Exercise 1.

DECISION TREES, EVPI and EVMI

Teratex, a textile company that has a productive experience in the foreign market of 25 years, must dec
The profits depend on the demand of the product. The table shows projected profits, in millions of dollar

Table 1. Decision process for the commercialization of the product

States of nature
Decision alternative
Demand low-utility Demand low average - utility
Manufacture 321 352
Subcontract 335 353
Buy 318 361
Probabilities Ʃ = 1 0.35 0.35

According to the corresponding information in Table 1 and the Predicted Value of Perfect Information (E

a. Use EVPI to determine if the company should try to get a better estimate of the demand.
b. A test market study of potential product demand is expected to report a favorable (F) or u

P(F/low) = 0.35 P(D/low) =

P(F/low average) = 0.41 P(D/ low average) =
P(F/high) = 0.32 P(D/high) =

c. What is the expected value of market research information?

d. What is the efficiency of the information?

Development

a.Use EVPI to determine if the company should try to get a better estimate of the demand

Node 1 Decision

Manufacture
Probabilitie
Demand Summation
Node 2 sƩ=1
Low 0.35 321 112.35
Low Average 0.35 352 123.20
High 0.30 367 110.10
Subcontract
Node 3
Low 0.35 335 117.25
Low Average 0.35 353 123.55
High 0.30 381 114.30
Buy
Node 4
Low 0.35 318 111.30
Low Average 0.35 361 126.35
High 0.30 375 112.50

By expected value you get: VEsIP

Node 2 345.65 millions of dollars Node 2

Node 3 355.10 millions of dollars Node 3
Node 4 350.15 millions of dollars Node 4

All nodes Max

Low 117.25 VEcIP
Low Average 126.35 VEsIP
High medium 114.30

VEsIP Node 1 =[MAX; Node2; Node3; Node4; Node5; Node6]=

The recommended decision is to manufacture waiting for a payment value of:

VEcIP =[Low Probabilities Ʃ = 1 * Demand + Low averega Probabilities Ʃ = 1 * Demand + Hig

VEcIP 357.90 millions of dollars

VEIP: =[VEcIP - VEsIP]

VEIP: 2.80 millions of dollars

b. A test market study of potential product demand is expected to report a favorable (F) or

P(F/low) = 0.35 P(D/low) =

P(F/low average) = 0.41 P(D/ low average) =
P(F/high) = 0.32 P(D/high) =

Bayes theorem:

𝑃(𝑠_𝑗∕𝐸)= (𝑃(𝐸∕ 〖𝑠 _𝑗) 〗 𝑃 (𝑠_𝑗))/(𝑃(𝐸)) P(s1)= 0.35

FAVORABLE Previous Probabilities

State of Nature (sj) P(sj) Conditional Probabilities P(F/sj)
Low 0.35 0.35
Low Average 0.35 0.41
High 0.3 0.32
 Previous
Probabilitie
s P(sj)
UNFAVORABLE
State of Nature (sj) Conditional Probabilities P(F/sj)
Low 0.35 0.65
Low Average 0.35 0.59
𝑃(𝑠_𝑗∕𝐸)= (𝑃(𝐸∕ 〖𝑠 _𝑗) 〗 𝑃 (𝑠_𝑗))/(𝑃(𝐸))
High 0.3 0.68

Manufacture
Probabilitie
Demand Summation
sƩ=1
Node 4
Low 0.34 321 109.14
Low Average 0.4 352 140.80 Total
High 0.27 367 99.09 349.03
Subcontract
Node 5
Low 0.34 335 113.90
Low Average 0.4 353 141.20 Total MAX
High 0.27 381 102.87 357.97 357.97
Buy
Node 6
Low 0.34 318 108.12
Low Average 0.4 361 144.40 Total
High 0.27 375 101.25 353.77
Manufacture
Probabilitie
Demand Summation
sƩ=1
Node 7
Low 0.36 321 115.56
Low Average 0.32 352 112.64 Total
High 0.32 367 117.44 345.64
Subcontract
Node 8
Low 0.36 335 120.60
Low Average 0.32 353 112.96 Total MAX
High 0.32 381 121.92 355.48 355.48
Buy
Node 9
Low 0.36 318 114.48
Low Average 0.32 361 115.52 Total
High 0.32 375 120.00 350.00
c. What is the expected value of market research information?

Node 4 349.03 millions of dollars Maximum node

Node 5 357.97 millions of dollars
Node 6 353.77 millions of dollars
Node 7 345.64 millions of dollars Maximum node
Node 8 355.48 millions of dollars
Node 9 350.00 millions of dollars

Node value 1 356.38 =VEcIM

Value of the sample information VEIM= [VEcIM - VEsIM]

VEcIM: 356.38 millions of dollars

VEsIM; 355.10 millions of dollars
VEIM: 1.28 millions of dollars

d. What is the efficiency of the information?

E= VEIM
VEIP

E= 1.28
2.80

E= 0.45764

Efficiency of: 45.8%

arket of 25 years, must decide if it manufactures a new product in its main plant, or if on the contrary the purchase
profits, in millions of dollars.

rcialization of the product VEIP Valor esperado de la información perfecta

es of nature VEIM Valor esperado de la información muestral
ow average - utility Demand High - utility
352 367
353 381
361 375
0.35 0.30

ue of Perfect Information (EVPI) theory, the Expected Value of Sample Information (EVMI) and Decision Trees, re

er estimate of the demand.

o report a favorable (F) or unfavorable (U) condition. The relevant conditional probabilities are:

0.65
age) = 0.59
0.68

estimate of the demand

 Node 3 355.10 millions of dollars

355.10 millions of dollars

ities Ʃ = 1 * Demand + High medium Probabilities Ʃ = 1 * Demand + High Probabilities Ʃ = 1 * Demand]

o report a favorable (F) or unfavorable (U) condition. The relevant conditional probabilities are:

0.65
0.59
0.68

P(s2)= 0.35 P(s3)= 0.30

Probabilities Later Probabilities

Joint P (Sj/F)
0.12 0.34
0.14 0.4
0.10 0.27
P(D) 0.36
 Later
Probabilitie Probabilitie
s s
Joint P (Sj/F)

0.23 0.36
0.21 0.32
0.20 0.32
P(D) 0.64
 Node4, Node5, Node6
357.97

Node7, Node8, Node9

355.48
 on the contrary the purchase from an external supplier.

o de la información perfecta
o de la información muestral

EVMI) and Decision Trees, respond:

bilities are:
es Ʃ = 1 * Demand]

bilities are:
Exercise 2. DECISION TREES, EVPI and EVMI

ElectroCom, a company that manufactures electronic components for the introduction in its product catalog
or if it buys it from an external supplier. The profits depend on the demand of the product. The table shows

Table 2. Decision process for the commercialization of the product

States of nature
Decision alternative Demand low average - Demand High Medium
Demand low-utility
utility utility
Manufacture 438 466 49
Subcontract 426 462 48
Buy 430 469 48
Lease 451 474 48
Outsource 436 470 48
Probabilities Ʃ = 1 0.17 0.29 0.2

According to the corresponding information in Table 2 and the Predicted Value of Perfect Information (EVP

a. Use EVPI to determine if the company should try to get a better estimate of the demand.
b. A test market study of potential product demand is expected to report a favorable (F) or unfavo

P(F/low) = 0.15 P(D/low) =

P(F/low average) = 0.45 P(D/ low average) =
P(F/high medium) = 0.30 P(D/high Medimun) =
P(F/high) = 0.50 P(D/high) =

c. What is the expected value of market research information?

d. What is the efficiency of the information?

Development

a. Use EVPI to determine if the company should try to get a better estimate of the demand.
Node 1
Decision

Manufacture
Probabilitie
Demand Summation
Node 2 sƩ=1

Low 0.17 438 74.46

Low Average 0.29 466 135.14
High medium 0.21 495 103.95
High 0.33 500 165.00
Subcontract
Node 3
Low 0.17 426 72.42
Low Average 0.29 462 133.98
High medium 0.21 487 102.27
High 0.33 512 168.96
Buy
Node 4
Low 0.17 430 73.10
Low Average 0.29 469 136.01
High medium 0.21 487 102.27
High 0.33 509 167.97
Lease
Node 5
Low 0.17 451 76.67
Low Average 0.29 474 137.46
High medium 0.21 487 102.27
High 0.33 503 165.99
Outsource
Node 6
Low 0.17 436 74.12
Low Average 0.29 470 136.30
High medium 0.21 488 102.48
High 0.33 508 167.64

By expected value you get: VEsIP

Node 2 478.55 millions of dollars Node 2

Node 3 477.63 millions of dollars Node 3
Node 4 479.35 millions of dollars Node 4
Node 5 482.39 millions of dollars Node 5
Node 6 480.54 millions of dollars Node 6

All nodes Max VEcIP Expected value of perfect information

Low 76.67 VEsIP Expected value without perfect information
Low Average 137.46
High medium 103.95
High 168.96

VEsIP Node 1 =[MAX; Node2; Node3; Node4; Node5; Node6]= Node 5 482.39

The recommended decision is to manufacture waiting for a payment value of: 482.39

VEcIP =[Low Probabilities Ʃ = 1 * Demand + Low averega Probabilities Ʃ = 1 * Demand + High mediu
VEcIP 487.04 millions of dollars
 VEIP =[VEcIP - VEsIP]
VEIP 4.65 millions of dollars

b. A test market study of potential product demand is expected to report a favorable (F) or unfavorable (U) c

P(F/low) = 0.15 P(D/low) = 0.85

P(F/low average) = 0.45 P(D/ low average) = 0.55
P(F/high medium) = 0.30 P(D/high Medimun) = 0.70
P(F/high) = 0.50 P(D/high) = 0.50

Bayes theorem:
𝑃(𝑠_𝑗∕𝐸)= (𝑃(𝐸∕ 〖𝑠 _𝑗) 〗 𝑃 (𝑠_𝑗))/(𝑃(𝐸)) P(s1)= 0.17 P(s2)= 0.29

FAVORABLE Previous Probabilities Conditional Probabilities

State of Nature (sj) P(sj) Probabilities P(F/sj) Joint
Low 0.17 0.15 0.03
Low Average 0.29 0.45 0.13
High medium 0.21 0.30 0.06
High 0.33 0.50 0.17
P(D)

Previous Probabilities
P(sj) Conditional Probabilities
UNFAVORABLE Probabilities P(F/sj) Joint
State of Nature (sj)
Low 0.17 0.85 0.14
Low Average 0.29 0.55 0.16
High medium 0.21 0.70 0.15
High 0.33 0.50 0.17
P(D)

Manufacture
Probabilitie
Demand Summation
sƩ=1
Node 4
Low 0.07 438 30.66
Low Average 0.34 466 158.44
High medium 0.16 495 79.20 Total
High 0.43 500 215.00 483.30
Subcontract
Node 5
Low 0.07 426 29.82
Low Average 0.34 462 157.08
High medium 0.16 487 77.92 Total
High 0.43 512 220.16 484.98
Buy
Node 6
Low 0.07 430 30.10
Low Average 0.34 469 159.46
High medium 0.16 487 77.92 Total MAX
High 0.43 509 218.87 486.35 486.94
Lease
Node 7
Low 0.07 451 31.57
Low Average 0.34 474 161.16
High medium 0.16 487 77.92 Total
High 0.43 503 216.29 486.94
Outsource
Node 8
Low 0.07 436 30.52
Low Average 0.34 470 159.80
High medium 0.16 488 78.08 Total
High 0.43 508 218.44 486.84
Manufacture
Probabilitie
Demand Summation
sƩ=1
Node 9
Low 0.23 438 100.74
Low Average 0.26 466 121.16
High medium 0.24 495 118.80 Total
High 0.27 500 135.00 475.70
Subcontract
Node 10
Low 0.23 426 97.98
Low Average 0.26 462 120.12
High medium 0.24 487 116.88 Total
High 0.27 512 138.24 473.22
Buy
Node 11
Low 0.23 430 98.90
Low Average 0.26 469 121.94
High medium 0.24 487 116.88 Total MAX
High 0.27 509 137.43 475.15 479.66
Lease
Node 12
Low 0.23 451 103.73
Low Average 0.26 474 123.24
High medium 0.24 487 116.88 Total
High 0.27 503 135.81 479.66
Outsource
Node 13
Low 0.23 436 100.28
Low Average 0.26 470 122.20
High medium 0.24 488 117.12 Total
High 0.27 508 137.16 476.76

c. What is the expected value of market research information?

Node 4 483.30 millions of dollars Maximum node

Node 5 484.98 millions of dollars 486.94
Node 6 486.35 millions of dollars
Node 7 486.94 millions of dollars
Node 8 486.84 millions of dollars
Node 9 475.70 millions of dollars Maximum node
Node 10 473.22 millions of dollars 479.66
Node 11 475.15 millions of dollars
Node 12 479.66 millions of dollars
Node 13 476.76 millions of dollars

Node value 1 482.46 =VEcIM

Value of the sample information VEIM= [VEcIM - VEsIM]

VEcIM: 482.46 millions of dollars

VEsIM; 482.39 millions of dollars
VEIM: 0.07 millions of dollars

d. What is the efficiency of the information?

E= VEIM/
VEIP

E= 0.07
4.65

E= 0.01409

Efficiency of 1.4%
 in its product catalog, must decide whether to manufacture a new product in its main plant, subcontract it with compa
uct. The table shows projected profits, in millions of dollars.

ation of the product

nature
emand High Medium- Demand High Medium-
utility utility
495 500
487 512
487 509
487 503
488 508
0.21 0.33

ect Information (EVPI) theory, the Expected Value of Sample Information (EVMI) and Decision Trees, respond:

of the demand.
vorable (F) or unfavorable (U) condition. The relevant conditional probabilities are:

0.85
0.55
0.70
0.50

ate of the demand.

 information
erfect information

millions of dollars

millions of dollars

emand + High medium Probabilities Ʃ = 1 * Demand + High Probabilities Ʃ = 1 * Demand]

or unfavorable (U) condition. The relevant conditional probabilities are:

P(s3)= 0.21 P(s4)= 0.33

Later Probabilities
P (Sj/F)
0.07
0.34
0.16
0.43
0.38

Later Probabilities
P (Sj/F)

0.23
0.26
0.24
0.27
0.62
Node4, Node5, Node6, Node7, Node8

Node9, Node10, Node11, Node12; Node13

contract it with company supervision

Trees, respond:
Exercise 3. DECISION TREES, EVPI and EVMI

Teratextyl, a textile company that has a productive experience in the foreign market of 30 years, must deci
The profits depend

Table 3. Decision process for the commercialization of the product

States of nature
Decision alternative Demand low average - Demand High Medium
Demand low-utility
utility utility
Manufacture 525 574 58
Subcontract 537 568 58
Buy 540 568 58
Lease 549 565 59
Outsource 536 571 59
Probabilities Ʃ = 1 0.17 0.29 0.2

According to the corresponding information in Table 3 and the Predicted Value of Perfect Information (EVP

a. Use EVPI to determine if the company should try to get a better estimate of the demand.
b. A test market study of potential product demand is expected to report a favorable (F) or unfavo

P(F/low) = 0.21 P(D/low) =

P(F/low average) = 0.25 P(D/ low average) =
P(F/high medium) = 0.42 P(D/high Medimun) =
P(F/high) = 0.30 P(D/high) =

c. What is the expected value of market research information?

d. What is the efficiency of the information?

Development

a. Use EVPI to determine if the company should try to get a better estimate of the demand.

Node 1 Decision

Manufacture
Probabilitie
Demand Summation
sƩ=1
Node 2
Low 0.17 525 89.25
Low Average 0.29 574 166.46
High medium 0.21 589 123.69
High 0.33 603 198.99
Subcontract
Node 3
Low 0.17 537 91.29
Low Average 0.29 568 164.72
High medium 0.21 586 123.06
High 0.33 610 201.30
Buy
Node 4
Low 0.17 540 91.80
Low Average 0.29 568 164.72
High medium 0.21 587 123.27
High 0.33 603 198.99
Lease
Node 5
Low 0.17 549 93.33
Low Average 0.29 565 163.85
High medium 0.21 593 124.53
High 0.33 602 198.66
Outsource
Node 6
Low 0.17 536 91.12
Low Average 0.29 571 165.59
High medium 0.21 592 124.32
High 0.33 602 198.66

By expected value you get: VEsIP

Node 2 578.39 millions of dollars Node 2

Node 3 580.37 millions of dollars Node 3
Node 4 578.78 millions of dollars Node 4
Node 5 580.37 millions of dollars Node 5
Node 6 579.69 millions of dollars Node 6

All nodes Max VEcIP Expected value of perfect information

Low 93.33 VEsIP Expected value without perfect information
Low Average 166.46
High medium 124.53
High 201.30

VEsIP Node 1 =[MAX; Node2; Node3; Node4; Node5; Node6]= 0 580.37

The recommended decision is to manufacture waiting for a payment value of: 580.37

VEcIP =[Low Probabilities Ʃ = 1 * Demand + Low averega Probabilities Ʃ = 1 * Demand + High mediu
VEcIP 585.62 millions of dollars
 VEIP: =[VEcIP - VEsIP]
VEIP: 5.25 millions of dollars

b. A test market study of potential product demand is expected to report a favorable (F) or

P(F/low) = 0.21 P(D/low) = 0.79

P(F/low average) = 0.25 P(D/ low average) = 0.75
P(F/high medium) = 0.42 P(D/high Medimun) = 0.58
P(F/high) = 0.30 P(D/high) = 0.70

Bayes theorem:
P(s1)= 0.17 P(s2)= 0.29 P(s3)=
𝑃(𝑠_𝑗∕𝐸)= (𝑃(𝐸∕ 〖𝑠 _𝑗) 〗 𝑃 (𝑠_𝑗))/(𝑃(𝐸))

FAVORABLE Previous Probabilities Conditional Probabilities

State of Nature (sj) P(sj) Probabilities P(F/sj) Joint
Low 0.17 0.21 0.04
Low Average 0.29 0.25 0.07
High medium 0.21 0.42 0.09
High 0.33 0.30 0.10
P(D)

UNFAVORABLE Previous Probabilities Conditional Probabilities

State of Nature (sj) P(sj) Probabilities P(F/sj) Joint
Low 0.17 0.79 0.13
Low Average 0.29 0.75 0.22
High medium 0.21 0.58 0.12
High 0.33 0.70 0.23
P(D)

Manufacture
Probabilitie Demand Summation
sƩ=1
Node 4
Low 0.12 525 63.00
Low Average 0.25 574 143.50
High medium 0.3 589 176.70 Total
High 0.34 603 205.02 588.22
Subcontract
Node 5
Low 0.12 537 64.44
Low Average 0.25 568 142.00
High medium 0.3 586 175.80 Total
High 0.34 610 207.40 589.64
Buy
Node 6
Low 0.12 540 64.80
Low Average 0.25 568 142.00
High medium 0.3 587 176.10 Total MAX
High 0.34 603 205.02 587.92 589.71
Lease
Node 7
Low 0.12 549 65.88
Low Average 0.25 565 141.25
High medium 0.3 593 177.90 Total
High 0.34 602 204.68 589.71
Outsource
Node 8
Low 0.12 536 64.32
Low Average 0.25 571 142.75
High medium 0.3 592 177.60 Total
High 0.34 602 204.68 589.35
Manufacture
Probabilitie Demand Summation
sƩ=1
Node 9
Low 0.19 525 99.75
Low Average 0.31 574 177.94
High medium 0.17 589 100.13 Total
High 0.33 603 198.99 576.81
Subcontract
Node 10
Low 0.19 537 102.03
Low Average 0.31 568 176.08
High medium 0.17 586 99.62 Total
High 0.33 610 201.30 579.03
Buy
Node 11
Low 0.19 540 102.60
Low Average 0.31 568 176.08
High medium 0.17 587 99.79 Total MAX
High 0.33 603 198.99 577.46 579.03
Lease
Node 12
Low 0.19 549 104.31
Low Average 0.31 565 175.15
High medium 0.17 593 100.81 Total
High 0.33 602 198.66 578.93
Outsource
Node 13
Low 0.19 536 101.84
Low Average 0.31 571 177.01
High medium 0.17 592 100.64 Total
High 0.33 602 198.66 578.15

c. What is the expected value of market research information?

Node 4 588.22 millions of dollars Maximum node Node4, Node5, Node6

Node 5 589.64 millions of dollars 589.71
Node 6 587.92 millions of dollars
Node 7 589.71 millions of dollars
Node 8 589.35 millions of dollars
Node 9 576.81 millions of dollars Maximum node Node9, Node10, Node
Node 10 579.03 millions of dollars 579.03
Node 11 577.46 millions of dollars
Node 12 578.93 millions of dollars
Node 13 578.15 millions of dollars

Node value 1 582.18 =VEcIM

Value of the sample information VEIM= [VEcIM - VEsIM]

VEcIM: 582.18 millions of dollars

VEsIM; 580.37 millions of dollars
VEIM: 1.81 millions of dollars

d. What is the efficiency of the information?

E= VEIM
VEIP

E= 1.81
5.25

E= 0.34569

Efficiency of 34.6%
 30 years, must decide if it manufactures a new product in its main plant, or if on the contrary the purchase from an e

ation of the product

nature
emand High Medium- Demand High Medium-
utility utility
589 603
586 610
587 603
593 602
592 602
0.21 0.33

ect Information (EVPI) theory, the Expected Value of Sample Information (EVMI) and Decision Trees, respond:

of the demand.
vorable (F) or unfavorable (U) condition. The relevant conditional probabilities are:

0.79
0.75
0.58
0.70

the demand.
 information
erfect information

millions of dollars

millions of dollars

emand + High medium Probabilities Ʃ = 1 * Demand + High Probabilities Ʃ = 1 * Demand]

ort a favorable (F) or unfavorable (U) condition. The relevant conditional probabilities are:

0.21 P(s4)= 0.33

Later Probabilities
P (Sj/F)
0.12
0.25
0.3
0.34
0.30

Later Probabilities
P (Sj/F)
0.19
0.31
0.17
0.33
0.70
ode4, Node5, Node6, Node7, Node8

ode9, Node10, Node11, Node12; Node13

e purchase from an external supplier.

Trees, respond:
 Decision theory

Unit 1: Task 1 - Expected value, trees of decision and theory of utility (Discussion Forum)

Presented by:

PRESENTED TO

National Open and Distance University

School of basic sciences - technology and engineering
Industry Engineering Program
CEAD José Acevedo y Gómez
Mar-20