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DISCUSSION QUESTIONS
4. EMV is defined as the expected monetary value. The EMV is the expected or average return that we would realize if we were to repeat the decision an infinite number of times. Expected value under certainty is the expected or average return that we would realize if we were to repeat the decision an infinite number of times, each time having perfect or complete information and making the best possible decision based on that information. EVPI is defined as the expected value of perfect information. EVPI is equal to the difference between EMV (the expected or average return given that we were to make the decision based on current or available information) and expected value under certainty and is the maximum amount we would be willing to pay for additional (perhaps, perfect) information. Determination of EVPI is useful any time the manager has the option of expending additional resources to acquire additional information and making the decision using currently available information. Maximax is the optimistic criterion. It maximizes the maximum outcome. Maximin is the pessimistic criterion. It maximizes the minimum outcome.
9. 10.
END-OF-MODULE PROBLEMS
A.1
Alternatives Large plant Small plant Overtime Do nothing Very Favorable Market $275,000 $200,000 $100,000 $0 Average Market $100,000 $60,000 $40,000 $0
States of Nature
Unfavorable Market $150,000 $10,000 $1,000 $0 Row Minimum 150,000 10,000 1,000 Row Maximum Row Average 75,000
275,000
200,000 100,000 0 maximax
83,333
46,333 0 equally likely
0
maximin
Row Row Minimum Maximum 10,000 50,000 20,000 80,000 40,000 100,000 160,000 300,000
maximin
(b)
Maximin decision: small station Equally likely decision: very large station
EMV (large stock) 0.322 + 0.512 + 0.22 12.2 EMV (average stock) 0.314 0.510 0.26 10.4 EMV (small stock) 0.39 0.58 0.24 7.5 Maximum EMV is large stock $12,200 EVPI $13,800 12,200 $1,600 where: $13,800 0.322 + 0.512 + 0.26 EMV (assembly line) 0.4$10,000 0.6$40,000 $28,000 EMV (new plant) 0.4$100,000 0.6$600,000 $320,000 EMV (nothing) 0 Select the new plant option. EVPI $364,000 $320,000 $44,000 (a) EMV (Alt. 1) 0.480 0.3120 0.3140 32 36 42 110 max. EMV EMV (Alt. 2) 0.490 0.390 0.390 36 27 27 90 EMV (Alt. 3) 0.450 0.370 0.3150 20 21 45 86 EVPI 117 110 7
$60 + 250 + 210 $520 Expected cost of part-timer 0.2 0 + 0.5350 + 0.31,000 $0 + 175 + 300 $475
A.4 A.5
A.6 A.7
(b) A.8
Thus, use part-time lawyers. A.9 Large has EMV = $75,000 ; Small has EMV = $83,333 ; Overtime EMV = $46,333 ; and Do nothing EMV $0 . Small plant is best decision.
A.10 EMV (major expansion) 150,000* EMV (minor expansion) 50,000 EMV (do nothing) 0 * Therefore, the company should do the major expansion. A.11 (a) Demand 11 Cases P 0.45 385
385 56 329
Stock
13 cases
420 56 364
455
$341.25
The recommended course of action, based on the expected monetary value criterion, is to stock 11 cases.
(b)
It should be intuitively obvious that if no loss due to overstocking is involved, one should always carry the maximum stock. This observation is confirmed by the following table. Demand 11 Cases P 0.45 385 385 385 Demand 12 Cases P 0.35 385 420 420 Demand 13 Cases P 0.20 385 420 455
A.12 Profit from each case sold: $95 $45 $50 . Loss from each case produced but not sold: $45. Demand (Cases) 7 8 P 0.3 P 0.5 300 300 350 350
The recommended course of action, based on the expected monetary value criterion, is to stock the maximum of 13 cases.
Production (Cases) 6 7
6 P 0.1 300
300 45 255 300 90 210 300 135 165
400
400
$352.50
400 45 355
450
$317.00
$150
$0
The recommended strategy (EMV = 72.5) is Try pilot If pilot is success: build plant If pilot is failure: do not build plant Note: All costs/revenues have been entered at the end of the branches of the tree. Although this procedure is not required in this example due to an implicit assumption of linear utility, it is required when using a more general representation of utility.
80
10
(b) (c)
Based on the expected monetary value criterion, Penny should elect to build a small plant. We can find the EVPI from the following: Expected value under certainty = (0.4) (400,000) + 0.6 (0) = $160,000 Maximum EMV = $26,000 EVPI = $160,000 $26,000 = $134,000
1% Defective (0.7) Buy from A 90 90 3% Defective (0.2) 5% Defective (0.1) 1% Defective (0.3) 3% Defective (0.4) 5% Defective (0.3) 50 150 250 50 150 250
A.15 (a)
(b)
60
45
(b) Build large wing Build small wing Do not build (c) Build large wing Build small wing Do not build
Population Trend Growth Stable 150 85 60 45 0 0 Population Trend Growth P 0.5 Stable P 0.5 150 85 60 45 0 0
Based on the expected monetary value criterion with the assumption that the states of nature are equally likely, she should build the large wing. (d) Build large wing Build small wing Do not build Population Trend Growth P 0.6 Stable P 0.4 150 85 60 45 0 0
Based on the expected monetary value criterion, she should build the large wing.
A.18
Favorable Small shop Unfavorable Favorable Survey says favorable Large shop Unfavorable No shop Use survey Small shop Unfavorable Favorable Survey says unfavorable Large shop Unfavorable No shop Favorable Small shop Unfavorable Favorable Decide now Large shop Unfavorable No shop Favorable
A.19
Small shop
Favorable (0.9) $21 Unfavorable (0.1) Favorable (0.9) $45 Unfavorable (0.1)
30 5 = 25 10 5 = 15 60 5 = 55 40 5 = 45 0 5 = 5
Large shop
No shop Use survey $25 $25 Favorable (0.12) $10.2 Unfavorable (0.88) Favorable (0.12) $33 Unfavorable (0.88)
Small shop
30 5 = 25 10 5 = 15 60 5 = 55 40 5 = 45 0 5 = 5
Large shop
No shop Favorable (0.5) $10 Unfavorable (0.5) Favorable (0.5) $10 Unfavorable (0.5)
Small shop
30 10 60 40 0
Large shop
No shop
The optimal strategy is to use the survey. If the survey indicates a favorable market, then build a large shop. If the survey does not indicate a favorable market, then do nothing.
A.20
8,500
(0.9) (0.1)
500
(0.9) (0.1)
9,000
(0.4) (0.6)
7,000
(0.4) (0.6)
4,500
(0.7) (0.3)
500
(0.7) (0.3)
Your advice should be to not gather additional information and to build a large video section. A.21 (a)
Major 10,000 Minor
10,000 5,000
(b)
EMV (major renovation) 5,000 EMV (minor renovation) 10,000* * best decision is minor renovation
A.22
Small 20,000
Good (1/3) Fair (1/3) Poor (1/3) Good (1/3) Medium 30,000 Poor (1/3) 55,000 Good (1/3) Large 30,000 Poor (1/3) Good (1/3) Very large 55,000 Poor (1/3) Fair (1/3) Fair (1/3) Fair (1/3)
50,000 20,000 10,000 80,000 30,000 20,000 100,000 30,000 40,000 300,000 25,000 160,000
10