Solution Practice Problem for the Final Exam

Q1:Cost Volume Profit Analysis:

As part of their application for a loan to buy Lakeside Farm, a property they hope to develop as a
bed-and-breakfast operation, the prospective owners have projected:
Monthly fixed cost (loan payment, taxes, insurance, maintenance) $6000
Variable cost per occupied room per night $ 20
Revenue per occupied room per night $ 75

a. Write the expression for total cost per month. Assume 30 days per month.
b. Write the expression for total revenue per month.
c. If there are 12 guest rooms available, can they break even? What percentage of
rooms would need to be occupied, on average, to break even?
ANSWER:

a. C(x) = 6000 + 20(30)x (monthly)

b. R(x) = 75(30)x (monthly)

At the Break-even: R(x)=C(x)

c. X=3.64
Break-even occupancy = 3.64 or 4 rooms must be occupied per night. This
would be a 33% (4/12=.33=33%) occupancy rate.

Q2:Decision Analysis:
Lakewood Fashions must decide how many lots of assorted ski wear to order for its three stores.
Information on pricing, sales, and inventory costs has led to the following payoff table, in
thousands.

Demand
Order Size Low Medium High
1 lot 12 15 15
2 lots 9 25 35
3 lots 6 35 60

a. What decision should be made by the optimist?

b. What decision should be made by the conservative?
c. What decision should be made using minimax regret?
Answer:
Demand Row Max Row Min
Order Size Low Medium High
1 lot 12 15 15 15 12
2 lots 9 25 35 35 9
3 lots 6 35 60 60 6
 a. MAX of MAX= 60….3 lots.
b. Max of Min=12…..1 lot
c. Regret Table
Demand
Order size Low Medium High Maximum
Regter
1 12-12=0 35-15=20 60-15=45 45
2 12-9=3 35-25=10 60-35=25 25
3 12-6=6 35-35=0 60-60=0 6

Minimum of the maximum regret is 6, meaning 3 lots.

Q3:Decision Analysis:
A payoff table is given as

State of Nature
Decision s1 s2 s3
d1 10 8 6
d2 14 15 2
d3 7 8 9

a. What decision should be made by the optimistic decision maker?

b. What decision should be made by the conservative decision maker?
c. What decision should be made under minimax regret?
d. If the probabilities of s1, s2, and s3 are .2, .4, and .4, respectively, then what decision
should be made under expected value?
e. What is the EVPI?
ANSWER:
a. d2
b.
d3
a three-way tie
c.
d. EV(d1) = 7.6
EV(d2) = 9.6 (the best)=EVwoPI
EV(d3) = 8.2

e. EVwPI=.2*14+.4*15+.4*9=12.4
EVPI = EVwPI-EVwoPI=12.4 − 9.6 = 2.8
Q4:Decision analysis:

A paint company has three sources for buying bright red pigment for their paints: Vietnam,
Taiwan, or Thailand. Unfortunately, the pigment is made from a bush whose annual growth is
heavily dependent upon the amount of rainfall during the growing season. The tables below
show probabilities and prices for wet, dry and normal growing seasons:

Probabilities
Wet Dry Normal
Vietnam .5 .2 .3
Taiwan .6 .3 .1
Thailand .4 .4 .2

Price/Pound ($)
Wet Dry Normal
Vietnam .95 1.10 1.00
Taiwan .85 1.20 .98
Thailand .90 1.15 1.05

What country should the company select and what is the expected value (price) associated with
it?
ANSWER:
EV (Vietnam) = .5(.95) + .2(l.10) + .3(1.00) = $.995
EV (Taiwan) = .6(.85) + .3(l.20) + .1(.98) = $.968
EV (Thailand) = .4(.90) + .4(1.15) + .2(l.05) = $1.03

Select Taiwan because it has the lowest EV.

Q5: Game Theory:

If the following two-person, zero-sum game has a mixed strategy:

a. Use dominance to reduce the game to a 2X2 game. Which strategies dominate?
b. Determine the optimal mixed strategy solution.
c. What is the value of the game?
Solution:
a. Strategy a3 is dominated by a2. Then strategy b2 is dominated by b1. The 2 x 2 game becomes:
 Player B
b1 b3
a1 0 2
Player A a2 5 -3

b. For Player A, let p = probability of a1 and 1 – p = probability of a2.

If player B choose b1, EV = 0p + 5(1 – p)

If player B choose b3, EV = 2p – 3(1 – p)

5(1 – p) = 2p – 3(1 – p)
5 – 5p = 2p – 3 + 3p
10p = 8
p = .8

(1 – p) = 1 - 0.8 = 0.20

For Player A, P(a1) = 0.80, P(a2) = 0.20, P(a3) = 0 as a3 was dominated.

So, Player A should randomly choose a strategy with a1 having a probability of 0.8
and a2 having a probability of 0.2.

For Player B, let q = probability of b1 and 1 – q = probability of b3.

If player A choose a1, EV = 0q + 2(1 – q)

If player A choose a2, EV = 5q – 3(1 – q)

2(1 – q) = 5q – 3(1 – q)

2 – 2q = 5q – 3 + 3q

10q = 5
q = 0 .50

(1 – q) = 1 - 0.50 = 0.50

For Player B, P(b1) = 0.50, P(b3) = 0.50.

c. Value of game using Player A: 5(1 – p)=5*.20=1

Value of game using Player B: 2(1 – q)=2*.5=1

Q6: Decision Analysis:
Embassy Publishing Company received a six-chapter manuscript for a new college textbook. The
editor of the college division is familiar with the manuscript and estimated a 0.65 probability that
the textbook will be successful. If successful, a profit of $750,000 will be realized. If the
company decides to publish the textbook and it is unsuccessful, a loss of $250,000 will occur.
Before making the decision to accept or reject the manuscript, the editor is considering
sending the manuscript out for review. A review process provides either a favorable (F) or
unfavorable (U) evaluation of the manuscript.
Past experience with the review process suggests that probabilities P(F)=0.7 and
P(U)=0.3 apply. Let s1=the textbook is successful, and s2=the textbook is unsuccessful. The
editor’s initial probabilities of s1 and s2 will be revised based on whether the review is favorable
or unfavorable. The revised probabilities are as follows:
P(s1|F) = 0.75 P (s1| U) =0.417
P(s2|F) = 0.25 P (s2 |U) = 0.583
a. Construct a decision tree assuming that the company will first make the decision of whether to
send the manuscript out for review and then make the decision to accept or reject the manuscript.
b. Analyze the decision tree to determine the optimal decision strategy for the publishing
company.
c. If the manuscript review costs $5000, what is your recommendation?
d. What is the expected value of perfect information? What does this EVPI suggest for the
company?

Solution: (a)
b. EV (node 7) = 0.75(750) + 0.25(-250) = 500
EV (node 8) = 0.417(750) + 0.583(-250) = 167
Decision (node 4) Accept EV = 500
Decision (node 5) Accept EV = 167

EV(node 2) = 0.7(500) + 0.3(167) = $400

Note: Regardless of the review outcome F or U, the recommended decision

alternative is to accept the manuscript.

EV(node 3) = .65(750) + .35(-250) = $400

The expected value is $400,000 regardless of review process. The company should
accept the manuscript.
 c. The manuscript review cannot alter the decision to accept the manuscript. Do not do
the manuscript review.

d. Perfect Information.

If s1, accept manuscript $750

If s2, reject manuscript -$250

EVwPI = 0.65(750) + 0.35(0) = 487.5

EVwoPI = 400

EVPI = 487.5 - 400 = 87.5 or $87,500.

A better procedure for assessing the market potential for the textbook may be
worthwhile.

Q7: Time Series Analysis:

FRED® (Federal Reserve Economic Data), a database of more than 3000 U.S. economic time
series, contains historical data on foreign exchange rates. The following data show the foreign
exchange rate for the United States and China (http://research.stlouisfed.org/fred2/).
The units for Rate are the number of Chinese yuan to one U.S. dollar.

a. Construct a time series plot. Does a linear trend appear to be present?

b. Use simple linear regression analysis to find the parameters for the line that minimizes
MSE for this time series.
c. Use the trend equation to forecast the exchange rate for August 2008.
 d. Would you feel comfortable using the trend equation to forecast the exchange rate for
December 2008?

Solution: a.

Chart Title
7.6

7.4 f(x) = − 0.0747551515151515 x + 7.55507333333333

R² = 0.981758513042503
7.2

6.8

6.6

6.4
0 2 4 6 8 10 12

b. and c. In the Excel sheet.

d. Yes, I am comfortable to use the trend equation to use it to forecast for December
2008 as the R2 is .9818 or 98.18%, which is extremely high to explain all the
variability in our historical data has.

*** To learn more about R2: https://www.mygreatlearning.com/blog/r-square/

Q8: Time Series Analysis:

The number of pizzas ordered on Friday evenings between 5:30 and 6:30 at a pizza delivery
location for the last 10 weeks is shown below. Use exponential smoothing with smoothing
constants of .2 and .8 to forecast a value for week 11. Compare your forecasts using MSE. Which
smoothing constant would you prefer?

58, 46, 55, 39, 42, 63, 54, 55, 61, 52

Answer: Excel Sheet (attached)

Q9: Linear Programming:
The Sanders Garden Shop mixes two types of grass seed into a blend. Each type of grass has been rated
(per pound) according to its shade tolerance, ability to stand up to traffic, and drought resistance, as
shown in the table. Type A seed costs $1 and Type B seed costs $2. If the blend needs to score at least
300 points for shade tolerance, 400 points for traffic resistance, and 750 points for drought resistance,
how many pounds of each seed should be in the blend? Which targets will be exceeded? How much will
the blend cost?
 Type A Type B
Shade Tolerance 1 1
Traffic Resistance 2 1
Drought Resistance 2 5
ANSWER: Let A = the pounds of Type A seed in the blend
Let B = the pounds of Type B seed in the blend
Min 1A + 2B (objective function)
s.t. 1A + 1B ≥ 300
2A + 1B ≥ 400 Constraints
2A + 5B ≥ 750
A, B ≥ 0

Extreme points are: (0,400), (100, 200), (250, 50) and (375,0).
Say, Z=1A+2B
Z(0,400)=1*0+2*400=800
Z(100,200)=1*100+2*200=500
Z(250, 50)=1*250+2*50=350 Minimum value
Z(375,0)=1*375+2*0=375

The optimal solution is at A = 250, B = 50. The cost is 350.

Standard form of the model:

Min 1A + 2B+0*S1+0*S2+0*S3
s.t. 1A + 1B -S1= 300………..(1)
2A + 1B -S2= 400………..(2)
2A + 5B-S3 = 750……… (3)
A, B, S1, S2, S3 ≥ 0

Substituting the optimal solution in each one of the constraints to get the values of S1, S2
and S3:
From constraint (1): 250+50-S1=300
 S1=0

From constraint (2): 2*250+50-S2=400

S2=150

From constraint (3): 2*250+5*50-S3=750

S3=0

Constraint 2 has a surplus value of 150.