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Week 3

1. Simulating an Outcome of a Bidding Process.

Department of Health in a large US city is accepting bids for the contract to design and deploy a

new citywide healthcare information platform. The IT company Rapid Deployment (RD) plans to

submit a bid and is considering a decision on how much to bid. Since RD does not know exactly

how much its main competitor will bid, it treats is main competitors bid B as a random variable

(RD believes that bids from other potential competitors are unlikely to win). RD estimates, based

on past experience, that B will be normally distributed with mean $12 million and the standard

deviation of $1 million. RD estimates that its own cost of designing and deploying the new

platform will be $11 million, and it plans to submit a bid amount A=$11.5 million. The company

that submits the lowest bid will win the contract, and if the bids are tied, RDs competitor will get

the contract as it has more experience with similar projects. Thus, if B turns out to be less than or

equal to $11.5 million, RD will lose this contract and RDs profit will be $0. On the other hand, if B

turns out to be greater than $11.5 million, then RD will win this contract, and RDs profit will be

equal to $11.5 million - $11million = $0.5 million. RD would like to use simulation to model the

distribution of its profit.

Questions:

(a) Write down an algebraic expression for RDs profit as a function of its competitors bid B.

Answer:

RDs profit (in $millions) can be expressed as IF(B11.5,0,0.5).

(b) Suppose that Excels Random Number Generation tool has generated the following sequence

of 5 random values from the normal distribution with mean of 12 and standard deviation of 1:

10.5, 12.3, 11.4, 13.8,12.5. These values reflect 5 random values of competitors bid, in $

millions. What is the sample mean of the RDs profit values corresponding to these

competitors bid values?

Answer:

The RDs profit is 0 for the bid values of 10.5 and 11.4, and 0.5 for

the bid values of 12.3, 13.8, and 12.5. The sample mean of numbers 0,

0.5,0,0.5,0.5 is (0+0.5+0+0.5+0.5)/5=0.3.

(c) Use Excel to set up and run a simulation of the RDs profit using n=100 simulation trials and

the random seed of 123. Based on the results of this simulation, what are the estimates for

the expected value and the standard deviation of the RDs profit?

Answer:

See RD.xlsx for the details of the simulation set-up. Based on the

results of the simulation with n=100 simulation trials and the random

seed of 123, the estimate for RDs expected profit is $0.345 million,

and the estimate for the standard deviation of RDs profit is $0.2324

million.

Page 1

Week 3

2. Setting Price for Hotel Rooms.

Bharatiya Ghar (BG) is an Indian real-estate development company that have just finished

building a hotel in Goa. BGs hotel has 150 luxury rooms, and the company needs to decide on

the long-term price levels to be charged for the hotel rooms. In particular, BG considers a potential

price level of 10000 per room per day. Based on the analysis of the market research and past

occupancy data, the company estimates that if it uses the 10000 price level, the daily demand

for rooms at the hotel D will be distributed as a Poisson random variable with parameter 1471.

The company assumes that if demand for rooms on a particular day exceeds 150, all extra room

requests (above 150) will be lost to another hotel.

Questions:

(a) Suppose the demand on a given day turns out to be 137. What is the total revenue that BG

will receive on that day?

Answer:

If the demand for rooms turns out to be 137, BGs revenue for that

day is 137*10000 = 1370000.

(b) Suppose the demand on a given day turns out to be 153. What is the total revenue that BG

will receive on that day?

Answer:

If the demand for rooms turns out to be 153, the first 150 room

requests will be satisfied, and the 3 remaining room requests will

be lost to competitors. Thus, BGs revenue for that day will be

150*10000 = 1500000.

(c) What is the algebraic expression for the daily total revenue BG will receive, R, as a function

of the daily demand D?

Answer:

BGs daily revenue (in ) can be calculated as

R = IF(D 150,10000*D,1500000).

Poisson random variable with parameter can only take integer non-negative values 0,1,2,, and has

both the mean and the variance equal to . It can be used to describe random quantities that cannot take

negative or fractional values, such as demand values. In particular, a Poisson random variable with

parameter 147 has the expected value of 147 and the standard deviation (i.e., square root of variance) of

147 12.12. Excels Random Number Generation utility includes the ability to generate instances of

Poisson random variables.

Page 2

Week 3

(d) Suppose that Excels Random Number Generation tool has generated the following sequence

of 5 random values from the Poisson distribution with parameter 147: 171, 148, 156, 157, 140.

These values reflect 5 random daily demand values. What is the sample standard deviation

of the BGs daily total revenue values corresponding to these demand values?

Answer:

BGs total daily revenue values, in , corresponding to the demand

values D = 171, 148, 156, 157, and 140 are R = 1500000, 1480000,

1500000, 1500000, 1400000. The sample standard deviation for these

five numbers can be calculated using STDEV() function in Excel. The

result is 43358.96678 or about 43359.

(e) Use Excel to set up and run a simulation of the total daily revenue R using n=100 simulation

trials and the random seed of 123. Based on the results of this simulation, what are the

estimates for the expected value and the standard deviation of the total daily revenue?

Answer:

See BG.xlsx for the details of the simulation set-up. Based on the

results of the simulation with n=100 simulation trials and the

random seed of 123, the estimate for BGs expected total daily

revenue is 1442700, and the estimate for the standard deviation of

BGs total daily revenue is 71602.9315.

(f) An analyst working for BG believes that the daily demand for rooms can be modeled in a

simpler way. In particular, she estimates that the daily demand can be high and equal to 159

or low and equal to 135. Each scenario, high or low, is equally likely to be observed on

any particular day. Note that under this demand model, the expected demand is equal to

0.5*159+0.5*135=147, and the standard deviation of the daily demand is equal to

0.5 (159 147)2 + 0.5 (135 147)2 = 12, which is close to the standard deviation of the

Poisson model described above. Calculate the expected value (mean) and the standard

deviation of BGs daily total revenue values under this alternative model.

Answer:

If the demand value on a particular day is high, i.e., D=159, then

the total revenue value on that day, in , is R = 1500000. On the

other hand, if the demand value on a particular day is low, i.e.,

D=135, then the total revenue value on that day, in , is R =

1350000. The expected value of the total daily revenue is then equal

to 0.5*1500000+0.5*1350000 = 1425000. The standard deviation of the

total daily revenue values is calculated as

0.5 (1500000 1425000)2 + 0.5 (1350000 1425000)2 =

0.5 (75000)2 + 0.5 (75000)2 = 75000.

Page 3

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