Kulliyyah of Economics and Management Sciences

Test 1 MGT 3050

Maximum Marks : 30 Date : 30/05/09

Time : 2pm – 3.30pm

Answer all questions.

Question 1
A machine shop owner is attempting to decide whether to purchase a new drill press, a
lathe or a grinder. The return from each will be determined by whether the company
succeeds in getting a government military contract. The profit or loss from each purchase
and the probabilities associated with each contract outcome are shown in the following
payoff table:

Contract No Contract
Purchase 0.40 0.60

Drill press $ 40,000 $ − 8,000

Lathe 20,000 4,000
Grinder 12,000 10,000

(a) Which machine should be purchased?

The machine shop owner is considering hiring a military consultant to ascertain whether
the shop will get the government contract. The consultant is a former military officer who
uses various personal contacts to find out such information. By talking to other shop
owners who have hired the consultant, the owner has estimated a 0.70 probability that the
consultant would present a favorable report, given that the contract is awarded to the shop
(P(f | c)), and a 0.80 probability that the consultant would present an unfavorable report,
given that the contract is not awarded (P(u | n)). Using decision tree analysis,
(b) Determine (i) the decision strategy the owner should follow, (ii) the expected value of
this strategy, and (iii) the maximum fee the owner should pay the consultant.
[2+17+1+2=22 marks]

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2. The Northwoods Outdoor Company specializes in outdoor recreational clothing.
Demand for its items is very seasonal peaking during October-December and April-
June. It has accumulated the following data for orders per quarter during the last
two years.

Orders (1000s)
2006 2007
January – March 18 19
April – June 23 25
July – September 20 22
October – December 41 45

(a) Compute the indices for the four quarters.

(b) Develop the trend line and forecast for the four quarters in 2008.
[4+9 = 13 marks]

Note. No need to adjust the seasonal irregular components if their sum is larger or
equal to 3.99.


 b0 = Y − b1 X , b1 =
∑ x y − (∑ x ∑ y )
i i i i n

∑ x − (∑ x ) n
2
 i
2
i


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Question 1
(a)

(b)
P(c) = probability of contract = 0.40;
P(n) = probability of no contract = 0.60;
P(f | c) = 0.70; P(u | c) = 0.30
P(u | n) = 0.80; P(f | n) = 0.20

Computation of posterior probabilities:

If f - Favorable

State of Nature P(sj) P(f | sj) P(f∩sj) P(sj | f)

c P(c) = 0.40 P(f | c) = 0.70 P(fc) = 0.28 P(c | f) = 0.70

n P(n) = 0.60 P(f | n) = 0.20 P(fn) = 0.12 P(n | f) = 0.30

P(f) = 0.40

If u - Unfavorable

State of Nature P(sj) P(u | sj) P(u∩sj) P(sj | u)

c P(c) = 0.40 P(u | c) = 0.30 P(uc) = 0.12 P(c | u) = 0.20

n P(n) = 0.60 P(u | n) = 0.80 P(un) = 0.48 P(n | u) = 0.80

P(u) = 0.60

(i) Decision strategy:

If report is favorable, purchase a Drill press;
If report is unfavorable, purchase a Grinder.

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(ii) EV (strategy) = $ 16,480.

(iii) EVSI = EVwSI – EvwoSI = $16,480 – $11,200 = $ 5,280

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2.
Computation of seasonal indices:

Year Quarter Sales 4-Qtr. Moving Centered Seasonal

Irregular
(1000s) Average Moving Avg.
Component
1 18
2 23
102/4 = 25.5
1 3 20 25.625 0.7805
103/4 = 25.75
4 41 26 1.5769
105/4 = 26.25
1 19 26.5 0.7170
107/4 = 26.75
2 25 27.25 0.9194
2 111/4 = 27.75
3 22
4 45

Sum of the indices is 3.9938 ≈ 4.00. Seasonal irregular components are considered as
indices of the corresponding quarters.

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Deseasonalization of the time series data

Year Quarter Yt St Yt/St

1 18 0.7170 25.10
1 2 23 0.9194 25.01
3 20 0.7805 25.62
4 41 1.5769 26
1 19 0.7170 26.50
2 2 25 0.9194 27.19
3 22 0.7805 28.19
4 45 1.5769 28.54

Trend projection calculation:

t Yt t Yt t2
1 25.10 25.10 1
2 25.01 50.02 4
3 25.62 76.86 9
4 26 104 16
5 26.50 132.5 25
6 27.19 163.14 36
7 28.19 197.33 49
8 28.54 228.32 64
Total 36 212.15 977.27 204

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 36 212 .15
We have t= = 4.5, Y = = 26 .52
8 8
977 .27 − (36 × 212 .15 ) / 8
b1 = = 0.5381 .
204 − (36 × 36 ) / 8
b0 = 26 .52 − 0.5381 × 4.5 = 24 .10
Tt = 24 .10 + 0.5381 t.

Forecasting without seasonal effect:

T9 = 24.10 + 0.5381 × 9 = 28.94

T10 = 24.10 + 0.5381 × 10 = 29.48

T11 = 24.10 + 0.5381 × 11 = 30.02

T12 = 24.10 + 0.5381 × 12 = 30.56

Forecasting with seasonal adjustment:

t Trend Forecast Seasonal Quarterly forecast

Index
13 28.94 0.7170 20.75
14 29.48 0.9194 27.10
15 30.02 0.7805 23.43
16 30.56 1.5769 48.19

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