OR definition, decision making environment, decision tree notes

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OR definition, decision making environment, decision tree notes

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0 FACULTY OF MANAGEMENT

OPERATIONS RESEARCH UNITED INSTITUTE OF MANAGEMENT

(03-04)

(ANS) O.R. simply defined as the research of operations.

By E.L. ARNOFF & M.J.NETZORG

O.R. is the systematic, method oriented study of the basic structure, characteristics, functions and

relationship of an organization to provide the executive with sound, scientific and quantitative basis for

decision making.

By C. KITTEL

O.R. is an aid for the executive in making his decisions by providing him with the needed quantitative

information based on the scientific method of analysis.

By FABRYCKY & TORGERSEN

O.R. is the application of scientific methods to the problem arising from operations involving integrated

systems of men, machine and materials. It normally utilizes the knowledge and skills of interdisciplinary

research team to provide the managers of such systems with optimum operating solutions.

By CHURCHMANN, ACOFF, ANNOFF

O.R. is the application of scientific methods, techniques and tools to problems involving the operations

of system so as to provide those in control of the operations with optimum solutions to the problem.

By J.O.R. SOCIETY, U.K

O.R. is the application of modern methods of mathematical science to complex problems involving

management of large systems of men, machine, materials and money in industry, business, government

and defence. This distinctive approach is to develop a scientific model of the system incorporating

measurement of factors such as chance and risk to predict and compare the outcomes of alternative

decisions, strategies or controls.

By OPERATIONS RESEARCH SOCIETY, AMERICA

OR is concerned with scientifically deciding how to best design and operate man-machine system usually

requiring the allocation of scare resources.

SCOPE OF O.R.

The scope of OR is not only confined to any specific agency like defence services but today it is widely

used in all industrial organizations. It can be used to find the best solution to any problem be it simple or

complex. The main fields where OR is extensively used are given below:

OR is used for the preparation of Five Year Plans, annual budgets, forecasting of income and

expenditure, scheduling of major projects of national importance, estimation of GNP, GDP, population,

employment and generation of agriculture yields etc.

Basically formulation of OR started from USA army, so it has wide application in the areas such as:

development of new technology, optimization of cost and time, tender evaluation, setting and layouts

of defence projects, assessment of “Threat analysis”, strategy of battle, effective maintenance and

replacement of equipment, inventory control, transportation and supply depots etc

.

FOR MBA IST YEAR FROM GAURAV SONKAR

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OR can be effectively used in plant location and setting finance planning, product and process

planning, facility planning and construction, production planning and control, purchasing,

maintenance management and personnel management etc. to name a few.

(iv) R & D and Engineering

Research and development being the heart of technological growth, OR has wide scope for and can be

applied in technology forecasting and evaluation, technology and project management, preparation of

tender and negotiation, value engineering, work/method study and so on.

(v) Business Management and Competition

OR can help in taking business decisions under risk and uncertainty, capital investment and returns,

business strategy formation, optimum advertisement outlay, optimum sales force and their distribution,

market survey and analysis and market research techniques etc.

(vi) Agriculture and Irrigation

In the area of agriculture and irrigation also OR can be useful for project management, construction of

major dams at minimum cost, optimum allocation of supply and collection points for fertilizer/seeds

and agriculture outputs and optimum mix of fertilizers for better yield.

(vii) Education and Training

OR can be used for obtaining optimum number of schools with their locations, optimum mix of

students/teacher student ratio, optimum financial outlay and other relevant information in training of

graduates to meet out the national requirements.

(viii) Transportation

Transportation models of OR can be applied to real life problems to forecast public transport

requirements, optimum routing, forecasting of income and expenses, project management for

railways, railway network distribution, etc. In the same way it can be useful in the field of

communication.

(ix) Home Management and Budgeting

OR can be effectively used for control of expenses to maximize savings, time management, work

study methods for all related works. Investment of surplus budget, appropriate insurance of life and

properties and estimate of depreciation and optimum premium of insurance etc.

(Q2) What are the scope of OR in management? Briefly explain the characteristics and limitations

of OR?

(Ans2) Scope of OR in Management:

(I) Allocation and Distribution:

Optimal allocation of limited resources such as men, machine, and material.

Location and size of warehouses, distribution centre, retail depot etc.

Distribution policy.

(II) Production and Facility Planning:

Selection, location and design of production plant.

Project scheduling & allocation of resources.

Forecasting.

Maintenance policy.

Scheduling & sequencing.

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(III) Procurement:

What, when and how to purchase at minimum procurement cost

Bidding and replacement policies.

(IV) Marketing:

Product selection, timing & competitive action

Selection of advertising media.

Demand forecast and stock level.

Customer’s preference for size, colour & packaging of various products.

(V) Finance:

Capital requirement, cash flow analysis.

Credit policies, credit risks etc.

Profit plan of the company.

Determination of optimum replacement policies.

(VI) Personnel:

Selection of personnel, determination of retirement age and skills

Recruitment of policies & assignments of jobs.

(VII) Research and Development:

Determination of areas of Research and Development

Reliability & control of development of projects.

Selection of projects & preparation of their budgets.

CHARACTERISTICS / FEATURES OF OR

The objective of the operations research models is to attempt and to locate best or optimal solution under

the specified conditions.

The main characteristics of OR are:

(a) It is system oriented

(b) Use of interdisciplinary team

(c) Application of scientific method

(d) Uncovering new problems.

(e) Improvement in the quality of decisions

(f) Use of computers

(g) Quantitative solutions

(h) Involvement of human factors

OR has some limitations however, these are related to the problem of model building and the time and

money factors involved in application rather then its practical utility. Some of them are as follows:

(a) Magnitude of Computation.

(b) Non-Quantifiable Factors.

(c) Distance between User and Analyst.

(d) Time and Money Costs.

(e) Implementation.

3 FACULTY OF MANAGEMENT

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(ANS) The effective use of OR techniques, requires to follow the systematic sequence of steps. In

general there are following six steps

FORMULATE THE

PROBLEM

CONSTRUCT A

MATHEMATICAL MODEL

SOLVE THE

MODEL

TEST THE

MODEL

ESTABLISHING

CONTROL OVER THE

SOLUTION

IMPLEMENTATION OF

SELECTED STRATEGY

STEP I: FORMULATE THE PROBLEM

The problem formulation phase is generally lengthy, requiring considerable time and efforts. It

involves the process to identify, understand and describe the problem or problems being faced

by an organization. In formulation a problem for OR study, analysis must be made on the four

major components.

Environment

Decision Maker

Objective

Alternative course of action and constraints.

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After the problem is clearly defined and understood, the next step is to collect required data

and construct a mathematical model. A mathematical model consists of a set of equations

which describes the system or problem. These equations represent effectiveness function or

objective function and constraints.

Once a mathematical model of the problem has been constructed, the next step is to solve it, that

is, to obtain the numerical value of decision variables. A solution may be extracted from a

model either by conducting experiments on it, that is, by simulation or by mathematical

analysis. Here the aim is to find out the optimal solution of the problem.

After solving a mathematical model, it is important to review the solution carefully to see that

the values make sense and that the resulting decisions can be implemented. When the model is

complete, it should be tested again as a whole for obvious or oversight errors. This may be done

by re-examining the formulation of the problem and comparing it with the model that may help

to reveal any mistakes.

After testing the model and its solution, the next step is to establish control over the solution by

proper feedback of the information on variables which deviated significantly.

If the solution of any problem is to be operative on repetitive basis then suitable control should

be designed to check the validity of the solution under control.

The decision maker has not only to identify good decision alternatives but also to select

alternatives that are capable of being implemented. It is important to ensure that any solution

implemented is continuously reviewed and updated in the light of changing environment.

In any case, the decision-maker who is in the best position to implement the results must be

aware of the objective, assumption and limitations of the model.

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(Ans) Operation research is the science of managing. As is known, management is most of the time

making decisions. It is thus a decision science which helps management to make better

decisions.

As one of the basic function of the management of an organization is decision making regarding

integrated system of men, machine, material and money so as to minimize cost, losses, risk and

uncertainty and to maximize production capacity, profits, skills of employees etc which must be

based on some scientific methods, rules, techniques and models and OR is that kit of scientific

and programmable rules providing the management a quantitative basis for decisions regarding

the operations under its control.

As operation research comes into existence in connection with war operations, but its need has

been equally felt by the industry because of following reasons:

Complexity:

In a big industry, the numbers of factor influencing a decision have been increased. Situation

has become big & complex because these factors interact with each other in complicated fashion.

There is, thus, great uncertainty about the outcomes of interaction of factors like technological,

environmental, competitive, etc. For instance, consider a factory production schedule which has

to take into account.

a) Customer demand

b) Requirement of raw materials

c) Equipment capacity and possibility of equipment failure, and

d) Restriction on manufacturing process.

Evidently, it is not easy to prepare a schedule which is both economical and realistic where as

operation research provides mathematical models to analyze the problem and gives the executive

a quantitative basis for decision making.

In a big industry, responsibility and authority of decision- making is scattered throughout the

organization and thus the organization, if it is not conscious, may be following inconsistent

goals. Mathematical quantification of OR overcomes this difficulty to a great extent.

Uncertainty:

There is a great uncertainty about the economic and general environment. With economic

growth, uncertainty is also growing. This makes the decision costlier and time-consuming. OR is,

thus, quite essential from reliability point of view.

Knowledge explosion:

Knowledge is increasing at a very fast rate. Majority of the industries are not up-to-date with the

latest knowledge and are, therefore, at a disadvantage. OR teams collect the latest information

for analysis purposes which are quite useful for the industries.

FOR MBA IST YEAR FROM GAURAV SONKAR

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In short OR is research of operations and is a problem solving and decision making science.

(Q5) What techniques are used to solve a decision making problems under uncertainty? Illustrate

any one technique with an example. (07-08)

(Ans) Under condition of uncertainty, the decision maker has knowledge about states of nature that

happens but lacks the knowledge about the probabilities of their occurrence. Situations like

launching a product fall under this category.

Under conditions of uncertainty, a few decision criterions are available which could be of help to

the decision maker.

Criterion Criterion Criterion Criterion Criterion

or or or or or Criterion

Criterion Criterion Regret Criterion of

of of Criterion of Realism Rationality

Optimism Pessimism

i) Maximax Criterion:

This criterion provides the decision maker with optimistic criterion. The working method is

summarizing as follow.

(a) Locate the maximum payoff values corresponding to each alternative (or course of action or

strategy), then

(b) Select an alternative with maximum payoff value.

This criterion provides the decision maker with pessimistic criterion. The working method is

summarizing as follow.

(a) Locate the minimum payoff values corresponding to each alternative (or course of action or

strategy), then

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(iii) Minimax Criterion:

This criterion is also known as opportunity loss decision criterion or minimax regret criterion because

decision maker feels regret after adopting wrong course of action resulting in an opportunity loss of

payoff. Thus we have intends to minimize this regret. The working method is summarizing as follow.

(a) Determine the amount of regret corresponding to each alternative for each state of nature.

The regret for jth event corresponding to ith alternative is given by

ith regret = (maximum payoff – ith payoff) for the jth event

(c) Choose the alternative which corresponds to the minimum of the maximum regrets.

Also called weighted average criterion, it is a compromise between the maximax (optimistic) and

minimax (pessimistic) decision criterion. This concept allows the decision maker to take into account

both maximum and minimum for each alternative and assign them weights according to his degree of

optimism (or pessimism). The working method is summarizing as follow:

(a) Choose an appropriate degree of optimism, α so that (1-α) represents degree of pessimism.

(b) Determine the maximum as well as minimum of each alternative and obtain

(c) Choose the alternative that yields the maximum value of P.

Also known as equal probabilities criterion or criterion of rationality. Since the probability of states of

nature are not known, it is assumed that all states of nature will occur with equal probability, i.e. assign

an equal probability. The working method is summarizing as follow:

(a) Determine expected value for each alternative; if n denotes the number of events and P’s

denote the payoffs, then expected value is given by 1\n[P1+P2+….+Pn]

(b) Choose the alternative that yields the maximum value of P.

FOR MBA IST YEAR FROM GAURAV SONKAR

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increase its production to meet the increasing market demand.

State of Nature

Alternative

High Moderate Low Nil

(Rs.) (Rs.) (Rs.) (Rs.)

Expand 50,000 25,000 - 25,000 - 45,000

Steps involved are

(a) Locate the maximum payoff values corresponding to each alternative (or course of action

or strategy), then

Alternative

High Moderate Low Nil

(Rs.) (Rs.) (Rs.) (Rs.)

Expand 50,000 25,000 - 25,000 - 45,000 50,000

Thus, according to maximax criterion the executive will choose alternative –“Construct”

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(Q6) What techniques are used to solve a decision making problems under risk? Illustrate anyone

technique with an example.

(Ans) Here more than one state of nature exists and the decision maker has sufficient information to

assign probabilities to each of these states. These probabilities could be obtained from the past

records or simply the subjective judgment of the decision maker. Under conditions of risk, a few

decision criterions are available which could be of help to the decision maker.

Criterion or Expected Loss Criterion or

for Perfect

Monetary Value Expected Value of

Regret Information

Criterion

Conditional Profit Table Conditional Profit Table P.I.

Expected Profit Table Conditional Loss table Expected Profit Table with

Expected Loss Table P.I.

The expected monetary value for a given course of action is the weighted sum of possible payoffs for

each alternative. It is obtained by summing the payoffs for each course of action multiplied by the

probabilities associated with state of nature. It consists of following steps:

(a) Construct a payoff table listing the alternative decisions and the various state of nature. Enter

the conditional profit for each decision event combination along with the associated

probabilities. (Construct Conditional profit table).

(b) Calculate the EMV for each decision alternative by multiplying the conditional profits by

assigned probabilities and adding the resulting conditional values. (Construct expected

profit table).

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EOL represents the amount by which maximum possible profit will be reduced under various possible

stock actions. The course of action that minimizes these losses or reductions is the optimal decision

alternative. The procedure to calculate expected opportunity losses is as follows:

a) Prepare the conditional profit table for each decision-event combination and write associated

probabilities. (Construct Conditional profit table).

b) For each event, determine the conditional opportunity loss (COL) by subtracting the payoff from the

maximum payoff for that event. (Construct Conditional loss table).

c) Calculate the expected opportunity loss for each decision alternative by multiplying the COL’s by

the associated probabilities and then adding the values. (Construct Expected loss table).

EVPI represents the maximum amount of money the decision maker has to pay to get this additional

information about the occurrence of various state of nature before a decision has to be made. The

procedure to calculate expected value of perfect information is as follows:

10 0.10

11 0.15

12 0.20

13 0.25

14 0.30

Cost of the copy is 30 paisa and sale price is 50 paisa. He cannot return the unsold copies.

How many should he order?

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10 11 Copies 12 13 14

Demand

Copies Copies Copies Copies

(No. of

Copies)

10 0.10 200 170 140 110 80

11 0.15 200 220 190 160 130

12 0.20 200 220 240 210 180

13 0.25 200 220 240 260 230

14 0.30 200 220 240 260 280

10 11 Copies 12 13 14

Demand

Copies Copies Copies Copies

(No. of

Copies)

10 0.10 20 17 14 11 8

11 0.15 30 33 28.5 24 19.5

12 0.20 40 44 48 42 36

13 0.25 50 55 60 65 57.5

14 0.30 60 66 72 78 84

Total Expected Profit 200 215 222.5 220 205

(paise)

Thus, therefore, the newspaper boy must order 12 copies to earn the highest possible average daily

profit of 222.5 paisa.

(Q7) Describe the rules for drawing the network diagram (decision tree) with suitable illustration.

(Ans)

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Decision Tree

A decision tree is a graphical representation of the decision process indicating decision alternative, states

of nature, probabilities attached to the states of nature and conditional benefits and losses.

It consists of a network of nodes and branches. Two types of nodes are used- decision node represented

by a square and state of nature (chance or event) node represented by a circle. Alternative course of

action (strategies) originate from the decision node as main branches (decision branches). At the end of

each decision branch, there is a state of nature node from which emanates chance events in the form of

sub-branches (chance branches). The respective payoffs & the probabilities associated with alternative

courses and the chance events are shown alongside these branches.

At the terminal of the chance branches are shown the expected values of the outcomes.

The general approach used in decision tree analysis is to work backward through the tree from right to

left, computing the expected value of each chance node. We then choose the particular branch leaving a

decision node which leads to chance node with the highest expected value.

This is known as roll back or fold back process.

Decision trees are useful for representing the inter-related, sequential and multi-dimensional aspects of a

decision-making problem.

By drawing a decision tree, one is in position to visualize the entire complexity of the decision problem

in all its dimensions & also the actual processes and stages for arriving at the final decision.

(i) Identify the decision points and the alternative courses of action at each decision

point systematically.

(ii) At each decision point determine the probability and the payoff associated with

each course of action.

(iii) Starting from the extreme right end, compute the expected payoff (EMV) for

each course of action.

(iv) Choose the course of action that yields the best payoff for each of the decisions.

(vi) Repeat above steps till the first decision points point is reached.

(vii) Finally, select the course of action which yields maximum possible EMV.

Illustration: Suppose we have the decision-making problem represented by the following

table:

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(A1) (A2)

S1 (High 0.6 4000 10,000

Demand)

S2 (Low Demand) 0.4 4000 - 5,000

p=0.6 4000

A1 2 S1

p=0.4

4000

1

p=0.6

10000

A2

A

2

DECISION

DECISION 3

NODE

NODE

p=0.4 -5000

For a decision alternative (strategy) the EMV is calculated by summing the products of payoff of each

state and its probability.

Questions

1. Considering a manufacturing company that is thinking of various alternatives to increase its

production to meet the increasing market demand.

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Which strategy or alternative will the company employ on the basis of:

STATE OF NATURE (PRODUCT DEMAND)

ALTERNATIVES

HIGH MODERATE LOW NIL

EXPAND 50,000 25,000 -25,000 -45,000

CONSTRUCT 70,000 30,000 -40,000 -80,000

SUBCONTRACT 30,000 15,000 -1,000 -10,000

a) Maximax Criterion Or Criterion of optimism

b) Maximin Criterion Or Criterion of pessimism

c) Minimax Criterion or Regret Criterion

d) Hurwicz Criterion Or Criterion of Realism

e) Laplace Criterion Or Criterion of Rationality

2. The following matrix gives the payoff of different strategies S 1, S2, S3 against conditions N1, N2,

N3 and N4

Indicate CONDITIONS the

decision N1 N2 N3 N4 taken

under the STRATEGY (Rs) (Rs) (Rs) (Rs)

following S1 4000 -100 6000 18000

approach: S2 20000 5000 400 0

a) S3 20000 15000 -2000 1000

Optimistic

b) Pessimistic

c) Regret

d) Hurwicz, The Degree Of Optimism Being 0.7

e) Equal Probability

3. A food product company is contemplating the introduction of a revolutionary new product with

new packaging to replace the existing product at a large increase in price (S 1) or a moderate

change in composition of the existing product with a new packaging at a small increase in price

(S2) or a small change in the composition of the existing product with a negligible increase in

price (S3). The three states of nature are: (i) high increase in sales (N 1), (ii) no change in sales

(N2) and decrease in sales (N3). The marketing department of the company worked out the pay-

offs in terms of yearly net profits for each course of action for these events. This is represented in

following table:

States of Courses of action

nature S1 S2 S3

N1 700000 500000 300000

N2 300000 450000 300000

N3 150000 0 300000

a) What is the maximax decision?

b) What is the maximin decision?

c) What is equally likely decision?

d) What is the criterion of realism decision? Use α = 0.5

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4. A newspaper boy has the following probabilities of selling a magazine:

No. of copies sold Probability

10 0.10

11 0.15

12 0.20

13 0.25

14 0.30

Cost of the copy is 30 paisa and sale price is 50 paisa. He cannot return the unsold copies. How

many should he order?

5. A physician purchases a particular vaccine on Monday each week. The vaccine must be used

with in the following week , otherwise it becomes worthless. The vaccine cost Rs.30 per dose

and the physician charges Rs. 50 per dose. In past 50 weeks, the physician has administered the

vaccine in the following quantities:

Doses per week: 20 30 50 60

Number of weeks: 5 15 20 10

Determine how many doses the physician buys every week. (2006-07)

6. A wholesaler of sports goods has an opportunity to buy 5,000 pairs of skis that have been

declared surplus for the manufacturer. The wholesaler will pay Rs.50 per pair and can obtain

Rs.100 per pair by selling skis to the retailers. The price is well established, but the wholesaler is

in doubt as to just how many pairs he will be able to sell. Any skis leftover, he can sell to

discount outlets at Rs.20 a pair. After the careful consideration of historical data, the wholesaler

assigns probabilities to the demand as follows:

Retailers Demand Probability

1000 pairs 0.6

3000 pairs 0.3

5000 pairs 0.1

a) Compute the conditional monetary and expected monetary values.

b) Compute the expected profit with a perfect predicting device.

c) Compute EVPI (2012 -13)

7. A television dealer finds that the cost of a TV in stock for a week is Rs. 30 and the cost of a unit

shortage is Rs. 70. For one particular model of TV the probability distribution of weekly sales is

as follow:

Weekly: 0 1 2 3 4 5 6

Probability: 0.1 0.1 0.2 0.25 0.15 0.15 0.05

How many units per week should the dealer order? (2008 – 09)

8. Under an employment promotion programmes it is proposed to allow sale of newspaper on the

basis during off peak hours. The vendor can purchase the newspapers at a special concessional

rate of 25 paise per copy against the selling price of 40 paise. Any unsold copies are, however a

dead loss. A vendor has estimated the following problem distribution for the number of copies

demanded:

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Number of Copies : 15 16 17 18 19 20

Probability : 0.04 0.19 0.33 0.26 0.11 0.07

a) How many copies should be ordered so that his expected profit will be maximum?

b) Compute EPPI?

c) The vendor is thinking of spending on a small market survey to obtain additional information

regarding the demand levels. How much should he be willing to spend on such a survey?

9. Suppose a grocer is faced with a problem of how many cases of milk be stock to meet

tomorrow’s demand. All the cases of milk left at the end of the day are worthless. Each case of

milk is sold for Rs. 8 and is purchased for Rs. 5. Hence each case sold brings a profits of Rs. 3

but if it is not sold at the end of the day, then it must be discarded resulting in a loss of Rs. 5. The

historical record of the number of cases of milk demanded is as follows :

No. of Cases of Over

0-12 13 14 15 16 17 18 Total

milk demanded 18

Number of Times

0 5 10 20 30 25 10 0 100

Demanded

Probability of

0 0.05 0.1 0.2 0.3 0.25 0.1 0 1

each

What should be the optimal decision of the grocer concerning the number of cases of milk to stock?

Assuming that the grocer has a perfect knowledge, then what would be his expected profit?

10. An ice-cream retailer buys ice-cream at a cost of Rs 5 per cup & sells it for the Rs 8 per cup; any

remaining unsold at the end of the day can be disposed of at a salvage price of Rs. 2 per cup. Past

sales have ranged between 15 to 18 cups per day; there is no reason to believe that the sales

volume will take on any other magnitude in future. Find the EMV if the sale history has the

following probabilities:

Mkt Size 15 16 17 18

Prob 0.1 0.2 0.4 0.3

11. A retailer has to decide on the optimal number of units to be stocked in respect of a certain under

the following circumstances:

a. Cost price in season : Rs 12

b. Selling price in season : Rs 18

c. Bargain price after season : Rs 9

d. Cost of holding an item in inventory beyond the season is Re. 1

The distribution of demand based on past data is shown below:

Demand 7 8 9 10 11

Probability 0.2 0.2 0.25 0.15 0.2

Determine the optimal act based on the expected monetary value criterion

12. A television dealer finds that the cost of holding a TV in stock for a week is Rs. 50. Customers

who cannot obtain new TV immediately tend to go to other dealers and he estimates that for

every customer who cannot get immediate delivery he loses an average of Rs 200. For one

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0.05, 0.10, 0.20, 0.30, 0.20 and 0.15 respectively.

(a) How many units per week should the dealer order? Assume that there is no time lag between

ordering and delivery.

(b) Compute ECPI

(c) The dealer is thinking of spending on a small market survey to obtain additional information

regarding the demand levels. How much should he be willing to spend on such a survey?

13. Wings Corner wants to decide how many man’s shirts to order for the Diwali season. For a

particular type of shirt, Wings must order in lots of 50 shirts. If it orders 50 shirts, cost is Rs. 60

per shirt, if it orders 100 shirts, cost is Rs. 55 per shirt and if it orders 150 or more shirts, the cost

is Rs. 50 per shirt. Wings selling price is Rs. 95, but only left over at the end of season will be

sold at 50% discount. It is assumed that demand will be 50, 100, 150, 200 or 250 shirts and that

the corner will no suffer any loss of goodwill if stock runs out of stock. It must place the entire

order for the season at the beginning with no opportunity for reordering. Wings has estimated the

probability of demand as follows:

Demand 50 100 150 200 250

Probability 0.15 0.25 0.25 0.20 0.15

(a) Use a payoff table to determine the order quantity that will maximize the expected contribution.

(b) Calculate the expected value of perfect information.

14. Suppose we have the decision making problem represented by the following table:

Course of Action

Demand Prob S1 S2 S3

(Subcontracting) (Begin Overtime) (Construct facilities)

Low 0.1 10 -20 -150

Medium 0.5 50 60 20

High 0.4 50 100 200

Show this decision situation in the form of a decision tree & indicate the most preferred decision &

corresponding expected value.

15. Pay-offs of three acts X, Y, and Z and the states of nature P, Q and R are given below:

Pay - Offs (Rs.)

Acts

State of Nature

X Y Z

P -120 -80 100

Q 200 400 -300

R 260 -260 600

The probabilities of the states of nature are 0.3, 0.5 and 0.2 respectively. Tabulate the expected

monetary value for the above data and the state which can be chosen as the best act. (2007 – 08)

18 FACULTY OF MANAGEMENT

OPERATIONS RESEARCH UNITED INSTITUTE OF MANAGEMENT

16. A businessman has two independent investment portfolios A & B available to him but he lacks

the capital to undertake both of them simultaneously. He can choose A first and then stop, If A is

successful then take B or vice – versa.

The probability of success of A is 0.6 while that for B it is 0.4. Both investment schemes requires an

initial capital outlays of Rs 10,000 and both return nothing if the venture is unsuccessful. Successful

completion of A will return Rs.20000 and successful completion of B returns Rs. 24000. Draw a

decision tree & determine best strategy.

17. A businessman has two independent investment portfolios A & B available to him but he lacks

the capital to undertake both of them simultaneously. He can choose A first and then stop, or if A

is successful then take B or vice – versa.

The probability of success of A is 0.7 while that for B it is 0.4. Both investment schemes requires an

initial capital outlays of Rs 2000, and both return nothing if the venture is unsuccessful. Successful

completion of A will return Rs.3000 (over cost) and successful completion of B returns Rs. 5000

(over cost). Draw a decision tree & determine best strategy. (2009-10)

18. A large steel manufacturing company has three option with regards to production: (i) produce

commercially (ii) build pilot plant (iii) stop producing steel. The management has estimated that

their pilot plant if built has 0.8 chances of high yield & 0.2 chances of low yield. If the pilot plant

does show a high yield, management assigns a probability of 0.75 that the commercial plant will

also have a high yield. If the pilot plant shows a low yield there is only a 0.1 chance that the

commercial plant will show a high yield. Finally management’s best assessment of the yield on a

commercial – size plant without building a pilot plant first has a 0.6 chance of high yield. A pilot

plant will cost Rs. 3,00,000. The profits earned under high & low yield conditions are Rs.

1,20,00,000 and – Rs. 12,00,000 respectively. Find the optimum decision for the company.

19. Mr. X of ABC Ltd. Wants to introduce a new product in the market. He has a choice of two

different research and development plans A & B. A costs Rs. 10 lakhs and has a 40 percent

chance of success where as B costs Rs. 5 lakhs with a 30 percent chance of success. In the event

of success, Mr. X has to decide whether or not to advertise the product heavily or lightly. Heavy

advertising will cost Rs. 4 lakhs but gives 0.7 probability of full acceptance and 0.3 probability

of partial acceptance by the market. Light advertising will cost Rs. 1 lakh with the probability 0.5

of full acceptance and 0.5 probability of partial acceptance. Full market acceptance of the

product develop as per plan A would be worth Rs. 40 lakhs and as per plan B would be worth Rs.

19 FACULTY OF MANAGEMENT

OPERATIONS RESEARCH UNITED INSTITUTE OF MANAGEMENT

30 lakhs. Partial acceptance in both cases will be worth Rs 20 lakhs. Which plan Should Mr. X

adopts and what sort of advertising will be done for marketing the product? Solve the problem

with the help of decision tree.

20. An investor is given the following investment alternatives and percentage rates of return.

Low Medium High

Regular Shares 7% 10% 15%

Risky Shares -10% 12% 25%

Property -12% 18% 30%

Over the past 300 days, 150 days have been medium market conditions and 60 days have had high

market increases.

On the basis of these data, state the optimum investment strategy for the investment. (2010 – 11)

21. Mr. X flies quite often from town A to town B. He can use the airport bus which cost Rs. 25 but

if he takes it, there is a 0.08 chance that he will miss the flight. The stay in a hotel costs Rs. 270

with a 0.96 chance of being on time for the flight. For Rs. 350 he can use a taxi which will make

99 percent chance of being on time for the flight. If Mr. X catches the plane on time, he will

conclude a business transaction that will produce a profit of Rs. 10,000, otherwise he will lose it.

Which mode of transport should Mr. X use? Answer on the basis of the EMV criterion.

(2011 – 12)

20 FACULTY OF MANAGEMENT

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