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DecisionAnalysis PracticeProblems

DMUO 2015

Dr.GunjanMalhotra
gmalhotra@imt.edu;mailforgunjan@gmail.com
9/8/2015

IMT,Ghaziabad,INDIA

Question1.
Bobsbikeshopisconsideringthreeoptionsforitsfacilitynextyear.
Bobcanexpandhiscurrentshop,movetoalargerfacility,ormake
nochange.Withagoodmarket,theannualpayoffwouldbe
$56,000ifheexpands,$70,000ifhemoves,and$30,000ifhedoes
nothing.Withanaveragemarket,hispayoffswillbe$21,000,
$35,000,and$10,000,respectively.Withapoormarket,hispayoff
willbe$29,000,$45,000,and$5,000respectively.
(a) WhichoptionshouldBobchooseifheusesthemaximax
criterion?
(b) WhichoptionshouldBobchooseifheusesthemaximincriterion?
(c) WhichoptionshouldBobchooseifheusestheequallylikely
criterion?
(d) WhichoptionshouldBobchooseifheusesthecriterionofrealism
with =0.6?
(e) WhichoptionshouldBobchooseifheusestheminimaxregret
criterion?

Answer1.
(a) Maximax
(b) Maximin
Alternatives Maximum Choice Minimum Choice
Expand
$56,000
-$29,000
Move
$70,000 Best -$45,000
No change $30,000
$5,000
Best

(c) Equally Likely (d) Hurwicz (0.6)


Average Choice Realism Choice
$16,000
$22,000
$20,000 Best $24,000 Best
$15,000
$20,000

Regret
Outcomes
(e) Minimax
Alternatives Good Average Poor Maximum Choice
Expand
$14,000 $14,000 $34,000 $34,000
Best
Move
$0
$0
$50,000 $50,000
No change $40,000 $25,000
$0
$40,000

Question2.
Bob(incontinuationtothepreviousquestion)
hasgatheredsomeadditionalinformation.The
probabilitiesofgood,average,andpoormarkets
are0.25,0.45,and0.3,respectively.
(a)UsingEMVs,whatoptionshouldBobchoose?
WhatisthemaximumEMV?
(b)UsingEOL,whatoptionshouldBobchoose?
WhatistheminimumEOL?
(c)ComputetheEVPIandshowthatitisthe
sameastheminimumEOL.

Answer2.
Alternatives
Expand
Move
No change

EMV
$14,750
$19,750
$13,500

Choice
Best

Expected Value WITH Perfect Information (EVwPI) = $34,750


Best Expected Monetary Value (EMV) =
$19,750
Expected Value OF Perfect Information (EVPI) =
$15,000
Alternatives
Expand
Move
No change

EOL
Choice
$20,000
$15,000 Best
$21,250

Question3.
JeffParksellsnewspapersonSundaymorningsinanarea
surroundedbythreebusychurches.AssumethatJeffsdemandcan
eitherbefor100,200,or300newspapers,dependingontrafficand
weather.Jeffhastheoptiontoorder100,200,or300newspapers
fromhissupplier.Jeffpays$1.25foreachnewspaperheordersand
sellseachfor$2.00.
(a)HowmanypapersshouldJefforderifhechoosesthemaximax
criterion?
(b)HowmanypapersshouldJefforderifhechoosesthemaximin
criterion?
(c)HowmanypapersshouldJefforderifhechoosestheequally
likelycriterion?
(d)HowmanypapersshouldJefforderifhechoosesthecriterion
ofrealism =0.4?
(e)HowmanypapersshouldJefforderifhechoosestheminimax
regretcriterion?

Answer3.
(c) Equally
Likely

(d) Hurwicz
(0.4)

(a) Maximax
(b) Maximin
(e) Minimax
Alternative Maximu Choic Minimu Choic
Maximu Choic
s
m
e
m
e Average Choice Realism Choice
m
e
100
$75
$75
Best
$75
$75
Best
$150
200
$150
-$50
$83
Best
$30
$125
Best
300
$225
Best -$175
$25
-$15
$250

Question4.
JeffPark(incontinuationtoquestion3)hasdone
someresearchanddiscoveredthatthe
probabilitiesfordemandsof100,200,and300
newspapersare0.4,0.35,and0.25,respectively.
(a)UsingEMVs,howmanypapershouldJeff
order?
(b)UsingEOL,howmanypapershouldJeff
order?
(c)ComputeJeffsEVwPI andEVPI.

Answer4.
Alternatives EMV Choice
100
$75
Best
200
$70
300
-$5
Expected Value WITH Perfect Information (EVwPI) = $139
Best Expected Monetary Value (EMV) =
$75
Expected Value OF Perfect Information (EVPI) =
$64
Alternatives EOL Choice
100
$64
Best
200
$69
300
$144

Question5.

Eventhoughindependentgasolinestationshavebeenhavingadifficulttime,
SusanSolomonhasbeenthinkingaboutstartingherownindependentgasoline
station.Susansproblemistodecidehowlargeherstationshouldbe.Theannual
returnswilldependonboththesizeofherstationandanumberofmarketing
factorsrelatedtotheoilindustryanddemandforgasoline.Afteracarefulanalysis,
Susandevelopedthefollowingpayoff(profit)table:
Size

GoodMarket($)

FairMarket($)

PoorMarket($)

Small

50,000

20,000

10,000

Medium

80,000

30,000

20,000

Large

1,00,000

30,000

40,000

VeryLarge
3,00,000
25,000
(a)whatisthemaximaxdecision?
(b)whatisthemaximin decision?
(c)whatistheequallylikelydecision?
(d)whatisthecriterionofrealismdecision,using =0.8?
(e)whatistheminimaxregretdecision?

1,60,000

Answer5.
(a) Maximax
(b) Maximin
Alternative Maximu Choic
Choic
s
m
e Minimum e
Small
$50,000
-$10,000 Best
Medium
$80,000
-$20,000
Large
$100,000
-$40,000
Very large $300,000 Best $160,000

(c) Equally
Likely

(d) Hurwicz
(0.8)

Average Choice Realism


$20,000
$38,000
$30,000
$60,000
$30,000
$72,000

(e) Minimax
Maximu Choic
Choice m
e
$250,000
$220,000
$200,000

$55,000 Best $208,000 Best $150,000 Best

Question6.

KennethBrownistheprincipalownerofBrownOil,Inc.Afterquittinghisuniversity
teachingjob,kenhasbeenabletoincreasehisannualsalarybyafactorofover100.
Atthepresenttime,kenisforcedtoconsiderpurchasingsomemoreequipmentfor
BrownOilbecauseofcompetition.Hisalternatives,outcomes,andpayoffs(profits)
areshowninthefollowingtable:
Equipment

Favorablemarket($)

Unfavorablemarket($)

Sub100

300,000

200,000

Oiler J

250,000

100,000

Texan

75,000

18,000

(a)Kenhasalwaysbeenveryoptimisticdecisionmaker.Whichalternativeisbest
fromKenspointofview?
(b)AlthoughkenistheprincipalownerofBrownOil,hisbrotherBobiscredited
withmakingthecompanyafinancialsuccess.Bobattributeshissuccesstohis
pessimisticattitudeaboutbusinessandtheoilindustry.Whichalternativeisbest
fromBobspointofview?
(c)TheLubricantisanexpensiveoilnewslettertokensubscribes.Inthelatestissue,
thenewsletterdescribeshowthedemandforoilproductswillbeextremelyhigh.
Apparently,theAmericanconsumerwillcontinuetouseoilproductsevenifthe
priceoftheseproductsdoubles.Indeed,oneofthearticlesintheLubricantstates
thatthechanceofafavourable marketforoilproductsis70%.Ifkenusesthese
probabilitiesindeterminingthebestdecision,whichalternativeisbest?

Answer6.
Outcomes
Alternatives Fav mkt Unfav mkt
Sub 100 $300,000 -$200,000
Oiler J
$250,000 -$100,000
Texan
$75,000 -$18,000

(a) Maximax
(b) Maximin
(c) EMV
Maximum Choice Minimum Choice EMV Choice
$300,000 Best -$200,000
$150,000 Best
$250,000
-$100,000
$145,000
$75,000
-$18,000 Best $47,100

DECISIONTREES

Question7.

Agroupofmedicalprofessionalsisconsideringconstructingaprivate
clinic.Ifpatientdemandfortheclinicishigh,thephysicianscouldrealizea
netprofitof$100,000.Ifthedemandislow,theycouldlose$40,000.Of
course,theydonthavetoproceedatall,inwhichcasethereisnocost.In
theabsenceofanymarketdata,thebestthephysicianscanguessisthat
thereisa5050chancethatdemandwillbegood.
(a)constructadecisiontreetohelpanalyzethisproblem.Whatshouldthe
medicalprofessionalsdo?
(b)Thephysicianshavebeenapproachedbyamarketresearchfirmthat
offerstoperformastudyofthemarketatafeeof$5,000.Themarket
researchersclaimthattheirexperienceenablesthemtouseBayes
theoremtomakethefollowingstatementsofprobability:

Probabilityofhighdemandgivenapositivestudyresult=0.82
Probabilityoflowdemandgivenapositivestudyresult=0.18
Probabilityofhighdemandgivenanegativestudyresult=0.11
Probabilityoflowdemandgivenanegativestudyresult=0.89
Probabilityofapositivestudyresult=0.55

Expandthedecisiontreeinpart(a)toreflecttheoptionsnowopenwith
themarketstudy.Whatshouldthemedicalprofessionalsdonow?

Answer7.

(a)EMVifweconstructtheclinic=0.5*$100,000+0.5*($40,000)=
$30,000.EMVifwedonothing=$0.Therefore,constructclinic.
(b)Excel:Constructclinicifresultispositive.Donotconstructclinicif
resultisnegative.EMV=$36,140
(c)EVSI=$11,140.Thus,thephysicianswouldpayupto$11,140morefor
thesurvey.Note: SinceEVSIshouldbecalculatedassumingnocostto
gatherthesampleinformation,$5,000hadtobeaddedbackto$36,140.
(d)EVwPI =$50,000.BestEMV=$30,000.EVPI=$20,000.Efficiency=
55.70%.

Answer7.
Problem 7

0.82
High demand

(a) Construct clinic; EMV = $30,000


(b) Conduct study. Construct clinic if positive result
Do not construct clinic if negative result.
EMV = $36,140
(c) EVSI =
$11,140
0.55
(d) EVwPI =
$50,000
Positive result
Best EMV =
$30,000
1
EVPI =
$20,000
$0 $69,800
Efficiency =
55.70%

$95,000
Construct

$1,00,000
$0

$69,800

$95,000

0.18
Low demand
-$45,000
-$40,000 -$45,000

Not Construct
-$5,000
$0

-$5,000

Study
-$5,000

0.11
High demand

$36,140

$95,000
Construct

$1,00,000
$0

-$29,600

0.45
Negative result

0.89
Low demand
-$45,000

2
$0

$95,000

-$40,000 -$45,000

-$5,000

Not Construct

$36,140

-$5,000
$0

-$5,000

0.50
High demand
$1,00,000
Construct
$0

$1,00,000 $1,00,000
$30,000

0.50
Low demand

No Study

-$40,000
1

$0

-$40,000

-$40,000

$30,000
Not Construct
$0
$0

$0

Question8.
JerryYoungisthinkingaboutopeningabicycleshopinhishometown.Jerrylovesto
takehisownbikeon50miletripswithhisfriends,buthebelievesthatanysmall
businessshouldbestartedonlyifthereisagoodchanceofmakingaprofit.Jerry
canopenasmallshop,alargeshop,ornoshopatall.Becausetherewillbeafive
yearleaseonthebuildingthatJerryisthinkingaboutusing,hewantstomakesure
thathemakesthecorrectdecision.
Jerryhasdonesomeanalysisabouttheprofitabilityofthebicycleshop.If
Jerrybuildsthelargebicycleshop,hewillearn$60,000ifthemarketisgood,buthewill
lose$40,000ifthemarketisbad.Thesmallshopwillreturna$30,000profitinagood
marketanda$10,000lossinabadmarket.Atthepresenttime,hebelievesthatthereis
a59%chancethatthemarketwillbegood.
Jerryalsohastheoptionofhiringhisoldmarketingprofessorfor$5,000to
conductamarketingresearchstudy.Ifthestudyisconducted,theresultscouldbe
eitherfavorableorunfavorable.Itisestimatedthatthereisa0.6probabilitythatthe
surveywillbefavorable.Furthermore,thereisa0.9probabilitythatthemarketwillbe
good,givenafavorableoutcomefromthestudy.However,themarketingprofessorhas
warnedJerrythatthereisonlyaprobabilityof0.12ofagoodmarketifthemarketing
researchresultsarenotfavorable.
(a)DevelopadecisiontreeforJerryandhelphimtodecidewhatheshoulddo.
(b)Howmuchisthemarketingprofessorsinformationworth?Whatisthe
efficiencyofthisinformation>

Answer8.
(a)Conductsurvey.Ifresultsarefavorable,
buildlargeshop.Iftheresultsareunfavorable,
don'tbuildanyshop.

(b)EVSI=$11,000.EVwPI =$35,400.Best
EMV=$19,000.EVPI=$16,400.Efficiency=
67.07%.

Answer8.
Problem 8

0.59
Good market

(a) Conduc t s urvey

$60,000

Large shop

If favorable, build large s hop


If unfavorable, don't build any s hop
EVSI =
$11,000
(b) EVwPI =
Bes t EMV =
EVPI =
Effic ienc y =

$0

$60,000

$60,000

0.41
Bad market

$19,000

$35,400
$19,000
$16,400
67.07%

-$40,000
-$40,000

-$40,000

0.59
Good market

No survey

$30,000
1

$0

Small shop

$30,000

$30,000

$19,000
$0

0.41
Bad market

$13,600

-$10,000
-$10,000

-$10,000

No shop
$0
$0

$0

0.90
Good market
$55,000

Large shop
$0

$60,000
$45,000

$55,000

0.10
Bad market

2
$25,000

-$45,000
-$40,000

-$45,000

0.90
Good market

0.60
Favorable

$25,000
1

$0

Small shop

$30,000

$25,000

$45,000
$0

$21,000

0.10
Bad market
-$15,000
-$10,000

-$15,000

No shop
-$5,000
$0

-$5,000

Survey
-$5,000

0.12
Good market

$25,000

$55,000

Large shop
$0

$60,000
-$33,000

$55,000

0.88
Bad market
-$45,000
-$40,000

0.12
Good market

0.40
Unfavorable

$25,000

3
$0

-$45,000

Small shop

$30,000

$25,000

-$5,000
$0

-$10,200

0.88
Bad market
-$15,000
-$10,000

-$15,000

No shop
-$5,000
$0

-$5,000

Question9.
RobJohnsonisaproductmanagerforDiamondChemical.The
firmisconsideringwhethertolaunchanewproductlinethat
willrequirebuildinganewfacility.Thetechnologyrequiredto
producethenewproductisyetuntested.IfRobdecidestobuild
thenewfacilityandtheprocessissuccessful,DiamondChemical
willrealizeaprofitof$650,000.Iftheprocessdoesnotsucceed,
thecompanywilllose$800,000.Robestimatesthatthereisa
0.6probabilitythattheprocesswillsucceed.
Robcanalsodecidetobuildapilotplantfor$50,000to
testthenewprocessbeforedecidingtobuildthefull scale
facility.Ifthepilotplantsucceeds,Robfeelsthechanceofthe
fullscalefacilitysucceedingis85%.Ifthepilotplantfails,Rob
feelsthechanceofthefullscalefacilitysucceedingisonly20%.
Theprobabilitythatthepilotplantwillsucceedisestimatedat
0.6.StructurethisproblemwithadecisiontreeandadviseRob
whattodo.

Answer9.
Buildthepilotplant.Ifthepilotplant
succeeds,buildfacility.Ifthepilotplantfails,
don'tbuildfacility.Expectedprofit=$209,500.

Answer9.
Problem 9

0.85
Facility works

Build the pilot plant.

$6,00,000

If pilot plant succeeds, build facility.

Build facility

$6,50,000

$6,00,000

If pilot plant fails, don't build facility.


Expected profit = $209,500

$0

$3,82,500

0.60
Pilot works

-$8,50,000
1

$0

0.15
Facility fails
-$8,00,000

-$8,50,000

$3,82,500
Don't build
-$50,000
$0

-$50,000

Build pilot
0.20
-$50,000

$2,09,500

Facility works
$6,00,000
Build facility
$0

-$5,60,000

0.40
Pilot fails

$6,00,000

0.80
Facility fails
-$8,50,000

2
$0

$6,50,000

-$8,00,000

-$8,50,000

-$50,000
Don't build
-$50,000

$0

-$50,000

$2,09,500
0.60
Facility works
$6,50,000
Build facility
$0

$6,50,000
$70,000

$6,50,000

0.40
Facility fails
-$8,00,000
-$8,00,000

-$8,00,000

Do nothing
$0
$0

$0

Question10.
RobJohnson(seeproblem9)hassomerevised
informationconcerningtheaccuracyofthepilot
plantprobabilities.Accordingtohisnew
information,theprobabilitythatthepilotplant
willbesuccessful,giventhatthefullscalefacility
willwork,is0.8.Theprobabilitythatthepilot
plantwillfail,giventhatthefullscalefacilitywill
fail,is0.85.Calculatetheposteriorprobabilities
andreevaluatethedecisiontreefromProblem9.
DoesthisnewinformationaffectDiamond
Chemicalsoriginaldecisions?

Answer10.
(a)

Prior Probabilities
P(Facility works) =
P(Facility fails) =
Conditional probabilities
P(Pilot works | Facility works) =
P(Pilot fails | Facility works) =
P(Pilot works | Facility fails) =
P(Pilot fails | Facility fails) =

Posterior probabilities GIVEN pilot works


Outcome
P(Pilot works | Outcome)
Facility works
0.80
Facility fails
0.15
Posterior probabilities GIVEN pilot fails
Outcome
P(Pilot fails | Outcome)
Facility works
0.20
Facility fails
0.85

0.60
0.40
0.80
0.20
0.15
0.85

Prior prob
0.60
0.40
P(Pilot works) =

Jt prob
0.48
0.06
0.54

Post. prob
0.89
0.11

Prior prob
0.60
0.40
P(Pilot fails) =

Jt prob
0.12
0.34
0.46

Post. prob
0.26
0.74

(b)Buildthepilotplant.Ifthepilotplantsucceeds,
buildfacility.Ifthepilotplantfails,don'tbuildfacility.
Expectedprofit=$244,300.

Answer10.

Question11.
ShamrockOilownsaparceloflandthathasthepotentialtobean
undergroundoilfield.Itwillcost$500,000todrillforoil.Ifoildoes
existontheland,Shamrockwillrealizeapayoffof$4,000,000(not
includingdrillingcosts).Withcurrentinformation,Shamrock
estimatesthatthereisa0.2probabilitythatoilispresentonthe
site.Shamrockalsohastheoptionofsellingthelandasisfor
$400,000,withoutfurtherinformationaboutthelikelihoodofoil
beingpresent.Athirdoptionistoperformgeologicaltestsatthe
site,whichwouldcost$100,000.Thereisa30%chancethatthe
testresultswillbepositive,afterwhichShamrockcanselltheland
for$650,000ordrilltheland,witha0.65probabilitythatoilexists.
Ifthetestresultsarenegative,Shamrockcansellthelandfor
$50,000ordrilltheland,with0.05probabilitythatoilexists.Using
adecisiontree,recommendacourseofactionforShamrockOil.

Answer11.
Testtheland.Ifthetestresultispositive,drill
foroil.Ifthetestresultisnegative,sellthe
land.Expectedprofit=$565,000.

Answer11.
Problem 11

Test land. If test is positive, drill. If test is negative, sell. Expected profit = $565,000.

Sell land
$400
$400

$400

Sell land
$550
0.3
Positive

$650

$550

2
$0

0.65

$2,000

Oil
$3,400
Drill Land
-$500

$4,000
$2,000

Test land

$3,400

0.35
Dry
-$600

-$100

$565

$0

-$600

2
$565

Sell land
-$50
0.7
Negative

$50

-$50

1
$0

0.05

-$50

Oil
$3,400
Drill land
-$500

$4,000
-$400

$3,400

0.95
Dry
-$600
$0

-$600

0.2
Oil
$3,500
Drill Land
-$500

$4,000
$300

$3,500

0.8
Dry
-$500
$0

-$500

Question12.
ShamrockOil(seeProblem11)hassomerevised
informationconcerningtheaccuracyofthe
geologicaltestprobabilities.Accordingtothis
newinformation,theprobabilitythatthetestwill
bepositive,giventhattheoilispresentinthe
ground,is0.85.Theprobabilitythatthetestwill
benegative,giventhatoilisnotpresent,is0.75.
Calculatetheposteriorprobabilitiesand
reevaluatethedecisiontreefromproblem11.
DoesthisinformationaffectShamrockOils
originaldecision?

Answer12.
(a)

Prior Probabilities
P(Oil well) =
P(Dry well) =
Conditional probabilities
P(Positive test | Oil well) =
P(Negative test | Oil well) =
P(Positive test | Dry well) =
P(Negative test | Dry well) =

Posterior probabilities GIVEN positive test


Outcome
P(Positive test | Outcome)
Oil well
0.85
Dry well
0.25
Posterior probabilities GIVEN negative test
Outcome
P(Negative test | Outcome)
Oil well
0.15
Dry well
0.75

0.20
0.80
0.85
0.15
0.25
0.75

Prior prob
0.20
0.80
P(Positive test) =

Jt prob
0.17
0.20
0.37

Post. prob
0.46
0.54

Prior prob
0.20
0.80
P(Negative test) =

Jt prob
0.03
0.60
0.63

Post. prob
0.05
0.95

(b) Testtheland.Ifthetestresultispositive,drill
foroil.Ifthetestresultisnegative,selltheland.
Expectedprofit=$427,300.

Answer12.
Problem 12

Test land. If test is positive, drill. If test is negative, sell. Expected profit = $427,300.
Sell land
$400
$400

$400.00

Sell land
$550
0.37
Positive

$650

$550

2
$0

0.46

$1,240

Oil
$3,400
Drill Land
-$500

$4,000
$1,240

Test land

$3,400

0.54
Dry
-$600

-$100

$427.30

$0

-$600

2
$427.30

Sell land
-$50
0.63
Negative

$50

-$50

1
$0

0.05

-$50

Oil
$3,400
Drill land
-$500

$4,000
-$400

$3,400

0.95
Dry
-$600
$0

-$600

0.2
Oil
$3,500
Drill Land
-$500

$4,000
$300.00

$3,500

0.8
Dry
-$500
$0

-$500

Question13
ShamrockOil(seeProblem11)hasdecidedtorelyonutility
theorytoassistinthedecisionconcerningtheoilfield.The
followingtabledescribesitsutilityfunction;allmonetaryvalues
areinthousandsofdollars:
MonetaryValue($)

Utility

600

0.00

500

0.03

50

0.10

400

0.15

550

0.17

3400

0.90

3500

1.00

(a)Redoproblem11usingthisinformation.
(b)HowcanyoubestdescribeShamrockOilsattitudetoward
risk?Justifyyouranswer.

Answer13.
(a)Testtheland.Ifthetestresultispositive,drillforoil.Ifthe
testresultisnegative,selltheland.Expectedutility=0.246.

Problem 13 (a)

Test land. If test is positive, drill. If test is negative, sell. Expected utility = 0.246.

Sell land

0.150

0.150

Sell land
0.170
0.30
Positive

0.170
2

0.65

0.585

Oil
0.900
Drill Land

0.90
0.585

Test land

0.35
Dry
0.000

0.246

0.00

2
0.246

Sell land
0.100
0.70
Negative

0.100
1

0.05

0.100

Oil
0.900
Drill land

0.90
0.045

0.95
Dry
0.000
0.00

0.20
Oil
1.000
Drill Land

1.000
0.224

0.80
Dry
0.030
0.030

Answer13.
(b)ShamrockOilisariskseeker.
Problem 13 (b)
Utility Curve
1.00
0.75

Utility

Dollar Utility
-$600
0.00
-$500
0.03
-$50
0.10
$400
0.15
$550
0.17
$3,400
0.90
$3,500
1.00

0.50
0.25
0.00
-$600

$0

$600

$1,200

$1,800

Monetary value
Risk seeker.

$2,400

$3,000

$3,600

Question14.
JimSellersisthinkingaboutproducinganewtypeofelectricrazorformen.Ifthemarket
isgood,hewouldgetareturnof$100,000,butifthemarketforthisnewtypeofrazoris
poor,hewouldlose$60,000.BecauseRonBushisaclosefriendofJimSellers,Jimis
consideringthepossibilityofusingBushMarketingResearchtogatheradditional
informationaboutthemarketfortherazor.RonhassuggestedtwooptionstoJim.The
firstalternativeisasophisticatedquestionnairethatwouldbeadministeredtoatest
market.Itwillcost$5,000.Thesecondalternativeistorunapilotstudy.Thiswould
involveproducingalimitednumberofthenewrazorsandtryingtosellthemintwocities
thataretypicalofAmericancities.Thepilotstudyismoreaccuratebutisalsomore
expensive.Itwillcost$20,000.RonhassuggestedthatitwouldbeagoodideaforJimto
conducteitherthequestionnaireorthepilotbeforemakingthedecisionconcerning
whethertoproducethenewrazor.ButJimisnotsureifthevalueofeitheroptionis
worththecost.
Forthesakeofsolvingthisproblem,assumethatJimhasthefollowing
probabilityestimatesavailable:theprobabilityofasuccessfulmarketwithout
performingthequestionnaireorpilotstudyis0.5,theprobabilityofasuccessfulmarket
givenapositivequestionnaireresultis0.78,theprobabilityofasuccessfulmarketgivena
negativequestionnaireresultis0.27,theprobabilityofthesuccessfulmarketgivena
positivepilotstudyresultis0.89,andtheprobabilityofasuccessfulmarketgivena
negativepilotstudyresultis0.18.Further,theprobabilityofapositivequestionnaire
resultis0.45andtheprobabilityofapositivepilotstudyresultisalso0.45.
(a) DrawthedecisiontreeforthisproblemandidentifythebestdecisionforJim.
(b) Whatisthevalueofthequestionnairesinformation?Whatisitsefficiency?
(c) Whatisthevalueofthe pilotstudysinformation?Whatisits efficiency?

Answer14.
(a)Conductthesurveyquestionnaire.Ifthe
responseispositive,producerazor.Ifthe
responseisnegative,donotproducerazor.
Expectedreturn=$24,160.

(b)EVPI=$30,000.EVSI=$9,160.Efficiency=
30.53%.

(c)EVPI=$30,000.EVSI=$17,080.Efficiency=
56.93%.

Answer14.
Problem 14

0.78
Good market

(a) Conduct questionnaire.


If positive, produce razor.
If negative, do not produce razor.
Expected return = $24,160.
EVPI =
$30,000
(b) EVSI =
Efficiency =

$9,160
30.53%

(c) EVSI =
Efficiency =

$17,080
56.93%

$95,000
Produce

$1,00,000

$0

$59,800

0.45
Positive result

0.22
Poor market
-$65,000

1
$0

$95,000

-$60,000

-$65,000

$59,800
Not Produce
-$5,000
$0

-$5,000

Questionnaire
-$5,000

0.27
Good market

$24,160

$95,000
Produce

$1,00,000

$0

-$21,800

0.55
Negative result

0.73
Poor market
-$65,000

2
$0

$95,000

-$60,000

-$65,000

-$5,000
Not Produce
-$5,000
$0

-$5,000
0.89
Good market
$80,000

Produce

$1,00,000

$0

$62,400

0.45
Positive pilot

0.11
Poor market
-$80,000

1
$0

$80,000

-$60,000

-$80,000

$62,400

Not Produce

$24,160

-$20,000
$0

-$20,000

Pilot study
-$20,000

0.18
Good market

$17,080

$80,000
Produce

$1,00,000

$0

-$51,200

0.55
Negative pilot

0.82
Poor market
-$80,000

2
$0

$80,000

-$60,000

-$80,000

-$20,000
Not Produce
-$20,000
$0

-$20,000

0.5
Good market
$1,00,000
Produce
$0

$1,00,000
$20,000

$1,00,000

0.5
Poor market

Neither test

-$60,000
1

$0

-$60,000

-$60,000

$20,000
Not produce
$0
$0

$0

Question15.
JimSellers(seeproblem14)hasbeenableto
estimatehisutilityforanumberofdifferent
values,andhewouldliketousetheseutility
valuesinmakinghisdecision.Theutilityvalues
areU($80,000)=0,U($65,000)=0.5,U(
$60,000)=0.55,U($80,000)=0.9,U($95,000)=
0.95,andU($100,000)=1.
(a)SolveProblem14(a)againusingutilityvalues.
(B)IsJimariskavoiderorriskseeker?Justifyyour
answer.

Answer15.

(a)Conductthesurveyquestionnaire.Ifthesurveyresponseispositive,
producerazor.Ifthesurveyresponseisnegative,donotproducerazor.
Expectedutility=0.823.

Pr oblem

15

(a)

0.78
Good m arket

Conduc t ques tionnaire.


If pos itive, produc e raz or.
If negative, do not produc e raz or.
Expec ted utility = 0.823.

0.950
Produc e

0.950
0.851

0.45
Pos itive res ult

0.22
Poor m arket
0.500

0.500

0.851
Not Produc e
0.800
0.800
Ques tionnaire
0.27
Good m arket

0.823

0.950
Produc e

0.950
0.622

0.55

0.73
Poor

m arket

Negative res ult

0.500
2

0.500

0.800
Not Produc e
0.800
0.800
0.89
Good m arket
0.900
Produc e

0.900
0.801

0.45
Pos itive pilot

0.000
1

0.00

0.11
Poor m arket
0.000

0.801

Not Produc e

0.823

0.700
0.700
Pilot s tudy
0.18
Good m arket

0.745

0.900
Produc e

0.900
0.162

0.55
Negative pilot

0.82
Poor m arket
0.000

0.000

0.700
Not Produc e
0.700
0.700
0.50
Good m arket
1.000
Produc e
0.775
Neither

1.000
0.50
Poor m arket

tes t

0.550
2

0.550

0.810
Not produc e
0.810
0.810

Answer15.
(b)Jimisariskavoider.
Problem 15 (b)
Utility Curve
1.00
0.75

Utility

Dollar
Utility
-$80,000
0.00
-$65,000
0.50
-$20,000
0.70
-$5,000
0.80
$0
0.81
$80,000
0.90
$95,000
0.95
$1,00,000
1.00

0.50
0.25
0.00
-$80,000

-$40,000

$0

$40,000

Monetary value
Risk avoider.

$80,000

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