ASSIGNMENT 2: DECISION ANALYSIS

Series A.

1. A group of medical professionals is considering the construction of a private clinic. If the

medical demand is high (i.e., there is a favourable market for the clinic), the physicians
could realize a net profit of R1,000,000. If the market is not favourable, they could lose
R400,000. Of course, they do not have to proceed at all, in which case there is no cost. In
the absence of any market data, the best the physicians can guess is that there is a 50–50
chance the clinic will be successful.

a) Develop a payoff (cost) table for this situation. (3)

b) What decision would physicians make if they were optimistic? (3)
c) What decision would physicians make if they were pessimistic? (3)
d) What decision would maximize expected profits? (3)

2. Even though independent gasoline stations have been having a difficult time, Susan
Solomon has been thinking about starting her own independent gasoline station. Susan’s
problem is to decide how large her station should be. The annual returns will depend on
both the size of her station and a number of marketing factors related to the oil industry and
demand for gasoline. After a careful analysis, Susan developed the following table:

SIZE OF FIRST GOOD FAIR MARKET POOR MARKET

STATION MARKET (R) (R) (R)
Small 500000 200000 -100000
Medium 800000 300000 -200000
Large 1000000 300000 -400000
Very large 3000000 250000 -1600000

For example, if Susan constructs a small station and the market is good, she will realize a
profit of R500,000.

a) What is the maximax decision? (3)

b) What is the maximin decision? (3)
c) What is the equally likely decision? (3)
d) What is the criterion of realism decision? Use α value of 0.8. (3)
e) Develop an opportunity loss table. (3)
f) What is the minimax regret decision? (3)

3. Mickey Lawson is considering investing some money that he inherited. The following payoff
table gives the profits that would be realized during the next year for each of three
investment alternatives Mickey is considering:

STATE OF MARKET
Equipment Favourable Unfavourable
Market (R) Market (R)
Socket Market 800000 -200000
Bond 300000 200000
CDs 230000 230000
 Probability 0.5 0.5

a) What decision would maximize expected profits? (3)

b) What is the maximum amount that should be paid for a perfect forecast of the
economy? (3)

Series B: Choose the correct assertion

1. The minimum expected opportunity loss (1)

a) is equal to the highest expected payoff.

b) is greater than the expected value with perfect information.
c) is equal to the expected value of perfect information.
d) is computed when finding the minimax regret decision.

2. In using the criterion of realism (Hurwicz criterion), the coefficient of realism (α) (1)

a) Describes the degree of pessimism of the decision maker.

b) Describes the degree of optimism of the decision maker.
c) Is the probability of a good state of nature.
d) Is usually less than zero.

3. If probabilities are available to the decision maker, then the decision-making

environment is called: (1)

a) Uncertainty.
b) Risk.
c) Certainty.
d) None of the above.

4. Which of the following is a decision-making criterion that is used for decision making
under risk? (1)
a) equally likely criterion
b) optimistic (maximax) criterion
c) Hurwicz criterion (criterion of realism)
d) expected monetary value criterion

TOTAL: 40