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Original Title: 2009 Exam 1

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Exam 1

Quantitative Methods for Management (SM 60.65)

INSTRUCTED TO DO SO

the exam will result in a failing grade, and the maximum penalty

stipulated by the School of Management

Instructions

1. Manage your time carefully

2. Read each question carefully

3. Do the calculations carefully

4. If you have extra time, check your answers to avoid silly mistakes

Dana Meseroll, President of Graphic Corporation, has signed a $1,050,000 contract to

deliver and install a sophisticated detection system called G-LAN to a major ship

building corporation.

Using normal production techniques, Graphic can produce and install G-LAN for

$600,000. However, if all possible precaution is taken, G-LAN can be produced and

installed at a cost of $720,000. If the machine is built with all precaution, it will function

up to specification for sure.

If G-LAN is built the normal way, there is an 8% chance the machine will not perform up

to specifications. It would then have to be shipped back and rebuilt at an additional cost

of $150,000 and then sent back to be installed at an additional cost of $210,000. A rebuilt

machine is guaranteed to function properly.

One option is to pre-test the machine, a test that would cost $20,000. The output of the

test would be Positive, Neutral, or Negative. If the G-LAN is functional, then the

chance that it would test positive is 70%, and the chance that it would test neutral is 20%.

If the G-LAN is not functioning, then the chance that it would test negative is 75% and

the chance that it would test neutral is 10%.

If the testing option is elected, Dana has the option to rebuild the machine after reviewing

the test result. Once again, rebuilding the machine would cost an additional $150,000 and

would guarantee that the machine would then function properly. Note that the shipping

and re-installation costs do not apply in this case.

Danas estimate of lost of goodwill and reputation from the machine not functioning

according to specifications after the first installment is $100,000.

a) (5 points) Write down the profits obtained at the end of each branch in the tree

provided on page 3. The units should be in thousands of dollars. Use a positive sign

for a profit and a negative sign for a loss.

b) (4 points) Complete the probability table below (using three decimal places). Show

your calculations in the spaces provided on page 2.

Test Result

Positive

G-LAN Defective

0.012

G-LAN Functional

0.644

Neutral

b1

Negative

b3

0.184

b2

0.080

0.092

b4

0.920

Calculate b1:

Calculate b2:

Calculate b3:

Calculate b4:

c) (6 points) Calculate p4-p9 in the decision tree, showing your calculations below.

Calculate p4:

Calculate p5:

Calculate p6:

Calculate p7:

Calculate p8:

Calculate p9:

d) (10 points) Fill in all the missing information in the tree on page 3. Calculate the

EMVs at all nodes (no need to show your calculations).

$____

$330

Ok, 0.920

$_____

Build perfect

$_____ Regular, no

test

B

Defective, 0.080

$_____

$____

$_____

Ship

Rebuild

Ok,

p4 = _____

Defective,

p5 = _____

$____

$____

$____

Test

Positive

p1 = _____

$_____

$_____

$_____

Neutral

p2 = _____

Ship

Ok,

p6 = _____

Defective,

p7 = _____

$____

$____

Rebuild

$____

$_____

Negative

p3 = _____

$_____

Ship

Rebuild

$____

Ok,

p8 = _____

Defective,

p9 = _____

$____

$____

Question 2 (5 points)

Use the decision tree from question 1 to answer this question.

What is the pre-test worth? To answer this question, first convince yourself that if the test

were for free, Dana Meseroll would elect to pre-test as the optimal strategy. Now,

imagine the cost of the test slowly increases, starting from zero going up to $1, $2, $3

and so forth. At this low cost, Dana would still elect to pre-test because it continues to be

the optimal decision. At some point, however, the test becomes too expensive, and Dana

would then choose to abandon the pre-test option. What is the maximum pre-test cost

before Dana decides to abandon the pre-test option? (This value represents the economic

worth of the test).

Show your reasoning below.

Sanjay Thomas has received a job offer from a top-flight management consulting firm

offering an annual salary of $80,000 (first year). He is also interested in opening an

upscale restaurant serving gourmet Indian cuisine, temporarily named the Gentle Lentil

Restaurant. The non-financial advantages of consulting (variety of work, intellectual

challenge) seem to be evenly matched against the non-financial advantages of opening

the Gentle Lentil Restaurant (less travel, business ownership)

According to his profitability analysis, Sanjay estimated the non-labor fixed costs of

operating the restaurant to be $3,995 per month and the variable costs of food to be

$11/meal served. The number of meals served is estimated to follow a Normal

distribution with mean 3,000 and standard deviation 1,000. Revenue per meal depends on

the local market, and follows the distribution specified in the table below:

Scenario

$20.00

25%

Healthy market

$18.50

35%

$16.50

30%

Unhealthy market

$15.00

10%

Labor costs is estimated to be uniformly distributed between $5,040 and $6,860 per

month

Sanjay also has on the table a financial partnership offer from his aunt. According to the

offer, if earnings in a given month fall below $3,500 his aunt would cover the difference.

In exchange, his aunt would receive 90% of all monthly earnings in excess of $9,000. If

earnings were between $3,500 and $9,000 all such moneys would go to Sanjay.

Write down the Excel formulas that appear in the following cells (see the spreadsheet on

the following page):

Cell C2 : _______________________________________________________________

Cell E2 : _______________________________________________________________

Cell I2 : _______________________________________________________________

Cell Q40 : _______________________________________________________________

Cell U43 : _______________________________________________________________

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