CHAPTER 3

The Science of Management: A Practical Approach to Decision Making

Chapter 3
DECISION ANALYSIS
OUTLINE
A. Review of Probability Concepts
B. Probability Distributions
C. The Six Steps in Decision Making
D. Types of Decision Making Environments
E. Decision Making Under Uncertainty
F. Decision Making Under Risk
G. Decision Trees
H. Replacement Analysis

LEARNING OUTCOMES
At the end of the course, the students are expected to:
1. Understand the basic foundations of probability analysis
2. Contrast statistically dependent and independent events
3. Differentiate and give examples of discrete and continuous probability distributions
4. Calculate expected values and variances and use the normal table
5. Summarize the decision making process
6. Make decisions under uncertainty using various criteria
7. Use probability values to make decisions under risk
8. Develop accurate and useful decision trees
9. Examine the use of probability concepts in replacement analysis and cost volume profit analysis

LEARNING AND REFLECTION ACTIVITIES

A. Discussion Questions
1. Identify and discuss two basic laws of probability.
2. Differentiate various approaches used in determining probability values.
3. What are the differences between events that are dependent and events that are independent?
Give examples.
4. What are the characteristics of a Bernoulli process? How is the Bernoulli process associated with
the binomial distribution?
5. What is expected value, and what does it measure? How is it computed for a discrete probability
distribution?
6. In a customer satisfaction survey of a pizza parlor, identify three information that reflects normal
distribution.
7. What is a state of nature? Give examples.
8. Differentiate state of nature from a decision alternative.
9. In what instances that a decision tree analysis is applicable?
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10. Describe an optimistic and a pessimistic decision maker.

11. Provide five examples of items in a business office that need replacement over time.
12. Is perfect information possible? Explain view.
13. Using a news articles from print or online, identify a risk factor that may affect the future of an
industry.

B. PROBLEM SETS
1. Sixteen people study French, 21 study Spanish and there are 30 altogether. Work out on the
following probabilities:
a. P(French)
b. P(Spanish)
c. P(French Only)
d. P(Spanish Only)
e. P(French or Spanish)
f. P(French and Spanish)

2. A number is chosen at random from the set of two-digit numbers from 10 to 99 inclusive. What is
the probability the number contains at least one digit 2?

3. You told your boyfriend/girlfriend you want to watch a particular movie you like, and you are
available on the weekends between 4 in the afternoon and midnight. He tells you that he is only
available Saturday between 6 and 8 at night. What are the chances that you can watch the movie
together?

4. The nose cone on a space vehicle must separate before the satellite can be placed into orbit and
put into use. Explosive bolts are fired in order to allow the nose cone to be jettisoned. If four such
bolts are used, each having a probability of 0.98 of firing correctly, what is the probability that all
four will function properly? Assume that the bolts are not wired in series and hence are
independent of each other.

5. Of the repair jobs that Bennie’s Machine Shop receives, 20 percent are welding jobs and 80
percent are machining jobs.
a. What is the probability that the next three jobs to come in will be welding jobs?
b. What is the probability that two of the next three jobs to come in will be machining
jobs?

6. A class contains 30 students. Ten are female (F) and US citizens (U); 12 are male (M) and US
citizens; 6 are female and non-US citizens (N); 2 are male and non-US citizens. A name is randomly
selected from the class roster and it is female. What is the probability that the student is a US
citizen?

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7. Your professor tells you that if you score an 85 or better on your midterm exam, then you have a
90% chance of getting an A for the course. You think you only have a 50% chance of scoring 85 or
better. Find the probability that both your score is 85 and better and you receive an A in the
course?

8. An urn contains 8 red chips, 10 green chips, and 2 white chips. A chip is drawn and replaced, and
then a second chip drawn. What is the probability of
a. a white chip on the first draw?
b. a white chip on the first draw and a red on the second?
c. two green chips being drawn?
d. a red chip on the second, given that a white chip was drawn on the first?

9. The Adams Tool Company uses an aptitude test to screen applicants for machinist positions. The
test is a standard one which has been used in similar applications with other companies. Past
records show that 70 percent of all persons taking the test score at least 700. Further, it has been
demonstrated that all persons who have scored 700 or more have a 60 percent probability of
performing satisfactorily on the job, whereas those who score less than 700 only have a 30
percent probability of satisfactory performance.
a. What is the probability that a person can achieve at least 700 on the test and also
perform satisfactorily on the job?
b. What is the probability that a person will score less than 700 and also perform
satisfactorily?

10. There are 100 members of the consumer testing panel: 40 women and 60 men. Of these, 15 of
the women and 35 of the men are married. One panel member is chosen at random. Find the
probability of the following outcomes:
a. Woman or unmarried
b. Woman or married
c. Man or unmarried
d. Man or married

11. The Andrada Company sent two advertising brochures to prospective customers to promote sales
of two new machines, machine A and machine B. The company estimated that the probability
that a customer would buy machine A was 20%, and the probability that the customer would buy
machine B was 30%. The probability that a given customer would buy both was estimated to be
15%. After seeing the first brochure, for machine A, the Eaves Company placed an order for one.
What is the probability that Eaves will also buy machine B when it receives the second brochure.

12. The Mandy Personal Products company manufactures personal grooming products for men,
including a new hair preparation for redhead men and then survey users’ reactions. Research
indicates that 46% of adults in the general population are male and that 92% of the population
have a hair color other than red. Mandy feels that it must have at least 1,000 distributions for a
valid test. How many persons from the population must it sample before it expects to find 1,000
redheaded men? You assume that hair color and sex are unrelated.

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13. A candidate for public office has claimed that 60% of voters will vote for her. If 5 registered voters
were sampled, what is the probability that exactly 3 would say they favor this candidate.

14. An electrical manufacturer produces microchips. The microchips are inspected at the end of the
production process at a quality control station. Out of every batch of microchips, four are
randomly selected and tested for defects. Given that 20% of all transistors are defective, what is
the probability that each batch of microchips will contain exactly two defective microchips?

15. Referring to the previous number (no. 14), the manager has determined that four microchips
from every large batch should be tested for quality. If two or more defective microchips are
found, the whole batch will be rejected. The manager wants to know the probability of rejecting
an entire batch of microchips, if in fact the batch has 20% defective items.

16. An accounts receivable auditor examines customer accounts for a client. Past records indicate
that the mean amount per account is $5,000 and that this particular random variable has a
standard deviation of $1,000.
a. What is the probability that an account selected at random will have a balance more than
$5,000?
b. What is the probability that an account selected at random will have a balance between
$5,000 and $6,500?
c. What is the probability that an account drawn at random will have a balance of more than
$7,000?
d. What is the probability that they will select at random an account with a balance between
$5,500 and $6,500?

17. The length of the rods coming out of the new cutting machine can be said to approximate a
normal distribution of 10 inches and a standard deviation of 0.2 inch. Find the probability that the
rod selected will have a length:
a. Less than 10 inches
b. Between 10.0 and 10.4 inches
c. Between 10.0 and 10.1 inches
d. Between 10.1 and 10.4 inches
e. Between 9.9 and 9.6 inches
f. Between 9.9 and 10.4 inches
g. Between 9.886 and 10.406 inches

18. RLA Company is planning to manufacture its own laptop computers, which is intended to be
marketed by next year under its own brand. One particular concern of the company has
something to do with the keyboard that will be integrated in the laptop computer.
The following are the different decision alternatives identified by the management:
a. Manufacture its own keyboard
b. Buy keyboards from the local supplier
c. Buy keyboards from Japan

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The payoff table is given below. The profit contribution is in thousand pesos.
FUTURE SALES LEVEL
ALTERNATIVES LOW MODERATE HIGH
Manufacture -30 20 110
Buy from local 20 60 50
Buy from Japan 10 45 80
Coefficient of realism= 60%
What is the best alternative using the following strategies?
(a) Maximax, (b) Maximin, (c) Laplace, (d) Hurwicz Strategy and (e) Minimax Regret.

19. Maria Rojas is considering the possibility of opening a small dress shop along Ybiernas St., a few
blocks from the university. She has located a good mall that attracts students. Her options are to
open a small shop, a medium-sized shop, or no shop at all. The market for a dress shop can be
good, average, or bad. The probabilities for these three possibilities are 0.2 for a good market, 0.5
for an average market, and 0.3 for a bad market. The net profit or loss for the medium-sized and
small shops for the various market conditions are given in the following table. Building no shop at
all yields no loss and no gain.
a. What do you recommend?
b. Calculate the EVPI.
c. Develop the opportunity loss table for this situation. What decisions would be made using
the minimax regret criterion and the minimum EOL criterion?

20. Barney has developed a serious heart condition, and his physician informed him that he has only
two years to live. However, it is possible that Barney’s life can be extended through surgery. If he
has open-heart surgery, and it is successful, he can expect to live another 10 years. If the surgery
is not successful, Barney would be expected to hang on for another 6 months. Barney also has
another option, a heart transplant. If this operation proves successful, Barney could live another
20 years. However, if unsuccessful, Barney will die. The open-heart surgery has a probability of
success of 90% whereas the heart transplant operation has a success fate of 40 percent for
patients of Barney’s age and physical condition. Barney wishes to make his decision in such a way
that his life expectancy will be maximixed. What should he do?

21. Owel is planning to open up a new branch of Engrande Lechon Manok at a new location in Molo
or expand the existing branch in Jaro. Demand on the new location is expected to be 60% high
and 40% low. Fixed cost will reach the amount of P150,000. If the demand becomes high, he
expects to have a revenue of P250,000, however if the demand becomes low, he could only
expect a revenue of P200,000. Upon analyzing the situation in his existing branch, he believes that
by introducing new recipes, the sales will reach the amount of P120,000 if the demand becomes
high. However, if the demand becomes low, he could only expect P80,000 revenue. Projection on
high demand in the existing branch tends to be 55% and upon computing the fixed cost, it would
reach the amount of P50,000. If you were the consultant of Owel, what would you advise?

22. The President of PLL Company is deciding whether to develop a new product or not. If the
company purchases the patent, it should develop the product. The selling price of the patent is
P50,000. There are two ways to develop the product, the Modern method and the Traditional
method. It costs P20,000 to use the Modern method and P15,000 for the Traditional method. The
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probability of success in the Modern method is 60%, while it is 70% for the Traditional method. If
the product is successfully developed, it will given an income of P500,000. Find the best
alternative using decision tree analysis.

23. A manager has to decide whether to prepare a bid or not. It costs P5,000 to prepare the bid. If the
bid is submitted, the probability that the contract will be awarded is 50%. If the company is
awarded the contract, it may earn an income of P100,000 if it succeeds or pay a fine of P8,000 if it
fails. The probability of success is estimated to be 80%. Should the manager prepare the bid?

24. The Iloilo City government has discovered that there is a good possibility there could be an
outbreak of the dreaded strain “G” flu during the coming flu season. Health officials are
contemplating a program whereby the general population could receive immunization shots on a
voluntary basis. A neighboring city, Bacolod, has already considered such a program and has
rejected it on the basis of public distrust that such programs have generated in the past with flu
scares which did not materialize. The Iloilo City officials have estimated that if such a program
were offered, there is a 0.6 probability that there will be a high turnout of people to get a shot,
and there is a 0.4 probability of a low turnout. They have further estimated that there is a 0.8
probability that the flu will strike both cities. :n order to analyze the problem quantitatively, they
have prepared the following conditional payoff values for various outcomes and actions.

Immunize Voluntary Turnout Flu Sate Conditional payoff, utiles

No ----- No strike 0
No ----- Strike -120
Yes High No strike -50
Yes Low No strike -10
Yes High Strike 80
Yes Low Strike 60

25. Thelma owns a small fleet of shrimp boats. Her growing concern is the loss of productivity
resulting from the replacement of bearings in the equipment used to pull the shrimp nets. A total
of 80 of these bearings are used in her fleet of boats. She estimates that the failure history of
bearings is as follows:
Hours after replacement
200 400 600 800 1000
Percent of bearings which .15 .30 .50 .80 1.00
fail before hours shown
(cumulative)
If a bearing fails while in operation, the boat must discontinue fishing until a replacement can be
made. Thelma estimates this to cost Php275.00 for each bearing that is replaced. As an
alternative, she is considering the systematic replacement of bearings during the period when the
boats are in harbor. Such replacement cost only Php80.00 per bearing. What decision should
Thelma make in order to minimize costs?

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FORMULA BANK

Description Formula
A basic statement of probability 0 ≤ P(event) ≤ 1
Law of addition for mutually exclusive events P(A or B) = P(A) + P(B)
Law of addition for events that are not mutually P(A or B) = P(A) + P(B) – P(A and B)
exclusive
Joint probability for independent events P(AB) = P(A) x P(B)
Conditional probability 𝑃(AB)
𝑃(A|B) =
𝑃(B)
Joint probability for dependent events P(AB) = P(A|B) x P(B)
𝑛
This equation computes the variance of a discrete
probability distribution 𝑉𝑎𝑟𝑖𝑎𝑛𝑐𝑒 = ∑[𝑋𝑖 − 𝐸(𝑋)]2 𝑃(𝑋𝑖 )
𝑖=1
This equation computes the variance of a discrete 𝜎 = √𝑣𝑎𝑟𝑖𝑎𝑛𝑐𝑒
probability distribution
Probability of r successes in n trials 𝑛!
𝑛 𝑡𝑟𝑖𝑎𝑙𝑠 = 𝑝𝑟 𝑞 𝑛−𝑟
𝑟! (𝑛 − 𝑟)!
The expected value of the binomial distribution Expected value (mean) = np
The variance of the binomial distribution Variance = np(1 – p )
This equation computes the number of standard 𝑋− 𝜇
𝑍=
distributions, Z, the point X is from the mean µ 𝜎