of Nature
Good Fair Poor
Alternatives Market Market Market
Open 1 380,000 70,000 - 400,000
Open 2 200,000 80,000 - 200,000
Do nothing 0 0 0

David believes there is a 40 percent chance that the market will be good, a 30 percent chance that it
will be fair, and a 30 percent chance that it will be poor.
a. If David were to use the expected monetary value criterion, what decision would be made?
b. A market research firm will analyze market conditions and will provide a perfect forecast (they
provide a money back guarantee). What is the most that should be paid for this forecast?
c. If David were to use the expected opportunity loss criterion, what decision would be made?

4) A manager needs to hire short-term employees to meet production demands. The manager would
like to hire one of three possible short-term workers. Ten hours are demanded with 50% probability,
20 hours are demanded with 30% probability, and 30 hours are demanded with 20% probability.
The table below represents the alternatives and possible states of nature.

States of Nature
(Worker hours demanded)
Alternatives 10 hr total pay 20 hr total pay 30 hr total pay
Worker 1 $1,000 $1,800 $2,400
Worker 2 $900 $1,800 $2,500
Worker 3 $950 $1,750 $2,550

Which alternative will minimize the expected monetary value? What is the expected value of
perfect information?

5) Consider the following payoff table.

State 1 State 2 State 3

Probability 0.4 0.35 0.25
Alternative 1 45 37 83
Alternative 2 16 59 72
Alternative 3 23 65 91
Alternative 4 44 33 55

a. Based upon these probabilities, a person would select Alternative 3. Explain why?
b. Suppose there is concern about the accuracy of these probabilities. A few of the analysts feel that
the likelihood of State 1 is higher and that the likelihood of State 2 is much lower. If the likelihood
of State 2 is reduced at the expense of State 1, how much lower can State 2's likelihood fall before
Alternative 3 is no longer optimal?

6) Solve this decision tree.

7) A market research survey is available for $5,000. Using a decision tree analysis, it is found
that the expected monetary value with no survey is $49,000. If the expected value of sample
information is -$4,000, what is the expected monetary value with the survey?

8) Mark M. Upp has just been fired as the university bookstore manager for setting prices too low
(only 20 percent above suggested retail). He is considering opening a competing bookstore near the
campus, and he has begun an analysis of the situation. There are two possible sites under
consideration. One is relatively small, while the other is large. If he opens at Site 1 and demand is
good, he will generate a profit of $50,000. If demand is low, he will lose $10,000. If he opens at
Site 2 and demand is high, he will generate a profit of $80,000, but he will lose $30,000 if demand
is low. He also has the option of not opening at either site. He believes that there is a 50 percent
chance that demand will be high. A market research study will cost $5,000. The probability of a
good demand given a favorable study is 0.8. The probability of a good demand given an
unfavorable study is 0.1. There is a 60 percent chance that the study will be favorable.
a. Should Mark use the study? Why?
b. If the study is done and the results are favorable, what would Mark's expected profit be?

9) A company is considering producing a new children's bar soap. A market research firm has
told the company that if they perform a survey, a positive survey of a favorable market occurs 65
percent of the time. That is, P(positive survey | favorable market) = 0.65. Similarly, 40 percent of
the time the survey falsely predicts a favorable market; thus, P(positive survey | unfavorable
market) = 0.40. These statistics indicate the accuracy of the survey. Prior to contacting the
market research firm, the company's best estimate of a favorable market was 50 percent. So,
P(favorable market) = 0.50 and P(unfavorable market) = 0.50. Using Bayes' theorem, determ ine
the probability of a favorable market given a favorable survey.

10) Mark M. Upp has just been fired as the university bookstore manager for setting prices too low
(only 20 percent above suggested retail). He is considering opening a competing bookstore near the
campus, and he has begun an analysis of the situation. There are two possible sites under
consideration. One is relatively small while the other is large. If he opens at Site 1 and demand is
good, he will generate a profit of $50,000. If demand is low, he will lose $10,000. If he opens at
Site 2 and demand is high he will generate a profit of $80,000, but he will lose $30,000 if demand is
low. He also has decided that he will open at one of these sites. He believes that there is a 60
percent chance that demand will be high. He assigns the following utilities to the different profits:

U(50,000) = 0.72 U(-10,000) = 0.22

U(80,000) = 1 U(-30,000) = 0

Using expected utility theory, what should Mark do?

11) Mark M. Upp has just been fired as the university book store manager for setting prices too low
(only 20 percent above suggested retail). He is considering opening a competing bookstore near the
campus, and he has begun an analysis of the situation. There are two possible sites under
consideration. One is relatively small, while the other is large. If he opens at Site 1 and demand is
good, he will generate a profit of $50,000. If demand is low, he will lose $10,000. If he opens at
Site 2 and demand is high he will generate a profit of $80,000, but he will lose $30,000 if demand is
low. He also has decided that he will open at one of these sites. He believes that there is a 50
percent chance that demand will be high. He assigns the following utilities to the different
profits:

U(50,000) = ? U(-10,000) = 0.22

U(80,000) = 1 U(-30,000) = 0

For what value of utility for $50,000, U(50000), will Mark be indifferent between the two
alternatives?