CHAPTER 3 DECISION ANALYSIS

Quantitative Analysis for Management Case Study and Problem Sets

Blake Electronics Case Study and 3-35, 3-38, 3-44, 3-48, & 3-52 Problems

Members:
Callos, Jarisse Nicole T.
Panares, Daniel John
Pombo, Roweno T. Jr.
Suico, Everjanetmie D.
BSA 3A
8:45-9:45am MWF; FIN 331

Submitted to:
Maria Grace M. Baysa

Submitted on:
July 20, 2016
3 35
a. Decision Tree Analysis

b. Calculations for EMV:

Node 2 = $95000(0.82) $45000(0.18) = $69800
Node 3 = $95000(0.11) $45000(0.89) = $29600
Node 4 = $10000(0.5) $40000(0.5) = $30000
Node 1 = $69800(0.55) $5000(0.45) = $36140
Therefore, they should perform a market study and construct a market
clinic.
c. EVSI = ( + ) ( )
= ($36140 + $5000) $30000 = $11140

The expected value of sample information is $11,140 and therefore,

physicians would pay up to this price for a market study.

d. Efficiency of Sample Information = (100%)

$11140
= (100%) = 55.7%
$20000

EVPI =
= [($100000)(0.5) + ($0)(0.5)] $30000 = $20000
3 38
Decision Tree Analysis

Calculations for EMVs:

Node 2 = $12000(0.9) $23000(0.1) = $8500
Node 3 = $2000(0.9) $13000(0.1) = $500
Node 4 = $12000(0.4) $23000(0.6) = $9000
Node 5 = $2000(0.4) $13000(0.6) = $7000
Node 6 = $15000(0.7) $20000(0.3) = $4500
Node 7 = $5000(0.7) $10000(0.3) = $500
Node 1 = $8500(0.5) $3000(0.5) = $2750

Therefore, Bill should opt not to gather additional information and choose
to build a quadplex.
3 44
A.
State of Conditional Prior Joint P(State of Nature | Good)
Nature Probability P(Good Probability Probability
| State of Nature)
Good .80 (.60) .48 .48/.52 = .92
Bad .10 (.40) .04 .04/.52 = .08
P(Survey Results Good) .52 1.00

State of Conditional Prior Joint P(State of Nature | Poor)

Nature Probability P(Poor Probability Probability
| State of Nature)
Good .20 (.60) .12 .12/.48 = .25
Bad .90 (.40) .36 .36/.52 = .75
P(Survey Results Poor) .48 1.00

B.
State of Conditional Prior Joint P(State of Nature | Good)
Nature Probability P(Good Probability Probability
| State of Nature)
Good .80 (.70) .56 .56/.59 = .95
Bad .10 (.30) .03 .03/.59 = .05
P(Survey Results Good) .59 1.00

State of Conditional Prior Joint P(State of Nature | Poor)

Nature Probability P(Poor Probability Probability
| State of Nature)
Good .20 (.70) .14 .14/.41 = .34
Bad .90 (.30) .27 .27/.41 = .66
P(Survey Results Poor) .41 1.00
3 48
Decision Tree Analysis

a) Broad Street = (.9 x 15 minutes) + (.2 x 40 minutes) = 21.5 minutes

Expressway = (.7 x 30 minutes) + (.7 x 30 minutes) = 42 minutes
The route which minimizes Lynns expected travel time is Broad Street for
only an estimated travel time of 21.5 minutes.
b) Broad Street = (.9 x .5) + (.2 x .5) = .55
Expressway = .7
Therefore, the expressway maximizes Lynns expected utility.
c) Since the slope shown below is that of a risk avoider, Lynn is a risk avoider.

Chart Title
1
0.9
0.9
0.8
0.7
0.7
0.6
Utility

0.5
0.4
0.3
0.2
0.2
0.1
0
15 minutes 20 minutes 25 minutes 30 minutes 35 minutes 40 minutes
Time (minutes)
3 52
Analysis of the data given:
STATE OF NATURE
ALTERNATIVES FAVORABLE MARKET (FM) UNFAVORABLE MARKET (UM)
Construct a retail store $100,000 $80,000
Do nothing $0 $0
Base scenario
Probabilities 0.6 0.4

STATE OF NATURE
RESULT OF SURVEY FAVORABLE MARKET UNFAVORABLE MARKET
Positive P (survey positive|FM) = 0.9 P (survey positive|UM) = 0.2
Negative P (survey negative|FM) = 0.1 P (survey negative|UM) = 0.8

POSTERIOR PROBABILITIES
CONDITIONAL
P (STATE OF
STATE OF PROBABILITY P (SURVEY PRIOR
POSITIVE|STATE OF JOINT PROBABILITY NATURE|SURVEY
NATURE PROBABILITY
NATURE) POSITIVE)
FM 0.9 X 0.6 0.54 0.54/0.62 = 0.87
UM 0.2 X 0.4 0.08 0.08/0.62 = 0.13
P (survey results positive) = 0.62 Total = 1.00

POSTERIOR PROBABILITIES

CONDITIONAL P (STATE OF
STATE OF PRIOR
PROBABILITY P (SURVEY JOINT PROBABILITY NATURE|SURVEY
NATURE NEGATIVE|STATE OF PROBABILITY
NEGATIVE)
NATURE)
FM 0.1 X 0.6 0.06 0.06/0.38 = 0.16
UM 0.8 X 0.4 0.32 0.32/0.38 = 0.84
P (survey results negative) = 0.38 Total = 1.00
(a.) What do you recommend?
We recommend Sue Reynolds to construct the retail store without
conducting a market survey. As shown in the figure above, it gives the
possible highest EMV of $ 28,000 in the base scenario as compared to
$27,492 if information is to be gathered and paid.

(b.) What impact would a 0.7 probability of obtaining favorable information have on
Sues decision? The probability of obtaining unfavorable information would then
be 0.3.

POSTERIOR PROBABILITIES
CONDITIONAL
P (STATE OF
STATE OF PROBABILITY P (SURVEY PRIOR
POSITIVE|STATE OF
JOINT PROBABILITY NATURE|SURVEY
NATURE PROBABILITY
NATURE) POSITIVE)
FM 0.9 X 0.7 0.63 0.63/0.69 = 0.91
UM 0.2 X 0.3 0.06 0.06/0.69 = 0.09
P (survey results positive) = 0.69 Total = 1.00
 POSTERIOR PROBABILITIES

CONDITIONAL P (STATE OF
STATE OF PRIOR
PROBABILITY P (SURVEY JOINT PROBABILITY NATURE|SURVEY
NATURE NEGATIVE|STATE OF PROBABILITY
NEGATIVE)
NATURE)
FM 0.1 X 0.7 0.07 0.07/0.31 = 0.23
UM 0.8 X 0.3 0.24 0.24/0.31 = 0.77
P (survey results negative) = 0.31 Total = 1.00

Node2 EMV = ($80,000 x 0.91) + (-$100,000 x 0.09) = $63,800

Node3 EMV = ($80,000 x 0.23) + (-$100,000 x 0.77) = -$58,600
Node1 EMV = ($63,800 x 0.69) + (-$20,000 x 0.31) = $37,822
Node4 EMV = ($100,000 x 0.60) + (-$80,000 x 0.40) = $28,000
The impact of change in probabilities for favorable and unfavorable market
would increase the node 1 EMV from $27,492 to $37,822. However, the
EMV of constructing the retail store without conducting market survey is
still $28,000. Consequently, the recommended decision would change to
constructing the retail store with conducting a market survey because it
has now the best EMV of $37,822 to be realized.
(c.) Sue believes that the probability of a successful and an unsuccessful retail store
given favorable information might be 0.8 and 0.2, respectively, instead of 0.9 and
0.1, respectively. What impact, if any, would this have on Sues decision and the
best EMV?
POSTERIOR PROBABILITIES
CONDITIONAL
P (STATE OF
STATE OF PROBABILITY P (SURVEY PRIOR
POSITIVE|STATE OF
JOINT PROBABILITY NATURE|SURVEY
NATURE PROBABILITY
NATURE) POSITIVE)
FM 0.8 X 0.6 0.48 0.48/0.56 = 0.86
UM 0.2 X 0.4 0.08 0.08/0.56 = 0.14
P (survey results positive) = 0.56 Total = 1.00

POSTERIOR PROBABILITIES

CONDITIONAL P (STATE OF
STATE OF PRIOR
PROBABILITY P (SURVEY JOINT PROBABILITY NATURE|SURVEY
NATURE NEGATIVE|STATE OF PROBABILITY
NEGATIVE)
NATURE)
FM 0.2 X 0.6 0.12 0.12/0.44 = 0.27
UM 0.8 X 0.4 0.32 0.32/0.44 = 0.73
P (survey results negative) = 0.44 Total = 1.00

Node2 EMV = ($80,000 x 0.86) + (-$100,000 x 0.14) = $54,800

Node3 EMV = ($80,000 x 0.27) + (-$100,000 x 0.73) = -$51,400
Node1 EMV = ($54,800 x 0.56) + (-$20,000 x 0.44) = $21,888
 Node4 EMV = ($100,000 x 0.60) + (-$80,000 x 0.40) = $28,000
The change of probabilities of a successful and an unsuccessful retail
store given favorable information from 0.9 and 0.10 to 0.8 and 0.2,
respectively, only decreases the EMV of constructing the retail store with a
survey to $21,888. This change of probabilities does not affect the best
EMV of $28,000. Consequently, the best EMV would still be constructing
the retail store without conducting a survey and this would still be the best
decision.
(d.) Sue had to pay $20,000 to get information. Would her decision change if the cost
of the information increased to $30,000?

Node2 EMV = ($70,000 x 0.87) + (-$110,000 x 0.13) = $46,600

Node3 EMV = ($70,000 x 0.16) + (-$110,000 x 0.84) = -$81,200
Node1 EMV = ($46,600 x 0.62) + (-$20,000 x 0.38) = $21,292
Sues first decision on the base scenario would not change. Definitely, the
decision to construct the retail store without conducting a market survey
is still the best choice because its EMV is far better than the recalculated
$21,292 EMV with a $30,000 cost of getting the information.
(e.) Using the data in this problem and the following utility table, compute the
expected utility. Is this the curve of a risk seeker or a risk avoider?

MONETARY VALUE UTILITY

$ 100,000 1
$ 80,000 0.4
$ - 0.2
$ 20,000 0.1
$ (80,000) 0.05
$ (100,000) 0
Figure 1: Utility curve of a risk seeker.

1.20

1.00

0.80
Utility

0.60

Utility
0.40

0.20

0.00
$(150.00) $(100.00) $(50.00) $- $50.00 $100.00 $150.00

Monetary Value (in thousand dollars)

E(construct retail store | survey positive) = [(0.87)(0.4)] + [(0.13)(0)] = 0.348
E(construct retail store | survey negative) = [(0.16)(0.4)] + [(0.84)(0)] = 0.064
E(construct retail store | no survey) = [(0.6)(1)] + [(0.4)(0.05)] = 0.62
E(construct retail store | conducts survey) = [(0.62)(0.348)] + [(0.38)(0.1)] = 0.25
As we can see from Figure 1 above, the utility curve from the given Utility table
indicates that identified utilities imply risk seeking manner.
(f.) Compute the expected utility given the following utility table. Does this utility
table represent a risk seeker or a risk avoider?

MONETARY VALUE UTILITY

$ 100,000 1
$ 80,000 0.9
$ - 0.8
$ (20,000) 0.6
$ (80,000) 0.4
Figure 2: Utility curve of a risk avoider

1.2

1
UTILITY

0.8

0.6

UTILITY
0.4

0.2

0
$(150.00) $(100.00) $(50.00) $- $50.00 $100.00 $150.00

MONETARY VALUE (IN THOUSAND DOLLARS)

E(construct retail store | survey positive) = [(0.87)(0.9)] + [(0.13)(0)] = 0.783

E(construct retail store | survey negative) = [(0.16)(0.9)] + [(0.84)(0)] = 0.144
E(construct retail store | no survey) = [(0.6)(1)] + [(0.4)(0.4)] = 0.76
E(construct retail store | conducts survey) = [(0.62)(0.783)] + [(0.38)(0.6)] = 0.71
As we can see from the utility curve, this is a curve of a risk avoider.
 CASE STUDY BLAKE ELECTRONICS

I. Problem Definition
The following problems were identified in the case of Blake Electronics:
a) Should Steve contract any of the marketing companies that will assess the
favorability of introducing the products to the market? If yes, then which
company should he choose? Marketing Associates, Inc. or Iverstine and
Walker?
b) Given the instances, should Steve even proceed with introducing the Master
Control Center to the market?

II. Possible Alternatives

Mr. Steve Blake has three successive possible alternatives in solving the
problem about the introduction of the Master Control Center in the market. First,
in estimating the probability of success and profitability of the Master Control
Center, Mr. Steve Blake can either apply for a market survey done by third
parties for additional information or he could rely on the estimations provided by
his research team. If Mr. Steve Blake chooses the probability estimations of his
research team, then his next alternatives would be whether to introduce the
Master Control Center or not, given the likelihood of success for each alternative.
On the other hand, if Mr. Steve Blake opts to apply for a market survey done by
third parties, he can either choose Marketing Associates Inc. (MIA) or Iverstine
and Walker to do the said survey. Whoever gives more favorable results
weighted with the corresponding cost is likely to be chosen by Mr. Steve Blake.
Using the survey results, Mr. Steve Blake would then decide on whether to
introduce the product to the market or not.

III. Possible Outcomes/State of Nature

There are four identified possible outcomes or state-of-nature for the
different alternatives. In conducting a market survey, possible outcomes would
either be favorable survey results or unfavorable survey results. On the other
hand, introducing the product would either result to a successful venture or an
unsuccessful venture. These state-of-natures come with varying probabilities.
Given in the problem was a 60% probability for a successful venture estimated
by the companys research team. Market Associates Inc., on the other hand,
estimates a 50-50 chance of a favorable and an unfavorable market survey
results. Furthermore, MAI also provides its success figures from which we can
 derive probability estimates for a successful venture or an unsuccessful venture
given a favorable or an unfavorable market survey result. Lastly, Iverstine and
Walker provide probability estimates of 90% for a favorable result, given a
successful venture and an 80% estimate of an unfavorable survey, given an
unsuccessful venture. From these estimates, we can then compute for the other
probability estimates needed using Bayes theorem.

IV. Payoff Table

STATE OF NATURE
ALTERNATIVE UNFAVORABLE
FAVORABLE MARKET
MARKET
($)
($)
Introduce product line 1,500,000 -500,000
Do not introduce product line 0 0
Probabilities 0.6 0.4
Table 1. Payoff table for introducing or not introducing the product line.
With the given cost approximation of $500,000 and sales approximation of
$2,000,000, we can evaluate the potential profits associated with the given outcomes.
When Steve decides to introduce the product line, a favorable market would result in a
net profit of $1,500,000 ($2,000,000-$500,000). On the other hand, an unfavorable
market would result in a net loss of $500,000 ($0-$500,000). However, if Steve decides
not to pursue the project, he would have a $0 profit in either market.

V. Decision Theory to be Applied

In the case of Blake Electronics, the type of decision making that has to be
undergone is that under risk. The data from the case can provide several possible
outcomes for each alternative, and the probability of occurrence of each outcome can
be computed. The case poses three interconnected problems as stated above and thus,
decisions have to be made in a logical and sequential order. Using the Decision Tree
Analysis would be the best model in this type of cases since it gives a clearer picture of
the choices available and the possible outcomes that would result therefrom, given the
graphical presentation that it provides.
VI. Application of Model and Decision-Making

Steves best estimates of a successful and unsuccessful venture are:

P(SV) = 0.60
P(UV) = 0.40

Probability Figures

SURVEY RESULTS
OUTCOME TOTAL
FAVORABLE UNFAVORABLE
35 20
Successful venture = 0.70 = 0.40 55
50 50
Unsuccessful 15 30
= 0.30 = 0.60 45
venture 50 50
50 50
TOTAL = 0.50 = 0.50 100
100 100
Table 2.1 Probability Figures for MAI
Of the 100 marketing research projects conducted by MAI, 50% showed
favorable survey results. Out of these positive results, 70% showed that the projects
had a successful venture and consequently, 30% had an unsuccessful venture. On the
other hand, 50% of 100 showed unfavorable survey results in which 40% resulted in a
successful venture and 60% experienced an unsuccessful venture.

STATE OF NATURE
RESULT OF SURVEY
SUCCESSSFUL UNSUCCESSSFUL
VENTURE (SV) VENTURE (UV)
Favorable 0.90 0.20
Unfavorable 0.10 0.80
Total 100 100
Table 2.2 Market Survey Reliability in Predicting States of Nature for I&W
Table shows that the chance of getting favorable results, given a successful
venture, is 90%. On the contrary, the chance of getting an unfavorable survey, given an
unsuccessful venture, is 80%. The 10% and 20% follows consequently.
 CONDITIONAL
POSTERIOR PROBABILITY
PROBABILITY
STATE OF PRIOR
P(FAVORABLE P(STATE OF
NATURE PROBABILITY JOINT
SURVEY|STATE NATURE|FAVORABLE
OF NATURE) PROBABILITY
SURVEY)
SV 0.90 x 0.60 =0.54 0.54/0.62=0.87
UV 0.20 x 0.40 =0.08 0.08/0.62=0.13
P(favorable survey results) =0.62 1.00
Table 2.3 Probability Revision Given a Favorable Survey
From the table, if Steve will choose Iverstine & Walker, the probability of having a
favorable survey result will be 62%. The probability of successfully marketing the Master
Control Center will be 87% given that the survey shows favorable results. On the other
hand, the chances of success can drop to 13% even if the survey reports are favorable.

CONDITIONAL
POSTERIOR PROBABILITY
PROBABILITY
STATE OF PRIOR
P(UNFAVORABLE
NATURE PROBABILITY P(STATE OF
SURVEY|STATE JOINT
NATURE|UNFAVORABLE
OF NATURE) PROBABILITY
SURVEY)
SV 0.10 x0.60 =0.06 0.06/0.38=0.16
UV 0.80 x0.40 =0.32 0.32/0.38=0.84
P(unfavorable survey results) =0.38 1.00
Table 2.4 Probability Revision Given an Unfavorable Survey
The table infers that if Steve will choose Iverstine & Walker, the chance of having
unfavorable survey results is 38%. Also, given that the survey shows unfavorable
results, the probability of successfully marketing the Master Control Center will be 16%.
On the other hand, the chance of an unsuccessful venture given an unfavorable survey
results is 84%.
Decision Tree with Payoffs, Probabilities, and EMVs for Blake Electronics
 The first decision point for Steve is whether to conduct the market survey or not.
If he chooses to do the market survey, he should choose between Marketing
Associates, Inc. (MAI), offering a $100,000 market survey, and Iverstine and Walker,
offering a $300,000 market survey. This is Steves second decision point. The surveys
will then render either favorable or unfavorable results (state-of-nature nodes 1 and 2).
Steves third decision point lies on whether he should introduce the new product or not.
The venture will either be successful or unsuccessful (state-of-nature nodes 3 through
7) if ever he opts to pursue the project. The different payoffs are stated on the right side
of the decision tree and are calculated as follows:
NO SURVEY (Successful Venture)
Payoff = $2,000,000 - $500,000 = $1,500,000
NO SURVEY (Unsuccessful Venture)
Payoff = $0 - $500,000 = -$500,000
MAI SURVEY (Successful Venture)
Payoff = $1,500,000 - $100,000 = $1,400,000
MAI SURVEY (Unsuccessful Venture)
Payoff = $500,000 - $100,000 = -$600,000
I&W SURVEY (Successful Venture)
Payoff = $1,500,000 - $300,000 = $1,200,000
I&W SURVEY (Unsuccessful Venture)
Payoff = $500,000 - $300,000 = -$800,000
NO SURVEY (Product not introduced)
Payoff = $0
MAI SURVEY (Product not introduced)
Payoff = $0 - $100,000 = -$100,000
I&W SURVEY (Product not introduced)
Payoff = $0 - $300,000 = -$300,000
EMV calculation:
Node1 EMV = ($800,000 x 0.50) + ($200,000 x 0.50) = $500,000.00
Node2 EMV = ($940,000 x 0.62) + (-$300,000 x 0.38) = $468,000.00
Node3 EMV = ($1,400,000 x 0.70) + (-$600,000 x 0.30) = $800,000.00
Node4 EMV = ($1,400,000 x 0.40) + (-$600,000 x 0.60) = $200,000.00
Node5 EMV = ($1,200,000 x 0.87) + (-$800,000 x 0.13) = $940,000.00
Node6 EMV = ($1,200,000 x 0.16) + (-$800,000 x 0.84) = -$480,000.00
Node7 EMV = ($1,500,000 x 0.60) + (-$500,000 x 0.40) = $700,000.00

Decision
With an EMV of $700,000, Steve Blake should introduce the Master Control
Center without conducting the market survey because it would yield him the best return
among all alternatives cited.