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3
C H A P T E R
Decision Analysis
TEACHING SUGGESTIONS
Teaching Suggestion 3.1: Using the Steps
of the Decision-Making Process.
The six steps used in decision theory are discussed in this chapter.
Students can be asked to describe a decision they made in the last
semester, such as buying a car or selecting an apartment, and de-
scribe the steps that they took. This will help in getting stu-
dents involved in decision theory. It will also help them realize
how this material can be useful to them in making important per-
sonal decisions.
Teaching Suggestion 3.2: Importance of Defining the Problem
and Listing All Possible Alternatives.
Clearly defining the problem and listing the possible alternatives can
be difficult. Students can be asked to do this for a typical decision-
making problem, such as constructing a new manufacturing plant.
Role-playing can be used to make this exercise more interesting.
Many students get too involved in the mathematical ap-
proaches and do not pay enough attention to the importance of
carefully defining the problem and considering all possible alter-
natives. These initial steps are important. Students need to realize
that if they do not carefully define the problem and list all alterna-
tives, most likely their analyses will be wrong.
Teaching Suggestion 3.3: Categorizing Decision-Making Types.
Decision-making types are discussed in this chapter; decision
making under certainty, risk, and uncertainty are included. Stu-
dents can be asked to describe an important decision they had to
make in the past year and categorize the decision type. A good ex-
ample can be a financial investment of $1,000. In-class discussion
can help students realize the importance of decision theory and its
potential use.
Teaching Suggestion 3.4: Starting the EVPI Concept.
The material on the expected value of perfect information (EVPI)
can be started with a discussion of how to place a value on infor-
mation and whether or not new information should be acquired.
The use of EVPI to place an upper limit on what you should pay
for information is a good way to start the section on this topic.
Teaching Suggestion 3.5: Starting the Decision-Making
Under Uncertainty Material.
The section on decision-making under uncertainty can be started
with a discussion of optimistic versus pessimistic decision makers.
Students can be shown how maximax is an optimistic approach,
while maximin is a pessimistic decision technique. While few peo-
ple use these techniques to solve real problems, the concepts and
general approaches are useful.
Teaching Suggestion 3.6: Decision Theory
and Life-Time Decisions.
This chapter investigates large and complex decisions. During
ones life, there are a few very important decisions that have a
major impact. Some call these life-time decisions. Students can
be asked to carefully consider these life-time decisions and how
decision theory can be used to assist them. Life-time decisions in-
clude decisions about what school to attend, marriage, and the
first job.
Teaching Suggestion 3.7: Popularity of Decision Trees
Among Business Executives.
Stress that decision trees are not just an academic subject; they are
a technique widely used by top-level managers. Everyone appreci-
ates a graphical display of a tough problem. It clarifies issues and
makes a great discussion base. Harvard business students regularly
use decision trees in case analysis.
Teaching Suggestion 3.8: Importance of Accurate
Tree Diagrams.
Developing accurate decision trees is an important part of this
chapter. Students can be asked to diagram several decision situa-
tions. The decisions can come from the end-of-chapter problems,
the instructor, or from student experiences.
Teaching Suggestion 3.9: Diagramming a Large Decision
Problem Using Branches.
Some students are intimidated by large and complex decision
trees. To avoid this situation, students can be shown that a large
decision tree is like having a number of smaller trees or decisions
that can be solved separately, starting at the end branches of the
tree. This can help students use decision-making techniques on
larger and more complex problems.
Teaching Suggestion 3.10: Using Tables to Perform
Bayesian Analysis.
Bayesian analysis can be difficult; the formulas can be hard to
remember and use. For many, using tables is the most effective
way to learn how to revise probability values. Once students un-
derstand how the tables are used, they can be shown that the for-
mulas are making exactly the same calculations.
ALTERNATIVE EXAMPLES
Alternative Example 3.1: Goleb Transport
George Goleb is considering the purchase of two types of industrial
robots. The Rob1 (alternative 1) is a large robot capable of perform-
ing a variety of tasks, including welding and painting. The Rob2 (al-
ternative 2) is a smaller and slower robot, but it has all the capabilities
17
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18 CHAPTER 3 DECISION ANALYSIS

of Rob1. The robots will be used to perform a variety of repair opera- The Hurwicz approach uses a coefficient of realism value of
tions on large industrial equipment. Of course, George can always do 0.7, and a weighted average of the best and the worst payoffs for
nothing and not buy any robots (alternative 3). The market for the re- each alternative is computed. The results are as follows:
pair could be either favorable (event 1) or unfavorable (event 2). Weighted average (alternative 1)  ($50,000)(0.7)
George has constructed a payoff matrix showing the expected returns  ($40,000)(0.3)
of each alternative and the probability of a favorable or unfavorable  $23,000
market. The data are presented below:
Weighted average (alternative 2)  ($30,000)(0.7)
 ($20,000)(0.3)
EVENT 1 EVENT 2  $15,000
Probability 0.6 0.4 Weighted average (alternative 3)  0
Alternative 1 50,000 40,000 The decision would be alternative 1.
Alternative 2 30,000 20,000 The minimax regret decision minimizes the maximum oppor-
Alternative 3 0 0 tunity loss. The opportunity loss table for Goleb is as follows:

Favorable Unfavorable Maximum

This problem can be solved using expected monetary value. The Alternatives Market Market in Row
equations are presented below:
Rob1 0 40,000 40,000
EMV (alternative 1)  ($50,000)(0.6)  ($40,000)(0.4) Rob2 20,000 20,000 20,000
 $14,000 Nothing 50,000 0 50,000
EMV (alternative 2)  ($30,000)(0.6)  ($20,000)(0.4)
 $10,000 The alternative that minimizes the maximum opportunity loss is
the Rob2. This is due to the $20,000 in the last column in the table
EMV (alternative 3)  0
above. Rob1 has a maximum opportunity loss of $40,000, and
The best solution is to purchase Rob1, the large robot. doing nothing has a maximum opportunity loss of $50,000.
Alternative Example 3.2: George Goleb is not confident about Alternative Example 3.3: George Goleb is considering the pos-
the probability of a favorable or unfavorable market. (See Alterna- sibility of conducting a survey on the market potential for indus-
tive Example 3.1.) He would like to determine the equally likely trial equipment repair using robots. The cost of the survey is
(Laplace), maximax, maximin, coefficient of realism (Hurwicz), and $5,000. George has developed a decision tree that shows the over-
minimax regret decisions. The Hurwicz coefficient should be 0.7. all decision, as in the figure on the next page.
The problem data are summarized below: This problem can be solved using EMV calculations. We
start with the end of the tree and work toward the beginning com-
puting EMV values. The results of the calculations are shown in
EVENT 1 EVENT 2
the tree. The conditional payoff of the solution is $18,802.
Probability 0.6 0.4
Alternative Example 3.4: George (in Alternative Example 3.3)
Alternative 1 50,000 40,000 would like to determine the expected value of sample information
Alternative 2 30,000 20,000 (EVSI). EVSI is equal to the expected value of the best decision
Alternative 3 0 0 with sample information, assuming no cost to gather it, minus the
expected value of the best decision without sample information.
Because the cost of the survey is $5,000, the expected value of the
The Laplace (equally likely) solution is computed averaging the best decision with sample information, assuming no cost to gather
payoffs for each alternative and choosing the best. The results are it, is $23,802. The expected value of the best decision without
shown below. Alternatives 1 and 2 both give the highest average sample information is found on the lower branch of the decision
return of $5,000. tree to be $14,000. Thus, EVSI is $9,802.
Average (alternative 1)  [$50,000  ($40,000)]/2 Alternative Example 3.5: This example reveals how the condi-
 $5,000 tional probability values for the George Goleb examples (above)
Average (alternative 2)  [$30,000  ($20,000)]/2 have been determined. The probability values about the survey are
 $5,000 summarized in the following table:
Average (alternative 3)  0
Results of Favorable Market Unfavorable Market
The maximin decision (pessimistic) maximizes the minimum pay- Survey (FM) (UM)
off outcome for every alternative: these are 40,000; 20,000; Positive (P) P(P | FM)  0.9 P(P | UM)  0.2
and 0. Therefore, the decision is to do nothing. Negative (N) P(N | FM)  0.1 P(N | UM)  0.8
The maximax decision (optimistic) maximizes the maximum
payoff for any alternative: these maximums are 50,000; 30,000; Using the values above and the fact that P(FM)  0.6 and
and 0. Therefore, the decision is to purchase the large robot P(UM)  0.4, we can compute the conditional probability values
(alternative 1). of a favorable or unfavorable market given a positive or negative
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CHAPTER 3 DECISION ANALYSIS 19

First Second
Decision Decision
Point Point

Favorable Market (0.871)

0 $45,000
,39 2
$ 33 Unfavorable Market (0.129)
$45,000
b1
Ro
Favorable Market (0.871)
$25,000
Rob2
3
2) Unfavorable Market (0.129)
.6 $25,000
(0
y
ve
r lts le
Su su rab $5,000
e
R vo
1 Fa
2 Favorable Market (0.158)
, 80 $45,000
Su sul tive

8 ey
$1 4
rv

ct urv
Re ega

Unfavorable Market (0.842)

ey

u
N

d tS $45,000
b1
(0

on e Ro
ts

C ark
.3

Favorable Market (0.158)

8)

M $25,000
Rob2
5 Unfavorable Market (0.842)
$25,000

$5,000
$5,000
Do
No
tC
on
du

Favorable Market (0.60)

$50,000
ct

0
Su

4 ,00 6 Unfavorable Market (0.40)

rv

$1 $40,000
ey

b1
Ro
Favorable Market (0.60)
$30,000
Rob2
7 Unfavorable Market (0.40)
$20,000

$0

Figure for Alternative Example 3.3

survey result. The calculations are presented in the following Alternative Example 3.6: In the section on utility theory, Mark
two tables. Simkin used utility theory to determine his best decision. What
Probability revision given a positive survey result decision would Mark make if he had the following utility values?
Is Mark still a risk seeker?
State of Conditional Prior Joint Posterior
Nature Probability Prob. Prob. Probability U($10,000)  0.8
FM 0.9 0.6 0.54 0.54/0.62  0.871 U($0)  0.9
UM 0.2 0.4 0.08 0.08/0.62  0.129 U($10,000)  1
Total 0.62 1.00 Using the data above, we can determine the expected utility of
each alternative as follows:
Probability given a negative survey result
U(Mark plays the game)  0.45(1)  0.55(0.8)  0.89
State of Conditional Prior Joint Posterior U(Mark doesnt play the game)  0.9
Nature Probability Prob. Prob. Probability
Thus, the best decision for Mark is not to play the game with an
FM 0.1 0.6 0.06 0.06/0.38  0.158 expected utility of 0.9. Given these data, Mark is a risk avoider.
UM 0.8 0.4 0.32 0.32/0.38  0.842
Total 0.38 1.00

M03_REND6289_10_IM_C03.QXD 5/7/08 3:48 PM Page 20
20 CHAPTER 3 DECISION ANALYSIS
SOLUTIONS TO DISCUSSION QUESTIONS
AND PROBLEMS
3-1. The purpose of this question is to make students use a per-
sonal experience to distinguish between good and bad decisions.
A good decision is based on logic and all of the available informa-
tion. A bad decision is one that is not based on logic and the avail-
able information. It is possible for an unfortunate or undesirable
outcome to occur after a good decision has been made. It is also
possible to have a favorable or desirable outcome occur after a bad
decision.
3-2. The decision-making process includes the following steps:
(1) define the problem, (2) list the alternatives, (3) identify the pos-
sible outcomes, (4) evaluate the consequences, (5) select an evalua-
tion criterion, and (6) make the appropriate decision. The first four
steps or procedures are common for all decision-making problems.
Steps 5 and 6, however, depend on the decision-making model.
3-3. An alternative is a course of action over which we have
complete control. A state of nature is an event or occurrence in
which we have no control. An example of an alternative is decid-
ing whether or not to take an umbrella to school or work on a par-
ticular day. An example of a state of nature is whether or not it
will rain on a particular day.
3-4. The basic differences between decision-making models
under certainty, risk, and uncertainty depend on the amount of
chance or risk that is involved in the decision. A decision-making
model under certainty assumes that we know with complete confi-
dence the future outcomes. Decision-making-under-risk models
assume that we do not know the outcomes for a particular decision
but that we do know the probability of occurrence of those out-
comes. With decision making under uncertainty, it is assumed that
we do not know the outcomes that will occur, and furthermore, we
do not know the probabilities that these outcomes will occur.
3-5. The techniques discussed in this chapter used to solve deci-
sion problems under uncertainty include maximax, maximin, equally
likely, coefficient of realism, and minimax regret. The maximax
decision-making criterion is an optimistic decision-making criterion,
while the maximin is a pessimistic decision-making criterion.
3-6. For a given state of nature, opportunity loss is the difference
between the payoff for a decision and the best possible payoff for
that state of nature. It indicates how much better the payoff could
have been for that state of nature. The minimax regret and the mini-
mum expected opportunity loss are the criteria used with this.
3-7. Alternatives, states of nature, probabilities for all states of
nature and all monetary outcomes (payoffs) are placed on the deci-
sion tree. In addition, intermediate results, such as EMVs for mid-
dle branches, can be placed on the decision tree.
3-8. Using the EMV criterion with a decision tree involves
starting at the terminal branches of the tree and working toward
the origin, computing expected monetary values and selecting the
best alternatives. The EMVs are found by multiplying the proba-
bilities of the states of nature times the economic consequences
and summing the results for each alternative. At each decision
point, the best alternative is selected.
3-9. A prior probability is one that exists before additional in-
formation is gathered. A posterior probability is one that can be
computed using Bayes Theorem based on prior probabilities and
additional information.
REVISED
3-10. The purpose of Bayesian analysis is to determine poste-
rior probabilities based on prior probabilities and new information.
Bayesian analysis can be used in the decision-making process
whenever additional information is gathered. This information can
then be combined with prior probabilities in arriving at posterior
probabilities. Once these posterior probabilities are computed,
they can be used in the decision-making process as any other prob-
ability value.
3-11. The expected value of sample information (EVSI) is the
increase in expected value that results from having sample infor-
mation. It is computed as follows:
EVSI  (expected value with sample information)
 (cost of information)  (expected value without
sample information)
3-12. The overall purpose of utility theory is to incorporate a de-
cision makers preference for risk in the decision-making process.
3-13. A utility function can be assessed in a number of different
ways. A common way is to use a standard gamble. With a standard
gamble, the best outcome is assigned a utility of 1, and the worst
outcome is assigned a utility of 0. Then, intermediate outcomes are
selected and the decision maker is given a choice between having
the intermediate outcome for sure and a gamble involving the best
and worst outcomes. The probability that makes the decision maker
indifferent between having the intermediate outcome for sure and a
gamble involving the best and worst outcomes is determined. This
probability then becomes the utility of the intermediate value. This
process is continued until utility values for all economic conse-
quences are determined. These utility values are then placed on a
utility curve.
3-14. When a utility curve is to be used in the decision-making
process, utility values from the utility curve replace all monetary
values at the terminal branches in a decision tree or in the body of
a decision table. Then, expected utilities are determined in the
same way as expected monetary values. The alternative with the
highest expected utility is selected as the best decision.
3-15. A risk seeker is a decision maker who enjoys and seeks
out risk. A risk avoider is a decision maker who avoids risk even if
the potential economic payoff is higher. The utility curve for a risk
seeker increases at an increasing rate. The utility curve for a risk
avoider increases at a decreasing rate.
3-16. a. Decision making under uncertainty.
b. Maximax criterion.
c. Sub 100 because the maximum payoff for this is
$300,000.
Row Row
Equipment Favorable Unfavorable Maximum Minimum
Sub 100 300,000 200,000 300,000 200,000
Oiler J 250,000 100,000 250,000 100,000
Texan 75,000 18,000 75,000 18,000
3-17. Using the maximin criterion, the best alternative is the
Texan (see table above) because the worst payoff for this
($18,000) is better than the worst payoffs for the other decisions.
3-18. a. Decision making under riskmaximize expected
monetary value.
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CHAPTER 3 DECISION ANALYSIS 21

b. EMV (Sub 100)  0.7(300,000)  0.3(200,000) 3-22. a. Expected value with perfect information is
 150,000 1,400(0.4)  900(0.4)  900(0.2)  1,100; the maxi-
mum EMV without the information is 900. Therefore,
EMV (Oiler J)  0.7(250,000)  0.3(100,000)
Allen should pay at most EVPI  1,100 900  $200.
 145,000
b. Yes, Allen should pay [1,100(0.4)  900(0.4) 
EMV (Texan)  0.7(75,000)  0.3(18,000)
900(0.2)]  900  $80.
 47,100
3-23. a. Opportunity loss table
Optimal decision: Sub 100.
c. Ken would change decision if EMV(Sub 100) is less Strong Fair Poor Max.
than the next best EMV, which is $145,000. Let X  Market Market Market Regret
payoff for Sub 100 in favorable market. Large 0 19,000 310,000 310,000
(0.7)(X)  (0.3)(200,000)  145,000 Medium 250,000 0 100,000 250,000
Small 350,000 29,000 32,000 350,000
0.7X  145,000  60,000  205,000 None 550,000 129,000 0 550,000
X  (205,000)/0.7  292,857.14
b. Minimax regret decision is to build medium.
The decision would change if this payoff were less than 292,857.14,
so it would have to decrease by about $7,143. 3-24. a.
3-19. a. The expected value (EV) is computed for each Stock Demand
alternative. (Cases) (Cases) 11 12 13 EMV

EV(stock market)  0.5(80,000)  0.5(20,000)  30,000 11 385 385 385 38512.

12 329 420 420 379.05
EV(Bonds)  0.5(30,000)  0.5(20,000)  25,000 13 273 364 455 341.25
EV(CDs)  0.5(23,000)  0.5(23,000)  23,000 Probabilities 0.45 0.35 0.20
Therefore, he should invest in the stock market.
b. EVPI  EV(with perfect information) b. Stock 11 cases.
 (Maximum EV without P, I) c. If no loss is involved in excess stock, the recom-
 [0.5(80,000)  0.5(23,000)]  30,000 mended course of action is to stock 13 cases and to re-
 51,500  30,000  21,500 plenish stock to this level each week. This follows from
the following decision table.
Thus, the most that should be paid is $21,500.
Stock Demand
3-20. The opportunity loss table is (Cases) (Cases) 11 12 13 EMV
11 385 385 385 385
Alternative Good Economy Poor Economy
12 385 420 420 404.25
Stock Market 0 43,000 13 385 420 455 411.25
Bonds 50,000 3,000
CDs 57,000 0 3-25.
Manu- Demand
EOL(Stock Market)  0.5(0)  0.5(43,000)  21,500*
facture (Cases)
This minimizes EOL.
(Cases) 6 7 8 9 EMV
EOL(Bonds)  0.5(50,000)  0.5(3,000)  26,500
6 300 300 300 300 300
EOL(CDs)  0.5(57,000)  0.5(0)  28,500 7 255 350 350 350 340.5
3-21. a. 8 210 305 400 400 352.5
9 165 260 355 450 317
Market
Alternative Condition Good Fair Poor EMV Probabilities 0.1 0.3 0.5 0.1

Stock market 1,400 800 0 880 John should manufacture 8 cases of cheese spread.
Bank deposit 900 900 900 900 3-26. Cost of produced case  $5.
Probabilities of 0.4 0.4 0.2 Cost of purchased case  $16.
market conditions Selling price  $15.
b. Best decision: deposit $10,000 in bank.
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22 CHAPTER 3 DECISION ANALYSIS

Money recovered from each unsold case  $3.

Supply Demand
(Cases) (Cases) 100 200 300 EMV
100 100(15) 100(5)  1000 200(15)  100(5)  300(15)  100(5)  900
100(16)  900 200(16)  800
200 100(15)  100(3)  200(15)  200(5)  2000 300(15)  200(5)  1610
200(5)  800 100(16)  1900
300 100(15)  200(3)  200(15)  100(3)  300(15)  300(5)  3000 1800
300(5)  600 300(5)  1800
Probabilities 0.3 0.4 0.3

b. Produce 300 cases each day.

3-27. a. The table presented is a decision table. The basis for
the decisions in the following questions is shown in the
table below.

EQUALLY CRIT. OF
MARKET MAXIMAX MAXIMIN LIKELY REALISM
Decision Row Row Row Weighted
Alternatives Good Fair Poor Maximum Minimum Average Average
Small 50,000 20,000 10,000 50,000 10,000 20,000 38,000
Medium 80,000 30,000 20,000 80,000 20,000 30,000 60,000
Large 100,000 30,000 40,000 100,000 40,000 30,000 72,000
Very Large 300,000 25,000 160,000 300,000 160,000 55,000 208,000

b. Maximax decision: Very large station.

c. Maximin decision: Small station.
d. Equally likely decision: Very large station.
e. Criterion of realism decision: Very large station.
f. Opportunity loss table:
MARKET MINIMAX
Decision Good Fair Poor Row
Alternatives Market Market Market Maximum
Small 250,000 10,000 0 250,000
Medium 220,000 0 10,000 220,000
Large 200,000 0 30,000 200,000
Very Large 0 5,000 150,000 150,000

Minimax regret decision: Very large station.

3-28. EMV for node 1  0.5(100,000)  0.5(40,000) 

$30,000. Choose the highest EMV, therefore construct the clinic.

Payoff
Favorable Market (0.5)
$100,000
ct 1
tru $40,000
o ns nic Unfavorable Market (0.5)
C Cli

$30,000
Do
N oth
ing
$0
EMV for no clinic is $0
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CHAPTER 3 DECISION ANALYSIS 23

3-29. a.
Payoff
Favorable Market (0.82)
$95,000
CONSTRUCT 2 Unfavorable Market (0.18)
$45,000

5)
ey .5
u rv e (0 $69,800
S bl
ra
vo
Fa DO NOT CONSTRUCT $5,000

1
t y Favorable Market (0.11)
uc ve $36,140
o nd Sur CONSTRUCT
$95,000
C et 3 Unfavorable Market (0.89)
Ne

k $45,000
ar
Su tive
ga

M
rv (0
ey .4
5)

$36,140 $5,000

DO NOT CONSTRUCT $5,000

Do
No
tC
on
du

Favorable Market (0.5)

ct

$100,000
Su

CONSTRUCT CLINIC
4
rv

Unfavorable Market (0.5)

ey

$40,000

$30,000

$0
DO NOT CONSTRUCT

b. EMV(node 2)  (0.82)($95,000)  (0.18)($45,000)

 77,900  8,100  $69,800
EMV(node 3)  (0.11)($95,000)  (0.89)($45,000)
 10,450  $40,050  $29,600
EMV(node 4)  $30,000
EMV(node 1)  (0.55)($69,800)  (0.45)($5,000)
 38,390  2,250  $36,140
The EMV for using the survey  $36,140.
EMV(no survey)  (0.5)($100,000)  (0.5)($40,000)
 $30,000
The survey should be used.
c. EVSI  ($36,140  $5,000)  $30,000  $11,140.
Thus, the physicians would pay up to $11,140 for the survey.
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24 CHAPTER 3 DECISION ANALYSIS

3-30.
Favorable Market
Large Shop
2 Unfavorable Market

No Shop
e
bl
o ra Favorable Market
v e y
Fa urv Small Shop
S 3 Unfavorable Market

1
k et U Favorable Market
ar ey Su nfa Large Shop
M urv rv vo 4
S ey ra Unfavorable Market
b le
No Shop

Favorable Market
N
o Small Shop
Su 5
rv Unfavorable Market
ey

Favorable Market
Large Shop
6 Unfavorable Market

No Shop

Favorable Market
Small Shop
7 Unfavorable Market

3-31.
a. EMV(node 2)  (0.9)(55,000)  (0.1)($45,000)
 49,500  4,500  $45,000
EMV(node 3)  (0.9)(25,000)  (0.1)(15,000)
 22,500  1,500  $21,000
EMV(node 4)  (0.12)(55,000)  (0.88)(45,000)
 6,600  39,600  $33,000
EMV(node 5)  (0.12)(25,000)  (0.88)(15,000)
 3,000  13,200  $10,200
EMV(node 6)  (0.5)(60,000)  (0.5)(40,000)
 30,000  20,000  $10,000
EMV(node 7)  (0.5)(30,000)  (0.5)(10,000)
 15,000  5,000  $10,000
EMV(node 1)  (0.6)(45,000)  (0.4)(5,000)
 27,000  2,000  $25,000
Since EMV(market survey) > EMV(no survey), Jerry should con-
duct the survey. Since EMV(large shop | favorable survey) is
larger than both EMV(small shop | favorable survey) and EMV(no
shop | favorable survey), Jerry should build a large shop if the sur-
vey is favorable. If the survey is unfavorable, Jerry should build
nothing since EMV(no shop | unfavorable survey) is larger than
both EMV(large shop | unfavorable survey) and EMV(small shop |
unfavorable survey).
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CHAPTER 3 DECISION ANALYSIS 25

Payoff
$45,000 Favorable Market (0.9)
Large Shop $55,000
2 Unfavorable Market (0.1)
$45,000 $45,000
No Shop
le 6) $5,000
ab 0.
v or y ( $21,000 Favorable Market (0.9)
e
Fa urv Small Shop $25,000
S 3 Unfavorable Market (0.1)
$25,000 $15,000
1
t $33,000 Favorable Market (0.12)
ke U
ar ey Su nfa Large Shop $55,000
M urv rv vo 4
S ey ra Unfavorable Market (0.88)
(0 ble $5,000 $45,000
.4
) No Shop
$5,000
$10,200 Favorable Market (0.12)
N $25,000
o Small Shop
Su 5
rv Unfavorable Market (0.88)
ey $15,000

$10,000 Favorable Market (0.5)

Large Shop $60,000
6 Unfavorable Market (0.5)
$10,000 $40,000
No Shop
$0
$10,000 Favorable Market (0.5)
Small Shop $30,000
7 Unfavorable Market (0.5)
$10,000

b. If no survey, EMV  0.5(30,000)  0.5(10,000) 

$10,000. To keep Jerry from changing decisions, the follow-
ing must be true:
EMV(survey) EMV(no survey)
Let P  probability of a favorable survey. Then,
P[EMV(favorable survey)]  (1  P) [EMV(unfavor-
able survey)] EMV(no survey)
This becomes:
P(45,000)  (1  P)(5,000) $10,000
Solving gives
45,000P  5,000  5,000P 10,000
50,000P 15,000
P 0.3
Thus, the probability of a favorable survey could be as low as
0.3. Since the marketing professor estimated the probability
at 0.6, the value can decrease by 0.3 without causing Jerry to
change his decision. Jerrys decision is not very sensitive to
this probability value.
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26 CHAPTER 3 DECISION ANALYSIS

3-32.
Payoff
$8,500 (0.9)
A3 $12,000
2 (0.1)
$23,000
$8,500 $500 (0.9)
A4 $2,000
)
n 5 3
i o 0. (0.1)
at le ( $13,000
rm b
fo ra A5
In avo $3,000
F
$2,750

1
e
or $9,000 (0.4)
r M on In $12,000
e t i U for A3
A 1 ath ma nf m 4 (0.6)
G for av at $23,000
In or ion $3,000
ab $7,000 (0.4)
le A4 $2,000
(0 5
.5) (0.6)
$13,000

A5
$3,000
A 2 o N e In
D or
M

ot fo
G rm
at at

$4,500
he io

(0.7)
A3 $15,000
r n

6 (0.3)
$20,000
$4,500 $500 (0.7)
A4 $5,000
7 (0.3)
$10,000
A5
$0

A1: gather more information P(S1)  0.5; P(S2)  0.5

A2: do not gather more information P(I1 | S1)  0.8; P(I2 | S1)  0.2
A3: build quadplex P(I1 | S2)  0.3; P(I2 | S2)  0.7
A4: build duplex a. P(successful store | favorable research)  P(S1 | I1)
A5: do nothing P ( I1 | S1 ) P ( S1 )
EMV(node 2)  0.9(12,000)  0.1(23,000)  8,500 P ( S1 | I1 ) =
P ( I1 | S1 ) P ( S1 ) + P ( I1 | S2 ) P ( S2 )
EMV(node 3)  0.9(2,000)  0.1(13,000)  500
0.8(0.5)
EMV(get information and then do nothing)  3,000 P ( S1 | I1 ) = = 0.73
0.8(0.5) + 0.3(0.5)
EMV(node 4)  0.4(12,000)  0.6(23,000)  9,000
EMV(node 5)  0.4(2,000)  0.6(13,000)  7,000 b. P(successful store | unfavorable research)  P(S1 | I2)
EMV(get information and then do nothing)  3,000 P ( I 2 | S1 ) P ( S1 )
P ( S1 | I 2 ) =
EMV(node 1)  0.5(8,500)  0.5(-3,000)  2,750 P ( I 2 | S1 ) P ( S1 ) + P ( I 2 | S2 ) P ( S2 )
EMV(build quadplex)  0.7(15,000)  0.3(20,000)  4,500 0.2(0.5)
P ( S1 | I 2 ) = = 0.22
EMV(build duplex)  0.7(5,000)  0.3(10,000)  500 0.2(0.5) + 0.7(0.5)
EMV(do nothing)  0
c. Now P(S1)  0.6 and P(S2)  0.4
Decisions: do not gather information; build quadplex.
0.8(0.6 )
3-33. I1: favorable research or information P ( S1 | I1 ) = = 0.8
0.8(0.6 ) + 0.3(0.4 )
I2: unfavorable research
S1: store successful 0.2(0.6 )
P ( S1 | I 2 ) = = 0.3
S2: store unsuccessful 0.2(0.6 ) + 0.7(0.4 )
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CHAPTER 3 DECISION ANALYSIS 27

3-34. I1: favorable survey or information b. EMV(A)  10,000(0.2)  2,000(0.3)

I2: unfavorable survey  (5,000)(0.5)  100
S1: facility successful EMV(B)  6,000(0.2)  4,000(0.3)  0(0.5)
S2: facility unsuccessful  2,400
P(S1)  0.3; P(S2)  0.7 Fund B should be selected.
P(I1 | S1)  0.8; P(I2 | S1)  0.2 c. Let X  payout for Fund A in a good economy.
P(I1 | S2)  0.3; P(I2 | S2)  0.7 EMV(A)  EMV(B)
P(successful facility | favorable survey)  P(S1 | I1) X(0.2)  2,000(0.3)  (5,000)(0.5)  2,400
0.2X  4,300
P ( I1 | S1 ) P ( S1 )
P ( S1 | I1 ) = X  4,300/0.2  21,500
P ( I1 | S1 ) P ( S1 ) + P ( I1 | S2 ) P ( S2 )
Therefore, the return would have to be $21,500 for Fund A in a
0.8(0.3) good economy for the two alternatives to be equally desirable
P ( S1 | I1 ) = = 0.533 based on the expected values.
0.8(0.3) + 0.3(0.7)
P(successful facility | unfavorable survey)  P(S1 | I2)
P ( I 2 | S1 ) P ( S1 )
P ( S1 | I 2 ) =
P ( I 2 | S1 ) P ( S1 ) + P ( I 2 | S2 ) P ( S2 )

0.2(0.3)
P ( S1 | I 2 ) = = 0.109
0.2(0.3) + 0.7(0.7)

3-35. a.

Good economy 0.2

10,000

Fair economy 0.3

2,000
Fund A
Poor economy 0.5
5,000

Good economy 0.2

6,000
Fund B Fair economy 0.3
4,000

Poor economy 0.5

0
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28 CHAPTER 3 DECISION ANALYSIS

3-36. a.

Payoff
Favorable Market
$95,000
Produce
3
Survey Razor Unfavorable Market
$65,000
Favorable
Do Not Produce Razor
$5,000
1 Favorable Market
$95,000
Produce
4
Survey Razor Unfavorable Market
$65,000
Unfavorable
ey

Do Not Produce Razor

urv

$5,000
tS

Favorable Market
uc

$80,000
nd

Produce
5
Co

Study Razor Unfavorable Market $80,000

Favorable
Do Not Produce Razor $20,000
Conduct
Pilot Favorable Market
2
Study $80,000
Produce
6
Study Razor Unfavorable Market
$80,000
Ne

Unfavorable Do Not Produce Razor

ith

$20,000
er
Te

Favorable Market
st

$100,000
Produce
7
Razor Unfavorable Market
$60,000
Do Not Produce Razor
$0

b. S1: survey favorable EMV(node 5)  80,000(0.89)  (80,000)(0.11)  62,400

S2: survey unfavorable EMV(node 6)  80,000(0.18)  (80,000)(0.82)
S3: study favorable  51,200
S4: study unfavorable EMV(node 7)  100,000(0.5)  (60,000)(0.5)  20,000
S5: market favorable EMV(conduct survey)  59,800(0.45)  (5,000)(0.55)
S6: market unfavorable  24,160
EMV(conduct pilot study)  62,400(0.45)  (20,000)(0.55)
P ( S5 | S1 ) =
0.7(0.5)
= 0.78  17,080
0.7(0.5) + 0.2(0.5) EMV(neither)  20,000
P(S6 | S1)  1 0.778  0.222 Therefore, the best decision is to conduct the survey. If it is favor-
able, produce the razor. If it is unfavorable, do not produce the razor.
0.3(0.5)
P ( S5 | S2 ) = = 0.27 3-37. The following computations are for the decision tree that
0.3(0.5) + 0.8(0.5)
follows.
P(S6 | S2)  1 0.27  0.73 EU(node 3)  0.95(0.78)  0.5(0.22)  0.85
0.8(0.5) EU(node 4)  0.95(0.27)  0.5(0.73)  0.62
P ( S5 | S3 ) = = 0.89
0.8(0.5) + 0.1(0.5) EU(node 5)  0.9(0.89)  0(0.11)  0.80
P(S6 | S3)  1 0.89  0.11 EU(node 6)  0.9(0.18)  0(0.82)  0.16
0.2(0.5) EU(node 7)  1(0.5)  0.55(0.5)  0.78
P ( S5 | S 4 ) = = 0.18
0.2(0.5) + 0.9(0.5) EU(conduct survey)  0.85(0.45)  0.8(0.55)  0.823

P(S6 | S4)  1 0.18  0.82 EU(conduct pilot study)  0.80(0.45)  0.7(0.55)  0.745

c. EMV(node 3)  95,000(0.78)  (65,000)(0.22) EU(neither test)  0.81

 59,800 Therefore, the best decision is to conduct the survey. Jim is a risk
EMV(node 4)  95,000(0.27)  (65,000)(0.73) avoider.
 21,800
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CHAPTER 3 DECISION ANALYSIS 29

Utility
0.85 Market Favorable (0.78)
0.95
Produce
3
Survey Razor Market Unfavorable (0.22)
0.5
Favorable Do Not Produce Razor
0.82 (0.45) 0.8
1 0.62 Market Favorable (0.27)
0.95
Produce
4
Survey Razor Market Unfavorable (0.73)
0.5
ey

Unfavorable Do Not Produce Razor

urv

(0.55) 0.8
tS

0.80 Market Favorable (0.89)

uc

0.9
nd

Produce
5
Co

Study Razor Market Unfavorable (0.11) 0

Favorable Do Not Produce Razor
Conduct 0.745 (0.45) 0.7
Pilot 0.16 Market Favorable (0.18)
2
Study 0.9
Produce
6
Study Razor Market Unfavorable (0.82)
0
Ne

Unfavorable Do Not Produce Razor

ith

(0.55) 0.7
er
Te

0.78 Market Favorable (0.5)

st

1
Produce
7
Razor Market Unfavorable (0.5)
0.55
Do Not Produce Razor
0.81

3-38. a. P(good economy | prediction of P(poor economy | prediction of

0.8(0.6 ) 0.9(0.3)
good economy)  = 0.923 poor economy)  = 0.659
0.8(0.6 ) + 0.1(0.4 ) 0.2(0.7) + 0.9(0.3)

P(poor economy | prediction of 3-39. The expected value of the payout by the insurance com-
pany is
0.1(0.4 )
good economy)  = 0.077 EV  0(0.999)  100,000(0.001)  100
0.8(0.6 ) + 0.1(0.4 )
The expected payout by the insurance company is $100, but the
P(good economy | prediction of
policy costs $200, so the net gain for the individual buying this
0.2(0.6 ) policy is negative ($100). Thus, buying the policy does not maxi-
poor economy)  = 0.25
0.2(0.6 ) + 0.9(0.4 ) mize EMV since not buying this policy would have an EMV of 0,
which is better than $100. However, a person who buys this pol-
P(poor economy | prediction of
icy would be maximizing the expected utility. The peace of mind
0.9(0.6 ) that goes along with the insurance policy has a relatively high util-
poor economy)  = 0.75
0.2(0.6 ) + 0.9(0.4 ) ity. A person who buys insurance would be a risk avoider.

b. P(good economy | prediction of

0.8(0.7)
good economy)  = 0.949
0.8(0.7) + 0.1(0.3)

P(poor economy | prediction of

0.1(0.3)
good economy)  = 0.051
0.8(0.7) + 0.1(0.3)

P(good economy | prediction of

0.2(0.7)
poor economy)  = 0.341
0.2(0.7) + 0.9(0.3)
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30 CHAPTER 3 DECISION ANALYSIS

3-40.

Payoff Utility
U = 0.8118 Favorable Market (0.82)
$95,000 0.99
Construct
2
Survey Clinic Unfavorable Market (0.18)
$45,000 0
Favorable Do Not Construct Clinic
U = 0.76 (0.55) $5,000 0.7
ct U = 0.1089 Favorable Market (0.11)
n du t 1 $95,000 0.99
e
Co ark Construct
3
M Survey Clinic Unfavorable Market (0.89)
$45,000 0
Unfavorable Do Not Construct Clinic
$5,000 0.7
D

(0.45)
o
N
ot rve

U = 0.55 Favorable Market (0.5)

Su
C y

$100,000 1.0
on

Construct
du

4
c

Clinic Unfavorable Market (0.5)

t

$40,000 0.1
Do Not Construct Clinic
$0 0.9

EU(node 2)  (0.82)(0.99)  (0.18)(0)  0.8118 b. Expected utility on Broad Street  0.2(0.5) 

EU(node 3)  (0.11)(0.99)  (0.89)(0)  0.1089 0.9(0.5)  0.55. Therefore, the expressway maximizes
EU(node 4)  0.5(1)  0.5(0.1)  0.55 expected utility.
EU(node 1)  (0.55)(0.8118)  (0.45)(0.7000)  0.7615 c. Lynn is a risk avoider.
EU(no survey)  0.9 1.0
The expected utility with no survey (0.9) is higher than the ex-
pected utility with a survey (0.7615), so the survey should be not 0.8
used. The medical professionals are risk avoiders.
0.6
Utility

3-41. EU(large plant | survey favorable)  0.78(0.95)

 0.22(0)  0.741 0.4
EU(small plant | survey favorable)  0.78(0.5)  0.22(0.1)
 0.412 0.2

EU(no plant | survey favorable)  0.2 0

0 10 20 30 40
EU(large plant | survey negative)  0.27(0.95)  0.73(0)
 0.2565 Time (minutes)

EU(small plant | survey negative)  0.27(0.5)  0.73(0.10)

3-43. Selling price  $20 per gallon; manufacturing cost 
 0.208
$12 per gallon; salvage value  $13; handling costs  $1 per
EU(no plant | survey negative)  0.2 gallon; and advertising costs  $3 per gallon. From this informa-
EU(large plant | no survey)  0.5(1)  0.5(0.05)  0.525 tion, we get:
EU(small plant | no survey)  0.5(0.6)  0.5(0.15)  0.375 marginal profit  selling price minus the manufacturing, handling,
EU(no plant | no survey)  0.3 and advertising costs
EU(conduct survey)  0.45(0.741)  0.55(0.2565)  0.4745 marginal profit  $20  $12  $1  $3  $4 per gallon
EU(no survey)  0.525 If more is produced than is needed, a marginal loss is incurred.
Johns decision would change. He would not conduct the survey marginal loss  $13  $12  $1  $3  $3 per gallon
and build the large plant. In addition, there is also a shortage cost. Coren has agreed to fulfill
3-42. a. Expected travel time on Broad Street  40(0.5)  any demand that cannot be met internally. This requires that Coren
15(0.5)  27.5 minutes. Broad Street has a lower ex- purchase chemicals from an outside company. Because the cost of
pected travel time. obtaining the chemical from the outside company is $25 and the
price charged by Coren is $20, this results in
Expressway 30 Minutes,
shortage cost  $5 per gallon
U = 0.7
In other words, Coren will lose $5 for every gallon that is sold that
Congestion (0.5) 40 Minutes, has to be purchased from an outside company due to a shortage.
Broad U = 0.2
1
Street No 15 Minutes,
Congestion (0.5) U = 0.9
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CHAPTER 3 DECISION ANALYSIS 31

a. A decision tree is shown below:

Decision Tree
(0.2) Demand 500 $2,000 = (500)(4)
(0.3) 1,000
$500 = (500)(4) (500)(5)
$1,500 (0.4) 1,500 $3,000 = (500)(4) (1,000)(5)
Stock
(0.1) 2,000 $5,500 = (500)(4) (1,500)(5)
500
(0.2) 500 $500 = (500)(4) (500)(3)
$1,800
(0.3) 1,000 $4,000 = (1,000)(4)
Stock
1,000 (0.4) 1,500 $1,500 = (1,000)(4) (5)(500)
(0.1) 2,000 $1,000 = (1,000)(4) (5)(1,000)
$3,300
(0.2) 500
Stock $1,000 = (500)(4) (3)(1,000)
1,500 (0.3) 1,000
$2,500 = (1,000)(4) (3)(500)
(0.4) 1,500 $6,000 = (1,500)(4)
Stock (0.1) 2,000 $3,500 = (1,500)(4) (5)(500)
2,000
(0.2) 500
$2,400 $2,500 = (500)(4) (3)(1,500)
(0.3) 1,000
$1,000 = (1,000)(4) (3)(1,000)
(0.4) 1,500
$4,500 = (1,500)(4) (3)(500)
(0.1) 2,000
$8,000 = (2,000)(4)

b. The computations are shown in the following table. These Decision TreeNo Survey
numbers are entered into the tree above. The best decision is to
(0.15)
stock 1,500 gallons. $500,000
Table for Problem 3-43 (0.40)
$500,000
Demand 00
0,0 (0.45)
$500,000
50
Stock 500 1,000 1,500 2,000 EMV
a ll $
Sm (0.15)
500 2,000 500 3,000 5,500 $1,500 $200,000
1,000 500 4,000 1,500 1,000 $1,800
Medium $670,000 (0.40)
1,500 1,000 2,500 6,000 3,500 $3,300 $700,000
2,000 2,500 1,000 4,500 8,000 $2,400 La
rge (0.45)
Maximum 2,000 4,000 6,000 8,000 $4,800  EVwPI $5 $800,000
80
,00
Probabilities 0.2 0.3 0.4 0.1 0 (0.15)
$200,000
c. EVwPI  (0.2)(2,000)  (0.3)(4,000)  (0.4)(6,000) (0.40) $400,000
 (0.1)(8,000)  $4,800
EVPI  EVwPI  EMV  $4,800  $3,300  $1,500 (0.45) $1,000,000
3-44. If no survey is to be conducted, the decision tree is fairly
straightforward. There are three main decisions, which are build- With no survey, we have: EMV(Small)  500,000;
ing a small, medium, or large facility. Extending from these EMV(Medium)  670,000; and EMV(Large)  580,000.
decision branches are three possible demands, representing the The medium facility, with an expected monetary value of
possible states of nature. The demand for this type of facility could $670,000, is selected because it represents the highest ex-
be either low (L), medium (M), or high (H). It was given in the pected monetary value.
problem that the probability for a low demand is 0.15. The proba- If the survey is used, we must compute the revised probabili-
bilities for a medium and a high demand are 0.40 and 0.45, respec- ties using Bayes theorem. For each alternative facility, three
tively. The problem also gave monetary consequences for building revised probabilities must be computed, representing low,
a small, medium, or large facility when the demand could be low, medium, and high demand for a facility. These probabilities
medium, or high for the facility. These data are reflected in the fol- can be computed using tables. One table is used to compute the
lowing decision tree. probabilities for low survey results, another table is used for
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32 CHAPTER 3 DECISION ANALYSIS

medium survey results, and a final table is used for high survey re- Decision TreeSurvey
sults. These tables are shown below. These probabilities will be used
in the decision tree that follows. L 450,000
For low survey resultsA1: Small M 450,000
State of Nature P(Bi) P(Ai | Bj) P(Bj and Ai) P(Bj | Ai)
H
B1 0.150 0.700 0.105 0.339 450,000
B2 0.400 0.400 0.160 0.516 L 150,000
B3 0.450 0.100 0.045 0.145
P(A1)  0.310 Medium M
650,000
For medium survey resultsA2: H
750,000
L 250,000
State of Nature P(Bi) P(Ai | Bj) P(Bj and Ai) P(Bj | Ai)
B1 0.150 0.200 0.030 0.082 Large M
350,000
B2 0.400 0.500 0.200 0.548

10)
Low 5,000
B3 0.450 0.300 0.135 0.370 H
950,000

(0.3
P(A2)  0.365

$49
L
450,000
For high survey resultsA3:
Small M
450,000
State of Nature P(Bi) P(Ai | Bj) P(Bj and Ai) P(Bj | Ai)
H
B1 0.150 0.100 0.015 0.046 450,000
B2 0.400 0.100 0.040 0.123 L
150,000
B3 0.450 0.600 0.270 0.831
P(A3)  0.325 $646,000 Medium M
650,000
Medium
When survey results are low, the probabilities are P(L)  (0.365) H
750,000
0.339; P(M)  0.516; and P(H)  0.145. This results in L
250,000
EMV(Small)  450,000; EMV(Medium)  495,000; and
EMV(Large)  233,600. Large M
350,000
When survey results are medium, the probabilities are P(L) 
H
High

0.082; P(M)  0.548; and P(H)  0.378. This results in EMV

$821 .325)

950,000
(Small)  450,000; EMV(Medium)  646,000; and EMV(Large)  L
(0
,000

522,800. 450,000
When survey results are high, the probabilities are P(L)  Small M
450,000
0.046; P(M)  0.123; and P(H)  0.831. This results in
H
EMV(Small)  450,000; EMV(Medium)  710,100; and 450,000
EMV(Large)  821,000. L
If the survey results are low, the best decision is to build the 150,000
medium facility with an expected return of $495,000. If the survey Medium M
650,000
results are medium, the best decision is also to build the medium
H
plant with an expected return of $646,000. On the other hand, if 750,000
the survey results are high, the best decision is to build the large L
250,000
facility with an expected monetary value of $821,000. The ex-
pected value of using the survey is computed as follows: Large M
350,000
EMV(with Survey)  0.310(495,000)  0.365(646,000) H
 0.325(821,000)  656,065 950,000
Because the expected monetary value for not conducting the sur-
vey is greater (670,000), the decision is not to conduct the survey
and to build the medium-sized facility.
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CHAPTER 3 DECISION ANALYSIS 33

3-45. a.

Payoff
Succeed (0.5)
$75,000 $250,000

1
Dont Succeed (0.5)
w n $100,000
w nto
Do
Succeed (0.6)
$140,000 $300,000
Mall
2
Dont Succeed (0.4)
Tra $100,000
ffic
Cir
No cle
Gr Succeed (0.75)
oc $250,000 $400,000
er
yS
to 3
re Dont Succeed (0.25)
$200,000

$0

Mary should select the traffic circle location (EMV  $250,000). EMV(8)  $75,000
b. Use Bayes Theorem to compute posterior probabilities. EMV(9)  $140,000
P(SD | SRP) = 0.78; | SRP) = 0.22
P(SD EMV(10)  $250,000
P(SM | SRP) = 0.84; | SRP) = 0.16
P(SM EMV(no grocery  C)  $0
P(SC | SRP) = 0.91; | SRP) = 0.09
P(SC EMV(A)  (best of four alternatives)  $316,000
P(SD | SRN) = 0.27; | SRN) = 0.73
P(SD EMV(B)  (best of four alternatives)  $88,000
P(SM | SRN) = 0.36;
P(SM | SRN) = 0.64 EMV(C)  (best of four alternatives)  $250,000
P(SC | SRN) = 0.53; | SRN) = 0.47
P(SC EMV(1)  (0.6)($316,000)  (0.4)($88,000)
Example computations:  $224,800
P ( SRP | SM ) P ( SM ) EMV(D)  (best of two alternatives)
P ( SM | SRP ) =  $250,000
P ( SRP | SM ) P ( SM ) + P ( SRP | SM ) P ( SM )
c. EVSI  [EMV(1)  cost]  (best EMV without
0.7(0.6 ) sample information)
P ( SM | SRP ) = = 0.84
0.7(0.6 ) + 0.2(0.4 )  $254,800 $250,000  $4,800.

0.3(0.75)
P ( SC | SRN ) = = 0.53
0.3(0.75) + 0.8(0.25)
These calculations are for the tree that follows:
EMV(2)  $171,600  $28,600  $143,000
EMV(3)  $226,800  $20,800  $206,000
EMV(4)  $336,700  $20,700  $316,000
EMV(no grocery  A)  $30,000
EMV(5)  $59,400  $94,900  $35,500
EMV(6)  $97,200  $83,200  $14,000
EMV(7)  $196,100  $108,100  $88,000
EMV(no grocery  B)  $30,000
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34 CHAPTER 3 DECISION ANALYSIS

First Second
Decision Decision
Point Point
Payoff
SD (0.78)
Downtown $220,000
2 SD (0.22)
$130,000
SM (0.84)
Mall $270,000
A 3
ts SM (0.16)
ul $130,000
es .6)
R (0 SC (0.91)
ey e Circle $370,000
urv itiv 4
S os SC (0.09)
P $230,000
1 No Grocery Store
t $30,000
ke
ar
Su ega

SD (0.27)
M $220,000
rv tiv

Downtown
N

se ey
ey e

a 5 SD (0.73)
h rv
Re (0.4

rc Su $130,000
u
su )

P
lts

SM (0.36)
Mall $270,000
D B 6 SM (0.64)
Do $130,000
No SC (0.53)
tP Circle $370,000
ur 7 SC (0.47)
cha $230,000
se
M No Grocery Store
ar $30,000
ke
tS SD (0.5)
ur Downtown $250,000
vey 8 SD (0.5)
$100,000
SM (0.6)
Mall $300,000
C 9 SM (0.4)
$100,000
SC (0.75)
Circle $400,000
10 SC (0.25)
$200,000
No Grocery Store
$0

3-46. a. Sue can use decision tree analysis to find the best solu-
tion. The results are presented below. In this case, the best decision
is to get information. If the information is favorable, she should
build the retail store. If the information is not favorable, she should
not build the retail store. The EMV for this decision is $29,200.
In the following results (using QM for Windows), Branch 1
(12) is to get information, Branch 2 (13) is the decision to not get
information, Branch 3 (24) is favorable information, Branch 4
(25) is unfavorable information, Branch 5 (38) is the decision to
build the retail store and get no information, Branch 6 (317) is the
decision to not build the retail store and to get no information,
Branch 7 (46) is the decision to build the retail store given favorable
information, Branch 8 (411) is the decision to not build given favor-
able information, Branch 9 (69) is a good market given favorable
information, Branch 10 (610) is a bad market given favorable in-
formation, Branch 11 (57) is the decision to build the retail store
given unfavorable information, Branch 12 (514) is the decision
not to build the retail store given unfavorable information, Branch
13 (712) is a successful retail store given unfavorable information,
Branch 14 (713) is an unsuccessful retail store given unfavorable
information, Branch 15 (815) is a successful retail store given that
no information is obtained, and Branch 16 (816) is an unsuccess-
ful retail store given no information is obtained.
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CHAPTER 3 DECISION ANALYSIS 35

b. The suggested changes would be reflected in Branches 4 and 5. The decision stays the same, but the EMV
increases to $46,000. The results are provided in the tables that follow:
Results for 3-46. a.
Start Ending Branch Profit Use Node Node
Node Node Probability (End Node) Branch? Type Value
Start 0 1 0 0 Decision 29,200
Branch 1 1 2 0 0 Yes Chance 29,200
Branch 2 1 3 0 0 Decision 28,000
Branch 3 2 4 0.6 0 Decision 62,000
Branch 4 2 5 0.4 0 Decision 20,000
Branch 5 3 8 0 0 Yes Chance 28,000
Branch 6 3 17 0 0 Final 0
Branch 7 4 6 0 0 Yes Chance 62,000
Branch 8 4 11 0 20,000 Final 20,000
Branch 9 6 9 0.9 80,000 Final 80,000
Branch 10 6 10 0.1 100,000 Final 100,000
Branch 11 5 7 0 0 Chance 64,000
Branch 12 5 14 0 20,000 Yes Final 20,000
Branch 13 7 12 0.2 80,000 Final 80,000
Branch 14 7 13 0.8 100,000 Final 100,000
Branch 15 8 15 0.6 100,000 Final 100,000
Branch 16 8 16 0.4 80,000 Final 80,000

Results for 3-46. b.

Start Ending Branch Profit Use Node Node
Node Node Probability (End Node) Branch? Type Value
Start 0 1 0 0 Decision 37,400
Branch 1 1 2 0 0 Yes Chance 37,400
Branch 2 1 3 0 0 Decision 28,000
Branch 3 2 4 0.7 0 Decision 62,000
Branch 4 2 5 0.3 0 Decision 20,000
Branch 5 3 8 0 0 Yes Chance 28,000
Branch 6 3 17 0 0 Final 0
Branch 7 4 6 0 0 Yes Chance 62,000
Branch 8 4 11 0 20,000 Final 20,000
Branch 9 6 9 0.9 80,000 Final 80,000
Branch 10 6 10 0.1 100,000 Final 100,000
Branch 11 5 7 0 0 Chance 64,000
Branch 12 5 14 0 20,000 Yes Final 20,000
Branch 13 7 12 0.2 80,000 Final 80,000
Branch 14 7 13 0.8 100,000 Final 100,000
Branch 15 8 15 0.6 100,000 Final 100,000
Branch 16 8 16 0.4 80,000 Final 80,000
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36 CHAPTER 3 DECISION ANALYSIS

c. Sue can determine the impact of the change by changing the probabilities and recomputing EMVs. This analysis
shows the decision changes. Given the new probability values, Sues best decision is build the retail store without
getting additional information. The EMV for this decision is $28,000. The results are presented below:
Results for 3-46. c.
Start Ending Branch Profit Use Node Node
Node Node Probability (End Node) Branch? Type Value
Start 0 1 0 0 Decision 28,000
Branch 1 1 2 0 0 Chance 18,400
Branch 2 1 3 0 0 Yes Decision 28,000
Branch 3 2 4 0.6 0 Decision 44,000
Branch 4 2 5 0.4 0 Decision 20,000
Branch 5 3 8 0 0 Yes Chance 28,000
Branch 6 3 17 0 0 Final 0
Branch 7 4 6 0 0 Yes Chance 44,000
Branch 8 4 11 0 20,000 Final 20,000
Branch 9 6 9 0.8 80,000 Final 80,000
Branch 10 6 10 0.2 100,000 Final 100,000
Branch 11 5 7 0 0 Chance 64,000
Branch 12 5 14 0 20,000 Yes Final 20,000
Branch 13 7 12 0.2 80,000 Final 80,000
Branch 14 7 13 0.8 100,000 Final 100,000
Branch 15 8 15 0.6 100,000 Final 100,000
Branch 16 8 16 0.4 80,000 Final 80,000

d. Yes, Sues decision would change from her original decision. With the higher cost of information, Sues decision
is to not get the information and build the retail store. The EMV of this decision is $28,000. The results are given
below:
Results for 3-46. d.

Start Ending Branch Profit Use Node Node

Node Node Probability (End Node) Branch? Type Value
Start 0 1 0 0 Decision 28,000
Branch 1 1 2 0 0 Chance 19,200
Branch 2 1 3 0 0 Yes Decision 28,000
Branch 3 2 4 0.6 0 Decision 52,000
Branch 4 2 5 0.4 0 Decision 30,000
Branch 5 3 8 0 0 Yes Chance 28,000
Branch 6 3 17 0 0 Final 0
Branch 7 4 6 0 0 Yes Chance 52,000
Branch 8 4 11 0 30,000 Final 30,000
Branch 9 6 9 0.9 70,000 Final 70,000
Branch 10 6 10 0.1 110,000 Final 110,000
Branch 11 5 7 0 0 Chance 74,000
Branch 12 5 14 0 30,000 Yes Final 30,000
Branch 13 7 12 0.2 70,000 Final 70,000
Branch 14 7 13 0.8 110,000 Final 110,000
Branch 15 8 15 0.6 100,000 Final 100,000
Branch 16 8 16 0.4 80,000 Final 80,000
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CHAPTER 3 DECISION ANALYSIS 37

e. The expected utility can be computed by replacing the monetary values with utility values. Given the utility values in the prob-
lem, the expected utility is 0.62. The utility table represents a risk seeker. The results are given below:
Results for 3-46. e.
Start Ending Branch Profit Use Ending Node Node
Node Node Probability (End Node) Branch? Node Type Value
Start 0 1 0 0 1 Decision 0.62
Branch 1 1 2 0 0 2 Chance 0.256
Branch 2 1 3 0 0 Yes 3 Decision 0.62
Branch 3 2 4 0.6 0 4 Decision 0.36
Branch 4 2 5 0.4 0 5 Decision 0.1
Branch 5 3 8 0 0 Yes 8 Chance 0.62
Branch 6 3 17 0 0.2 17 Final 0.20
Branch 7 4 6 0 0 Yes 6 Chance 0.36
Branch 8 4 11 0 0.1 11 Final 0.1
Branch 9 6 9 0.9 0.4 9 Final 0.4
Branch 10 6 10 0.1 0 10 Final 0
Branch 11 5 7 0 0 7 Chance 0.08
Branch 12 5 14 0 0.1 Yes 14 Final 0.1
Branch 13 7 12 0.2 0.4 12 Final 0.4
Branch 14 7 13 0.8 0 13 Final 0
Branch 15 8 15 0.6 1 15 Final 1
Branch 16 8 16 0.4 0.05 16 Final 0.05
f. This problem can be solved by replacing monetary values with utility values. The expected utility is 0.80. The utility table
given in the problem is representative of a risk avoider. The results are presented below:
Results for 3-46. f.
Start Ending Branch Profit Use Node Node
Node Node Probability (End Node) Branch? Type Value
Start 0 1 0 0 Decision 0.80
Branch 1 1 2 0 0 Chance 0.726
Branch 2 1 3 0 0 Yes Decision 0.80
Branch 3 2 4 0.6 0 Decision 0.81
Branch 4 2 5 0.4 0 Decision 0.60
Branch 5 3 8 0 0 Yes Chance 0.76
Branch 6 3 17 0 0.8 Final 0.80
Branch 7 4 6 0 0 Yes Chance 0.81
Branch 8 4 11 0 0.6 Final 0.60
Branch 9 6 9 0.9 0.9 Final 0.90
Branch 10 6 10 0.1 0 Final 0.00
Branch 11 5 7 0 0 Chance 0.18
Branch 12 5 14 0 0.6 Yes Final 0.60
Branch 13 7 12 0.2 0.9 Final 0.90
Branch 14 7 13 0.8 0 Final 0.00
Branch 15 8 15 0.6 1 Final 1.00
Branch 16 8 16 0.4 0.4 Final 0.40

3-47. a. The decision table for Chris Dunphy along with the ex-
pected profits or expected monetary values (EMVs) for each alter-
native are shown on the next page.
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38 CHAPTER 3 DECISION ANALYSIS

Table for Problem 3-47a

Return in $1,000:
Event 1 Event 2 Event 3 Event 4 Event 5
Number of
Watches Probability 0.100 0.200 0.500 0.100 0.100
100,000 Alternative 1 100,000 110,000 120,000 135,000 140,000
150,000 Alternative 2 90,000 120,000 140,000 155,000 170,000
200,000 Alternative 3 85,000 110,000 135,000 160,000 175,000
250,000 Alternative 4 80,000 120,000 155,000 170,000 180,000
300,000 Alternative 5 65,000 100,000 155,000 180,000 195,000
350,000 Alternative 6 50,000 100,000 160,000 190,000 210,000
400,000 Alternative 7 45,000 95,000 170,000 200,000 230,000
450,000 Alternative 8 30,000 90,000 165,000 230,000 245,000
500,000 Alternative 9 20,000 85,000 160,000 270,000 295,000

Expected profit:
Alternative Expected Profit
1 119,500
2 135,500
3 131,500
4 144,500
5 141,500
6 145,000
7 151,500
8 151,000
9 155,500 best alternative

For this decision problem, Alternative 9 gives the highest ex-

pected profit of $155,500.
b. The expected value with perfect information is $175,500, and
the expected value of perfect information (EVPI) is $20,000.
c. The new probability estimates will give more emphasis to
event 2 and less to event 5. The overall impact is shown
below. As you can see, stocking 400,000 watches is now the
best decision with an expected value of $140,700.
Return in $1,000:
EVENT 1 EVENT 2 EVENT 3 EVENT 4 EVENT 5
Probability 0.100 0.280 0.500 0.100 0.020
Alternative 1 100,000 110,000 120,000 135,000 140,000
Alternative 2 90,000 120,000 140,000 155,000 170,000
Alternative 3 85,000 110,000 135,000 160,000 175,000
Alternative 4 80,000 120,000 155,000 170,000 180,000
Alternative 5 65,000 100,000 155,000 180,000 195,000
Alternative 6 50,000 100,000 160,000 190,000 210,000
Alternative 7 45,000 95,000 170,000 200,000 230,000
Alternative 8 30,000 90,000 165,000 230,000 245,000
Alternative 9 20,000 85,000 160,000 270,000 295,000

Expected profit:
Alternative Expected Profit
1 117.100
2 131,500
3 126,300
4 139,700
5 133,900
6 136,200
7 140,700 best alternative:
8 138,600 stock 400,000 watches
9 138,700
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CHAPTER 3 DECISION ANALYSIS 39

d. Stocking 400,000 is still the best alternative. The results

are shown below.

Return in $1,000:
Event 1 Event 2 Event 3 Event 4 Event 5
Probability 0.100 0.280 0.500 0.100 0.020
Alternative 1 100,000 110,000 120,000 135,000 140,000
Alternative 2 90,000 120,000 140,000 155,000 170,000
Alternative 3 85,000 110,000 135,000 160,000 175,000
Alternative 4 80,000 120,000 155,000 170,000 180,000
Alternative 5 65,000 100,000 155,000 180,000 195,000
Alternative 6 50,000 100,000 160,000 190,000 210,000
Alternative 7 45,000 95,000 170,000 200,000 230,000
Alternative 8 30,000 90,000 165,000 230,000 245,000
Alternative 9 20,000 85,000 160,000 270,000 340,000

Expected profit b. Back roads (minimum time used).

Alternative Expected Profit c. Expected time with perfect information:
1 117,100
15  1/2 + 25  1/3 + 30  1/6 = 20.83 minutes
2 131,500 Time saved is 313; minutes.
3 126,300 3-51. a. EMV can be used to determine the best strategy to min-
4 139,700
imize costs. The QM for Windows solution is shown on
5 133,900
6 136,200
the next page. The best decision is to go with the partial
7 140,700 best alternative: service (maintenance) agreement.
8 138,600 stock 400,000 watches
9 139,600

3-48. a. Decision under uncertainty.

b.
Population Population Row
Same Grows Average
Large wing 85,000 150,000 32,500
Small wing 45,000 60,000 7,500
No wing 0 0 0

c. Best alternative: large wing.

3-49. a. Note: This problem can also be solved using marginal
analysis.
Weighted
Population Population Average with
Same Grows = 0.75
Large wing 85,000 150,000 91,250
Small wing 45,000 60,000 33,750
No wing 0 0 0

b. Best decision: large wing.

c. No.
3-50. a.
No Mild Severe Expected
Congestion Congestion Congestion Time
Tennessee 15 30 45 25
Back roads 20 25 35 24.17
Expressway 30 30 30 30

Probabilities (30 days)/ (20 days)/ (10 days)/

(60 days) = 1/2 (60 days) = 1/3 (60 days) = 1/6
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40 CHAPTER 3 DECISION ANALYSIS

Solution to 3-51a
Expected Row Row
Value Minimum Maximum
($) ($) ($)
Probabilities 0.2 0.8
Maint. No Maint.
Cost ($) Cost ($)
No Service Agreement 3,000 0 600 0 3,000
Partial Service Agreement 1,500 300 540 0 1,500
Complete Service Agreement 500 500 500 500 500

Column best 500 0 500

The minimum expected monetary value is 500 given by Complete

Service Agreement
b. The new probability estimates dramatically change
Sims decision. The best decision given this new informa-
tion is to still go with the complete service or maintenance
policy with an expected cost of $500. The results are
shown below.
Solution to 3-51b
Does Not Expected
Needs Repair Need Repair Value
($) ($) ($)
Probabilities 0.8 0.2

No Service 3,000 0 2,400

Agreement
Partial Service 1,500 300 1,260
Agreement
Complete Service 500 500 500
Agreement

Column best 500

3-52. We can use QM for Windows to solve this decision mak-

ing under uncertainty problem. We have made up probability val-
ues, which will be ignored in the analysis. As you can see, the
maximax decision is Option 4, and the maximum decision is Op-
tion 1. To compute the equality likely decision, we used equal
probability values of 0.25 for each of the four scenarios. As seen
below, the equally likely decision, which is the same as the EMV
decision in this case, is Option 3.

Solution to 3-52
Expected Row Row
Value ($) Minimum ($) Miximum ($)
Probabilities 0.25 0.25 0.25 0.25

Judge ($) Trial ($) Court ($) Arbitration ($)

Option 1 5,000 5,000 5,000 5,000 5,000 5,000 5,000

Option 2 10,000 5,000 2,000 0 4,250 0 10,000
Option 3 20,000 7,000 1,000 5,000 5,750 5,000 20,000
Option 4 30,000 15,000 10,000 20,000 3,750 20,000 30,000

Column best 5,750 5,000 30,000

The maximum expected monetary value is 5,750 given by Option 3.

The maximum is 5,000 given by Option 1. The maximax is 30,000
given by Option 4.
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CHAPTER 3 DECISION ANALYSIS 41

SOLUTION TO STARTING RIGHT CASE

This is a decision-making-under-uncertainty case. There are two
events: a favorable market (event 1) and an unfavorable market
(event 2). There are four alternatives, which include do nothing
(alternative 1), invest in corporate bonds (alternative 2), invest in
preferred stock (alternative 3), and invest in common stock (alter-
native 4). The decision table is presented below. Note that for al-
ternative 2, the return in a good market is $30,000 (1  0.13)5 
$55,273. The return in a good market is $120,000 (4 x $30,000)
for alternative 3, and $240,000 (8 x $30,000) for alternative 4.

Payoff table
Laplace Hurwicz
Event 1 Event 2 Average Value Minimum Maximum Value
Alternative 1 0 0 0.0 0 0 0.00
Alternative 2 55,273 10,000 22,636.5 10,000 55,273 2,819.97
Alternative 3 120,000 15,000 152,500.0 15,000 120,000 150.00
Alternative 4 240,000 30,000 105,000.0 30,000 240,000 300.00

Regret table 6 MonthAdopt the 6-month program: if a competitors product

Maximum is available at the end of 6 months, then copy; otherwise proceed
Alternative Event 1 Event 2 Regret with research and development.
Alternative 1 240,000 0 240,000 8 MonthAdopt the 6-month program: proceed for 8 months; if
Alternative 2 184,727 10,000 184,727 no competition at 8 months, proceed; otherwise stop development.
Alternative 3 120,000 15,000 120,000 Success or failure of development effort:
Alternative 4 0 30,000 30,000
OkDevelopment effort ultimately a success
NoDevelopment effort ultimately a failure
a. Sue Pansky is a risk avoider and should use the maximin
decision approach. She should do nothing and not make an Column:
investment in Starting Right. S Sales revenue
b. Ray Cahn should use a coefficient of realism of 0.11. RResearch and development expenditures
The best decision is to do nothing. EEquipment costs
c. Lila Battle should eliminate alternative 1 of doing noth- IIntroduction to market costs
ing and apply the maximin criterion. The result is to invest in Market size and Revenues:
the corporate bonds.
Without With
d. George Yates should use the equally likely decision cri- Competition Competition
terion. The best decision for George is to invest in common
stock. SSubstantial (P  0.1) $800,000 $400,000
MModerate (P  0.6) $600,000 $300,000
e. Pete Metarko is a risk seeker. He should invest in com-
LLow (P  0.3) $500,000 $250,000
mon stock.
f. Julia Day can eliminate the preferred stock alternative Competition:
and still offer alternatives to risk seekers (common stock) and C6Competition at end of 6 months (P  .5)
risk avoiders (doing nothing or investing in corporate bonds). No C6No competition at end of 6 months (P  .5)
C8Competition at end of 8 months (P  .6)
SOLUTIONS TO INTERNET CASES
No C8No competition at end of 8 months (P  .4)
Drink-at-Home, Inc. Case C12Competition at end of 12 months (P  .8)
Abbreviations and values used in the following decision trees: No C12No competition at end of 12 months (P  .2)
Normalproceed with research and development at a normal
pace.
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42 CHAPTER 3 DECISION ANALYSIS

Drink-at-Home. Inc. Case (continued) Mkt S R E I

S (.1)
C12 (.8) 400 100 100 150 = 50
M (.6)
300 100 100 150 = 50
L (.3)
Ok (.9) 250 100 100 150 = 100
S (.1)
800 100 100 150 = 450
Normal No C12 (.2) M (.6)
600 100 100 150 = 250
L (.3)
500 100 100 150 = 150
No (.1) (Stop)
100 = 100
C8 (.6)
80 = 80
S (.1)
400 140 100 150 = 10
8 Month Ok (.9) M (.6)
300 140 100 150 = 90
No C8 (.4) L (.3)
250 140 100 150 = 140
S (.1)
800 140 100 150 = 410
No (.1) M (.6)
600 140 100 150 = 210
6 Mo

L (.3)
500 140 100 150 = 110
S (.1)
nth

C6 (.5) 400 90 100 150 = 60

M (.6)
300 90 100 150 = 40
L (.3)
250 90 100 150 = 90
S (.1)
400 100 100 150 = 50
C12 (.8) M (.6)
300 100 100 150 = 50
L (.3)
Ok (.9) 250 100 100 150 = 100
S (.1)
800 100 100 150 = 450
No C6 (.5) No C12 (.2) M (.6)
600 100 100 150 = 250
L (.3)
500 100 100 150 = 150
No (.1)
100 = 100

Mkt
S (.1)
50
C12 (.8) M (.6)
50
L (.3)
Ok (.9) 100
S (.1)
450
Normal No C12 (.2) M (.6)
250
L (.3)
150
No (.1) (Stop)
100
C8 (.6)
80
S (.1)
10
8 Month Ok (.9) M (.6)
90
No C8 (.4) L (.3)
140
S (.1)
410
No (.1) M (.6)
210
L (.3)
6 Mo

110
S (.1)
nth

C6 (.5) 60
M (.6)
40
L (.3)
90
S (.1)
50
C12 (.8) M (.6)
50
L (.3)
Ok (.9) 100
S (.1)
450
No C6 (.5) No C12 (.2) M (.6)
250
L (.3)
150
No (.1)
100
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CHAPTER 3 DECISION ANALYSIS 43

Drink-at-Home, Inc. Case (continued)

Mkt
S (.1)
50
C12 (.8) M (.6)
50
55 L (.3)
Ok (.9) 100
(4) S (.1)
450
Normal 6.4 240 M (.6)
250
No C12 (.2) L (.3)
150
No (.1) (Stop)
100
C8 (.6)
80
S (.1)
10
8 Month 74.2 Ok (.9) M (.6)
(74.2) 90
95 L (.3)
No C8 (.4) 140
S (.1)
410
No (.1) M (.6)
210
200 L (.3)
6 Mo

110
S (.1)
nth

C6 (.5) 60
M (.6)
40
45 L (.3)
90
S (.1)
50
C 12 (.8) M (.6)
50
55 L (.3)
Ok (.9) 100
S (.1)
450
No C6 (.5) 240 M (.6)
(19.3) 250
L (.3)
No C12 (.2) 150
No (.1)
100

The optimal program is to adopt the 6-month program

Ruth Jones Heart By-Pass Operation Case

Prob. Years Expected Rate

One Year .50 1 .50

Two Years .20 2 .40

Five Years .20 5 1.00

er ss
rg pa
Su By-

Eight Years .10 8 .80

o
N

2.7 years

0 Years .05 0 0.0

Su

One Year .45 1 .45

rg
e
ry

Five Years .20 5 1.00

Ten Years .13 10 1.30

Fifteen Years .08 15 1.20

Twenty Years .05 20 1.00

Twenty-five .04 25 1.00

Years
5.95 years
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44 CHAPTER 3 DECISION ANALYSIS

Expected survival rate with surgery (5.95 years) exceeds the

nonsurgical survival rate of 2.70 years. Surgery is favorable.

Ski Right Case

a. Bob can solve this case using decision analysis. As you can
see, the best decision is to have Leadville Barts make the hel-
mets and have Progressive Products do the rest with an ex-
pected value of $2,600. The final option of not using Progres-
sive, however, was very close with an expected value of $2,500.

EXPECTED
POOR AVERAGE GOOD EXCELLENT VALUE
Probabilities 0.1 0.3 0.4 0.2
Option 1PP 5,000 2,000 2,000 5,000 700
Option 2LB and PP 10,000 4,000 6,000 12,000 2,600
Option 3TR and PP 15,000 10,000 7,000 13,000 900
Option 4CC and PP 30,000 20,000 10,000 30,000 1,000
Option 5LB, CC, and TR 60,000 35,000 20,000 55,000 2,500

With Perfect Information 5,000 2,000 25,000 55,000 17,900

The maximum expected monetary value is 2,600 given by

Option 2  LB and PP.
b and c. The opportunity loss and the expected value of per-
fect information is presented below. The EVPI is $15,300.
Expected value with perfect information  17,900
Expected monetary value  2,600
Expected value of perfect information  15,300
Opportunity loss table
POOR MARKET AVERAGE GOOD EXCELLENT
Probabilities 0.1 0.3 0.4 0.2
Option 1PP 0 0 18,000 50,000
Option 2LB and PP 5,000 2,000 14,000 43,000
Option 3TR and PP 10,000 8,000 13,000 42,000
Option 4CC and PP 25,000 18,000 10,000 25,000
Option 5LB, CC, and TR 55,000 33,000 0 0

d. Bob was logical in approaching this problem. However,

there are other alternatives that might be considered. One
possibility is to sell the idea and the rights to produce this
product to Progressive Products for a fixed amount.

STUDY TIME CASE

Raquel must decide which of the three cases (1, 2, or 3) to study, and
how much time to devote to each. We will assume that it is equally
likely (a 1/3 chance) that each case is chosen. If she misses at most 8
points (lets assume she is correct in thinking that) on the other parts
of the exam, scoring 20 points or more on this part will give her an A
for the course. Scoring 0 or 12 points on this portion of the exam will
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CHAPTER 3 DECISION ANALYSIS 45

result in a grade of B for the course. The table below gives the differ-
ent possibilities points and grade in the course.

Case 1 Case 2 Case 3

on Exam on Exam on Exam EV Grade in Course
Study 1, 2, 3 12 B 12 B 12 B 12 B
Study 1,2 20 A 20 A 0B 40/3 A 2/3 chance or B 1/3 chance
Study 1,3 20 A 0B 20 A 40/3 A 2/3 chance or B 1/3 chance
Study 2,3 0B 20 A 20 A 40/3 A 2/3 chance or B 1/3 chance
Study 1 25 A 0B 0B 25/3 A 1/3 chance or B 2/3 chance
Study 2 0B 25 A 0B 25/3 A 1/3 chance or B 2/3 chance
Study 3 0B 0B 25 A 25/3 A 1/3 chance or B 2/3 chance

Thus, Raquel should study 2 cases since this will give her a
2/3 chance of an A in the course. Notice that this also has the high-
est expected value. This is a situation in which the values (points)
are not always indicative of the importance of the result since 0 or
12 results in a B for the course, and 20 or 25 results in an A for the
course.