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Exam 1
Quantitative Methods for Management (SM 60.65)

INSTRUCTED TO DO SO

## This exam is to be completed individually. Dishonest behavior during

the exam will result in a failing grade, and the maximum penalty
stipulated by the School of Management

Instructions
3. Do the calculations carefully
4. If you have extra time, check your answers to avoid silly mistakes

## Question 1 (25 points)

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).

## Question 3 (20 points)

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%

## Not so healthy market

\$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 : _______________________________________________________________