Hand out : Decision Tree 1. Mr. Pankaj wants to invest Rs. 50 lakhs for a period of one ear!

and has the followin" options #nvest in fi$ed deposits which will ield constant annual interest of ! sa %.5& #nvest in a propert in cit . The propert rates 'a increase! and the propert 'a fetch Rs. (0 )akhs at the end of the ear! with the pro*a*ilit of 0.5. +ut! the propert prices 'i"ht not increase so 'uch and 'i"ht fetch Rs 55 )akhs at the end of the ear. The pro*a*ilit of this happenin" is 0.,. The propert rate 'a re'ain unchan"ed and the propert 'i"ht fetch onl Rs 50 )akhs. The pro*a*ilit for this is 0. #nvest in a propert in the su*ur* of the cit . #f the su*ur* "rows! the propert 'i"ht "ive "ood profit! otherwise the rate of the propert 'i"ht even decline. The chance that the invest'ent will "ive Rs .0 )akhs is ,0& ! and the chance that the invest'ent will *e just worth Rs. ,5 )akhs is .0&. #nvest in 'utual funds. #f the stock 'arket is "ood! it 'i"ht *e worth Rs. 5. )akhs/ otherwise it 'i"ht *e worth onl Rs. 5- )akhs. The chances that the 'arket 'i"ht *e "ood or otherwise is (0& and 00& !respectivel .Help Pankaj take appropriate decision -. 1 co'pan is plannin" to open a super *a2aar in a cit . The co'pan has selected three different locations na'el location 1! + and 3. )ocation 1 is in the upper class do'inated localit . Here! if the project is successful! it would "ive net profit of Rs. 50 )akhs per annu'! *ut if the project is not successful! the co'pan would lose Rs. (5 )akhs. )ocation + is in 'iddle class do'inated localit . Here! if the project is successful! the co'pan would "et net profit of Rs ,0 )akhs per annu' *ut if it fails it would have annual loss of Rs. 15 )akhs.The third location 3 is on the hi"hwa ! little out of cit . Here! if the project is successful! would ield net profit of Rs 15 )akhs! and if it is unsuccessful! it would result in neither profit nor loss. The success of a project at each location is dependent on the retail industr . #f the retail industr does well! project at an location would *e successful! and if the "rowth in the retail industr declines the project would not *e so successful irrespective of location. There is a (0& chance that the retail industr would "row. 4iven this scenario! in which location should the co'pan open the super*a2aar5 ,. 6vel n Parkhill is considerin" three possi*le wa s to invest the 7-00!000 she has just inherited. 819 :o'e of her friends are considerin" financin" a co'*ined laundro'at! video;"a'e arcade! and pi22eria! where the oun" sin"les in the area can 'eet and pla while doin" their laundr . This venture is hi"hl risk and could result in either a 'ajor loss or a su*stantial "ain within a ear. 6vel n esti'ates that with pro*a*ilit 0.(! she will lose all of her 'one . However! with pro*a*ilit 0.0! she will 'ake a 7-00!000 profit. 8-9 :he can invest in so'e new apart'ents that are *ein" *uilt in town. <ithin 1 ear! this fairl conservative project will produce a profit of at least 710!000! *ut it 'i"ht ield 715!000! 7-0!000! 7-5!000! or possi*l even 7,0!000. 6vel n esti'ates the pro*a*ilities of these five returns at 0.-0! 0.,0! 0.-5! 0.-0. and 0.05! respectivel . 8,9 :he can invest in so'e "overn'ent securities that have a current ield of =.-5 percent. 8a9 8*9 8c9 8d9 8e9 0. 3onstruct a decision tree to help 6vel n decide how to invest her 'one . <hich invest'ent will 'a$i'i2e her e$pected 1; ear profit5 How hi"h would the ield on the "overn'ent *onds have to *e *efore she would decide to invest in the'5 How 'uch would she *e willin" to pa for perfect infor'ation a*out the success of the laundro'at5 How 'uch would she *e willin" to pa for perfect infor'ation a*out the success of the apart'ents5

1 far'er is considerin" drillin" a well. #n the past onl .0& wells drilled were successful at -0 'etres depth in that area Moreover on findin" no water at -0 'etres! so'e person in that area drilled it up to -5 'etres *ut onl -0& struck water at that level. The prevailin" cost of drillin" is Rs. 500 per 'etre. The far'er esti'ated that in case he does not "et water in his own well he will have to pa Rs. 15000 to *u water fro' outside for the sa'e period of "ettin" water fro' the well. Deter'ine the far'er>s decision strate" .

5. The ?il #ndia 3orporation 8?#39 is considerin" whether to "o for an offshore oil drillin" contract to *e awarded in +o'*a Hi"h. #f ?#3 *id! value would *e Rs (00 'illion with a (5& chance of "ainin" the contract. The ?#3 'a set up a new drillin" operation or 'ove alread e$istin" operation! which has proved successful! to a new site. The pro*a*ilit of success and e$pected returns are a follows: ?utco'e @ew drillin" operation 6$istin" ?peration Pro*a*ilit 6$pected revenue Pro*a*ilit 6$pected revenue 8Rs 'illion9 8Rs 'illion9 :uccess 0..5 =00 0.=5 .00 Aailure 0.-5 -00 0.15 ,50 #n the 3orporation do not *id or lose the contract! the can use Rs (00 'illion to 'odernise their operation. This would result in a return of either 5 percent or = percent on the su' invested with pro*a*ilities 0.05 and 0.55. 81ssu'e that all costs and revenue have *een discounted to present value.9 8a9 3onstruct a decision tree for the pro*le' showin" clearl the courses of action. 8*9 + appl in" an appropriate decision criterion reco''end whether or not the ?il #ndia 3orporation should *id the contract. (. Ra'an #ndustries )td has a new product which the e$pect has "reat potential. 1t the 'o'ent the have two courses of action open to the': To test 'arket 8: 19 and to drop product 8:-9. #f the test it! it will cost Rs 50!000 and the response could *e positive or ne"ative with pro*a*ilities 0..0 and 0.,0! respectivel . #f it is positive! the could either 'arket it with full effort or drop the product. #f the 'arket with full scale! then the result 'i"ht *e low! 'ediu'! or hi"h de'and and the respective net pa offs would *e B Rs 1!00!000! Rs 1!50!000C; or Rs 5!00!000. These outco'es have pro*a*ilities of 0.-5! 0.55 and 0.-0! respectivel . #f the result of the test 'arketin" is ne"ative the have decided to drop the product. #f! at an point! the drop the product there is a net "ain of Rs -5!000 fro' the sale of scrap. 1ll financial values have *een discounted to the present. Daw a decision tree for the pro*le' and indicate the 'ost preferred decision. .. 1 'anufacturin" co'pan has just developed a new product. ?n a *asis of past e$perience! a product such as this will either *e successful! with an e$pected "ross return of Rs 1!00!000! or unsuccessful! with an e$pected "ross return of Rs -0!000. :i'ilar products 'anufactured * the co'pan have a record of *ein" successful a*out 50 percent of the ti'e. The production and 'arketin" costs of the new product are e$pected to *e Rs 50!000. The co'pan is considerin" whether to 'arket this new product or to drop it. +efore 'akin" its decision! a test 'arketin" effort can *e conducted at a cost of Rs 10!000. +ased on past e$perience! test 'arketin" results have *een favoura*le a*out .0 percent of the ti'e. Aurther'ore! products favoura*l tested have *een successful =0 percent of the ti'e. However! when the test 'arketin" result has *een unfavoura*le! the product has onl *een successful ,0 percent of the ti'e. <hat course of action should the co'pan pursue5 =. The ?re Minin" 3o'pan is atte'ptin" to decide whether or not a certain piece of land should *e purchased. The land cost is Rs ,!00!000. #f there are co''ercial ore deposits on the land! the esti'ated value of propert is Rs 5!00!000. #f no ore deposits e$ist! however! the propert value is esti'ated at Rs -!00!000. +efore purchasin" the land! the propert can *e cored at a cost of Rs -0!000. The corin" will indicate if conditions are favoura*le or unfavoura*le for ore 'inin". #f the corin" report is favoura*le the pro*a*ilit of recovera*le ore deposits on the land is 0.=! while if the corin" report is unfavoura*le the pro*a*ilit is onl 0.-. Prior to o*tainin" an corin" infor'ation! 'ana"e'ent esti'ates that the odds are 50;50 that ore is present on the land. Mana"e'ent has also received corin" reports on pieces of land si'ilar to the ore in Duestion and found that (0 percent of the corin" reports were favoura*le. 3onstruct a decision tree and deter'ine whether the co'pan should purchase the land! decline to purchase it! or take a corin" test *efore 'akin" its decision. :pecif the opti'al course of action and 6ME.