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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
one’s 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
18 CHAPTER 3 DECISION ANALYSIS

of Rob1. The robots will be used to perform a variety of repair The Hurwicz approach uses a coefficient of realism value of
opera- tions on large industrial equipment. Of course, George can 0.7, and a weighted average of the best and the worst payoffs for
always do nothing and not buy any robots (alternative 3). The market each alternative is computed. The results are as follows:
for the re- pair could be either favorable (event 1) or unfavorable Weighted average (alternative 1) = ($50,000)(0.7)
(event 2). George has constructed a payoff matrix showing the + (—$40,000)(0.3)
expected returns of each alternative and the probability of a favorable
= $23,000
or unfavorable 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 Maximu

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

First
Decision
Point
Second
Decision
Point

Favorable Market (0.871)

$45,000
2 Unfavorable Market (0.129)
–$45,000
Favorable Market (0.871)
$25,000
Rob2
3
Unfavorable Market (0.129)
–$25,000

–$5,000

1
Favorable Market (0.158)
$45,000
4 Unfavorable Market (0.842)
–$45,000
Favorable Market (0.158)
$25,000
Rob2
5 Unfavorable Market (0.842)
–$25,000

–$5,000
$–5,000

Favorable Market (0.60)

$50,000
6 Unfavorable Market (0.40)
–$40,000
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 Simkin
two tables.
used utility theory to determine his best decision. What decision would
Probability revision given a positive survey result
Mark make if he had the following utility values? Is Mark still a risk
State of Condition Prio Join Posterio seeker?
Nature al r t r U(—$10,000) = 0.8
Probabilit Prob Prob Probabilit
U($0) = 0.9
y . . y
FM 0.9 0.6 0.54 0.54/0.62 = 0.871 U($10,000) = 1
UM 0.2 0.4 0.08 0.08/0.62 = 0.129 Using the data above, we can determine the expected utility of
Total 0.62 1.00 each alternative as follows:
U(Mark plays the game) = 0.45(1) + 0.55(0.8) =
Probability given a negative survey result 0.89 U(Mark doesn’t play the game) = 0.9
State of Condition Prio Join Posterio Thus, the best decision for Mark is not to play the game with an
Nature al r t r expected utility of 0.9. Given these data, Mark is a risk avoider.
Probabilit Prob Prob Probabilit
y . . y
FM 0.1 0.6 0.06 0.06/0.38 = 0.158
UM 0.8 0.4 0.32 0.32/0.38 = 0.842
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.
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 maker’s 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
$300,000.
Row Row
Equipmen Favorabl Unfavorabl Maximu Minimum
t e e m
Sub 100 300,000 —200,000 300,000 —200,000
Oiler J 250,000 —100,000 250,000 —100,000
Texan 75,000 —18,000 75,000 —18,000
3-17. Using the maximin criterion, the best alternative is the
Texan (see table above) because the worst payoff for this ($—
18,000) is better than the worst payoffs for the other decisions. 3-
18. a. Decision making under risk—maximize expected
monetary value.
 CHAPTER 3 D E C I S I O N A N A LY S I S 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-
EMV (Oiler J) = 0.7(250,000) + 0.3(–100,000) mum EMV without the information is 900. Therefore,
= 145,000 Allen should pay at most EVPI = 1,100 – 900 = $200.
EMV (Texan) = 0.7(75,000) + 0.3(–18,000) b. Yes, Allen should pay [1,100(0.4) + 900(0.4) +
= 47,100 900(0.2)] — 900 = $80.
Optimal decision: Sub 100. 3-23. a. Opportunity loss table
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
0.7X < 145,000 + 60,000 = 205,000 Small 350,000 29,000 32,000 350,000
X < (205,000)/0.7 = 292,857.14 None 550,000 129,000 0 550,000
The decision would change if this payoff were less than
292,857.14, so it would have to decrease by about $7,143. b. Minimax regret decision is to build medium.

3-19. a. The expected value (EV) is computed for each 3-24. a.

alternative. Stock Demand
(Cases (Cases) 11 12 13 EMV
EV(stock market) = 0.5(80,000) + 0.5(—20,000) =
)
30,000
11 385 385 385 385
EV(Bonds) = 0.5(30,000) + 0.5(20,000) = 25,000 12 329 420 420 379.05
EV(CDs) = 0.5(23,000) + 0.5(23,000) = 23,000 13 273 364 455 341.25
Therefore, he should invest in the stock market. Probabilities 0.45 0.35 0.20
b. EVPI = EV(with perfect information)
— (Maximum EV without P, I) b. Stock 11 cases.
= [0.5(80,000) + 0.5(23,000)] — 30,000 c. If no loss is involved in excess stock, the recom-
= 51,500 — 30,000 = 21,500 mended course of action is to stock 13 cases and to re-
plenish stock to this level each week. This follows from
Thus, the most that should be paid is $21,500.
the following decision table.
3-20. The opportunity loss table is
Stock Demand
(Cases) (Cases) 11 12 13 EMV
Alternative Good Economy Poor Economy
11 385 385 385 385
Stock Market 0 43,000 12 385 420 420 404.25
Bonds 50,000 3,000
13 385 420 455 411.25
CDs 57,000 0

EOL(Stock Market) = 0.5(0) + 0.5(43,000) = 21,500*

3-25.
This minimizes EOL.
Manu Demand
EOL(Bonds) = 0.5(50,000) + 0.5(3,000) = 26,500 - (Cases)
EOL(CDs) = 0.5(57,000) + 0.5(0) = 28,500 factur 6 7 8 9 EMV
3-21. a. e
(Cases
)
6 300 300 300 300 300
Market 7 255 350 350 350 340.5
Alternative Conditio Good Fair Poor EMV 8 210 305 400 400 352.5
n 9 165 260 355 450 317
Probabilities of 0.4 0.4 0.2 John should manufacture 8 cases of cheese spread.
Stock market
market conditions 1,400 800 0 880
3-26. Cost of produced case = $5.
Bank deposit 900 900 900 900
b. Best decision: deposit $10,000 in bank. Cost of purchased case = $16.
Selling price = $15.
22 CHAPTER 3 DECISION ANALYSIS

Money recovered from each unsold case = $3.

Suppl Demand
y (Cases) 100 200 300 EMV
(Cases
)
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 Weighte
Alternatives Good Fair Poor Maximu Minimu Average d
m m Averag
e
Small 50,000 20,000 — 50,000 —10,000 20,000 38,000
10,000
Medium 80,000 30,000 — 80,000 —20,000 30,000 60,000
20,000
Large 100,000 30,000 — 100,000 —40,000 30,000 72,000
40,000
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 Marke Maximu
t m
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
1
–$40,000
Unfavorable Market (0.5)

$30,000

$0
EMV for no clinic is $0
 CHAPTER 3 D E C I S I O N A N A LY S I S 23

3-29. a.

Payoff
Favorable Market (0.82)
$95,000
CONSTRUCT 2 Unfavorable Market (0.18)
–$45,000

$69,800

DO NOT CONSTRUCT –$5,000

1
Favorable Market (0.11)
$36,140 Unfavorable Market (0.89) $95,000
CONSTRUCT
3
–$45,000

$36,140 –$5,000

DO NOT CONSTRUCT –$5,000

Favorable Market (0.5)

Unfavorable Market (0.5) $100,000
CONSTRUCT CLINIC
4
–$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.
24 CHAPTER 3 DECISION ANALYSIS

3-30.
Favorable Market
Large Shop
2 Unfavorable Market

No Shop

Favorable Market
Small Shop
3 Unfavorable Market

Favorable Market
Large Shop
4 Unfavorable Market
No Shop

Favorable Market
Small Shop
5 Unfavorable Market

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).
 CHAPTER 3 D E C I S I O N A N A LY S I S 25

Payoff
$45,000 Favorable Market (0.9)
Large Shop $55,000
2 Unfavorable Market (0.1)
$45,000 –$45,000
No Shop
–$5,000
$21,000 Favorable Market (0.9)
Small Shop $25,000
3 Unfavorable Market (0.1)
$25,000 –$15,000
1
–$33,000 Favorable Market (0.12)
Large Shop $55,000
4 Unfavorable Market (0.88)
–$5,000 –$45,000
No Shop
–$5,000
–$10,200 Favorable Market (0.12)
Small Shop $25,000
5 Unfavorable Market (0.88)
–$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. Jerry’s decision is not very sensitive to
this probability value.
26 CHAPTER 3 DECISION ANALYSIS

3-32.
Payoff
$8,500 2 (0.9)
A3 $500 $12,000
(0.1)
3 (0.9) –$23,000
$8,500 (0.1)
A4 $2,000
–$13,000
A5
–$3,000
$2,750
1

–$9,000 4 (0.4)
A3 –$7,000 $12,000
(0.6)
4
5 (0.4) –$23,000
–$3,000 (0.6)
A $2,000

–$13,000

A5
–$3,000

$4,500 6 (0.7)
A3 $500 $15,000
(0.3)
7 (0.7) –$20,000
$4,500 (0.3)
A4 $5,000
–$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( I | S1 )P(S1 )
P(S1 | I1 ) P( I |1S )P(S
EMV(node 2) = 0.9(12,000) + 0.1(—23,000) = 1 1 1)  P( I 1| S )P(S
2 )2
8,500
EMV(node 3) = 0.9(2,000) + 0.1(—13,000) = 500
EMV(get information and then do nothing) = — P(S | I )  0.8(0.5)  0.73
3,000
1 1
EMV(node 4) = 0.4(12,000) + 0.6(—23,000) = — 0.8(0.5)  0.3(0.5)
9,000
b. P(successful store | unfavorable research) = P(S1 | I2)
EMV(node 5) = 0.4(2,000) + 0.6(—13,000) = —
7,000
EMV(get information and then do nothing) = — P(S | I )  P( I2 | S1 )P(S1 )
3,000
1 2
EMV(node 1) = 0.5(8,500) + 0.5(-3,000) = 2,750 P( I2| S 1)P(S )1  P( I |2 S )P(S
2 )2
EMV(build quadplex) = 0.7(15,000) + 0.3(—20,000) = 0.2(0.5)
4,500 P(S | I )   0.22
1 2
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.
3-33. I : favorable research or information 0.8(0.6)
P(S | I )   0.8
1 1 1
0.8(0.6)  0.3(0.4)
I2: unfavorable research
S1: store successful P(S | I )  0.2(0.6)  0.3
1 2
S2: store unsuccessful 0.2(0.6)  0.7(0.4)
 CHAPTER 3 D E C I S I O N A N A LY S I S 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
P(I1 | S2) = 0.3; P(I2 | S2) = 0.7 economy. 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( I | S1 )P(S1 )
P(S1 | I1 ) P( I |1S )P(S X = 4,300/0.2 = 21,500
1 1 1)  P( I 1| S )P(S
2 )2
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(S | I )   0.533
1 1
0.8(0.3)  0.3(0.7) based on the expected values.

P(successful facility | unfavorable survey) = P(S1 |

I 2)
P(S | I ) 
1 2
P( I2 | S1 )P(S1 )
P( I | S )P(S )  P( I | S )P(S )
2 1 1 2 2 2

P(S | I )  0.2(0.3)  0.109

1 2
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
28 CHAPTER 3 DECISION ANALYSIS

3-36. a.

Payoff
Favorable Market
$95,000
Produce
Razor 3 Unfavorable Market
Survey –$65,000
Favorable
Do Not Produce Razor
–$5,000
1 Favorable Market $95,000
Produce
Razor 4 Unfavorable Market
Survey –$65,000
Unfavorable
Do Not Produce Razor
–$5,000
Favorable Market $80,000

Study Produce
Razor 5 Unfavorable Market –$80,000
Favorable Do Not Produce Razor –$20,000
Conduct
Pilot Favorable Market
Study 2 $80,000
Produce
6
Razor Unfavorable Market
Study –$80,000
Unfavorable
Do Not Produce Razor
–$20,000

Produce Favorable Market

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

b. S1: survey favorable

S2: survey unfavorable
S3: study favorable EMV(node 5) = 80,000(0.89) + (—80,000)(0.11) = 62,400
S4: study unfavorable EMV(node 6) = 80,000(0.18) + (—80,000)(0.82)
= —51,200
S5: market favorable
EMV(node 7) = 100,000(0.5) + (—60,000)(0.5) = 20,000
S6: market unfavorable
EMV(conduct survey) = 59,800(0.45) + (–5,000)(0.55)
= 24,160
EMV(conduct pilot study) = 62,400(0.45) + (—20,000)
(0.55)
P(S | S )  0.7(0.5) = 17,080
 0.78
5 1
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.
P(S | S )  0.3(0.5)  0.27 3-37. The following computations are for the decision tree that
5 2
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
P(S | S ) 
0.8(0.5)  0.89 EU(node 4) = 0.95(0.27) + 0.5(0.73) = 0.62
5 3
0.8(0.5)  0.1(0.5) EMV(node 4) = 95,000(0.27) + (—65,000)(0.73)
P(S6 | S3) = 1 – 0.89 = 0.11 = —21,800
0.2(0.5)
P(S | S )   0.18
5 4
0.2(0.5)  0.9(0.5)
P(S6 | S4) = 1 – 0.18 = 0.82
c. EMV(node 3) = 95,000(0.78) + (—65,000)(0.22)
= 59,800
 EU(node 5) = 0.9(0.89) + 0(0.11) = 0.80
EU(node 6) = 0.9(0.18) + 0(0.82) = 0.16
EU(node 7) = 1(0.5) + 0.55(0.5) = 0.78
EU(conduct survey) = 0.85(0.45) + 0.8(0.55) = 0.823
EU(conduct pilot study) = 0.80(0.45) +
0.7(0.55) = 0.745 EU(neither test) = 0.81
Therefore, the best decision is to conduct the survey. Jim is
a risk avoider.
 CHAPTER 3 D E C I S I O N A N A LY S I S 29

Utility
0.85 Market Favorable (0.78)
0.95
Produce
3
Survey Razor Market Unfavorable (0.22)
0.5

0.82 Favorable Do Not Produce Razor

(0.45) 0.8
1 Market Favorable (0.27)
0.62
0.95
Produce
Survey 4
Razor Market Unfavorable (0.73)
0.5
Unfavorable
Do Not Produce Razor
(0.55) 0.8
0.80 Market Favorable (0.89)
0.9
Produce
5
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)
Study 2 0.9
Produce
6
Study Razor Market Unfavorable (0.82)
0
Unfavorable
Do Not Produce Razor
(0.55) 0.7

Produce
0.78 Market Favorable (0.5)
Razor 1
7
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-
0.1(0.4) pany is
good economy) =  0.077
0.8(0.6)  0.1(0.4) EV = 0(0.999) + 100,000(0.001) = 100
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
poor economy) = 0.2(0.6)  0.25 policy is negative (–$100). Thus, buying the policy does not maxi-
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
poor economy) = 0.9(0.6)  0.75 that goes along with the insurance policy has a relatively high util-
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)
30 CHAPTER 3 DECISION ANALYSIS

3-40.

Payoff Utility
U = 0.8118 Favorable Market (0.82)
$95,000 0.99
Construct
Survey Clinic 2 Unfavorable Market (0.18)
–$45,000 0
Favorable Do Not Construct Clinic
U = 0.76 (0.55) –$5,000 0.7
1 U = 0.1089 Favorable Market (0.11)
$95,000 0.99
Construct
Clinic 3 Unfavorable Market (0.89)
Survey –$45,000 0
Unfavorable
(0.45) Do Not Construct Clinic
– 0.7
$5,000
U = 0.55 Favorable Market (0.5)
1.0
Construct $100,000
Clinic 4 Unfavorable Market (0.5)
0.1
–$40,000
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
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
used. The medical professionals are risk avoiders.
3-41. EU(large plant | survey favorable) = 0.78(0.95)
+ 0.22(0) = 0.741
EU(small plant | survey favorable) = 0.78(0.5) + 0.22(0.1)
= 0.412
EU(no plant | survey favorable) = 0.2
EU(large plant | survey negative) = 0.27(0.95) + 0.73(0) 1.0 0 10 20 30 40
= 0.2565
Time (minutes)
0.8

0.6
Utility

0.4

0.2

EU(small plant | survey negative) = 0.27(0.5) + 0.73(0.10)
= 0.208
EU(no plant | survey negative) = 0.2
EU(large plant | no survey) = 0.5(1) + 0.5(0.05) = 0.525
EU(small plant | no survey) = 0.5(0.6) + 0.5(0.15) =
0.375 EU(no plant | no survey) = 0.3
EU(conduct survey) = 0.45(0.741) + 0.55(0.2565) =
0.4745
EU(no survey) = 0.525
John’s decision would change. He would not conduct the survey
and build the large plant.
3-42. a. Expected travel time on Broad Street = 40(0.5) +
15(0.5) = 27.5 minutes. Broad Street has a lower ex-
pected travel time.
Expressway
0
3-43. Selling price = $20 per gallon; manufacturing cost =
$12 per gallon; salvage value = $13; handling costs = $1 per
gallon; and advertising costs = $3 per gallon. From this informa-
tion, we get:
marginal profit = selling price minus the manufacturing,
handling, and advertising costs
marginal profit = $20 — $12 — $1 — $3 = $4 per gallon
If more is produced than is needed, a marginal loss is incurred.
marginal loss = $13 — $12 — $1 — $3 = $3 per gallon
In addition, there is also a shortage cost. Coren has agreed to fulfill
any demand that cannot be met internally. This requires that
Coren purchase chemicals from an outside company. Because the
cost of obtaining the chemical from the outside company is $25
and the price charged by Coren is $20, this results in
Broad 1
Street
 30 Minutes, that has to be purchased from an outside company due to a
shor
U = 0.7 tage shortage.
Congestion (0.5) No
Congestion (0.5) 40 Minutes, cost
U = 0.2 =
$5
15 Minutes,
per
U = 0.9 gall
on
I
n

o
t
h
e
r

w
o
r
d
s
,

C
o
r
e
n

w
i
l
l

l
o
s
e

$
5

f
o
r

e
v
e
r
y

g
a
l
l
o
n

t
h
a
t

i
s

s
o
l
d
 CHAPTER 3 D E C I S I O N A N A LY S I S 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
Stock 500 –$3,000 = (500)(4) – (1,000)(5)
(0.1) 2,000 –$5,500 = (500)(4) – (1,500)(5)
$1,800
Stock 1,000 (0.2) 500 $500 = (500)(4) – (500)(3)
(0.3) 1,000 $4,000 = (1,000)(4)
$3,300
Stock 1,500 (0.4) 1,500 $1,500 = (1,000)(4) – (5)(500)
(0.1) 2,000 –$1,000 = (1,000)(4) – (5)(1,000)

(0.2) 500
–$1,000 = (500)(4) – (3)(1,000)
(0.3) 1,000
$2,500 = (1,000)(4) – (3)(500)
(0.4) 1,500 $6,000 = (1,500)(4)
Stock 2,000 (0.1) 2,000 $3,500 = (1,500)(4) – (5)(500)
(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 Tree–No Survey
numbers are entered into the tree above. The best decision is to
stock 1,500 gallons. (0.15)
$500,000
Table for Problem 3-43 (0.40)
$500,000
Demand
Stock 500 1,0001,5002,000 EMV (0.45) $500,000
500 2,000 —500 —3,000 —5,500 —$1,500
1,000 500 4,000 1,500 1,000 $1,800 (0.15) $200,000
1,500 —1,000 2,500 6,000 3,500 $3,300 Medium $670,000 (0.40)
2,000 —2,500 1,000 4,500 8,000 $2,400 $700,000
Maximum 2,000 4,000 6,000 8,000 $4,800 = EVwPI
(0.45) $800,000
Probabilities 0.2 0.3 0.4 0.1
(0.15) –$200,000
c. EVwPI = (0.2)(2,000) + (0.3)(4,000) + (0.4)(6,000)
+ (0.1)(8,000) = $4,800 $400,000
(0.40)
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) =
decision branches are three possible demands, representing the 580,000.
possible states of nature. The demand for this type of facility The medium facility, with an expected monetary value of
could be either low (L), medium (M), or high (H). It was given in $670,000, is selected because it represents the highest ex-
the problem that the probability for a low demand is 0.15. The pected monetary value.
proba- bilities for a medium and a high demand are 0.40 and 0.45, If the survey is used, we must compute the revised
respec- tively. The problem also gave monetary consequences for probabili- ties using Bayes’ theorem. For each alternative
building a small, medium, or large facility when the demand could facility, three revised probabilities must be computed,
be low, medium, or high for the facility. These data are reflected representing low, medium, and high demand for a facility.
in the fol- lowing decision tree. These probabilities can be computed using tables. One table is
used to compute the probabilities for low survey results,
another table is used for
 32 CHAPTER 3 DECISION ANALYSIS

medium survey results, and a final table is used for high survey re- Decision Tree–Survey
sults. These tables are shown below. These probabilities will be used
in the decision tree that follows. L 450,000
For low survey results—A1: Small M
450,000
State of P(Bi) P(Ai | Bj) P(Bj and Ai) P(Bj | HL
Nature Ai) 450,000
B1 0.150 0.700 0.105 0.339
B2 0.400 0.400 0.160 0.516 150,000
B3 0.450 0.100 0.045 0.145 Medium M
650,000
P(A1) = 0.310
For medium survey results—A2: HL 750,000
M
HL –250,000
State of P(Bi) P(Ai | Bj) P(Bj and Ai) P(Bj |
Nature Ai) 350,000
B1 0.150 0.200 0.030 0.082 Large
B2 0.400 0.500 0.200 0.548 950,000
B3 0.450 0.300 0.135 0.370
P(A2) = 0.365
450,000
For high survey results—A3: Small M
HL 450,000
State of P(Bi) P(Ai | Bj) P(Bj and Ai) P(Bj |
Nature Ai) 450,000
B1 0.150 0.100 0.015 0.046 150,000
B2 0.400 0.100 0.040 0.123
$646,000 Medium M
B3 0.450 0.600 0.270 0.831 650,000
Medium (0.365)
P(A3) = 0.325
HL
Large 750,000
When survey results are low, the probabilities are P(L) =
0.339; P(M) = 0.516; and P(H) = 0.145. This results in –250,000
EMV(Small) = 450,000; EMV(Medium) = 495,000; and M
EMV(Large) = 233,600. 350,000
When survey results are medium, the probabilities are P(L) H
= 0.082; P(M) = 0.548; and P(H) = 0.378. This results in EMV 950,000
(Small) = 450,000; EMV(Medium) = 646,000; and EMV(Large)
L 450,000
= 522,800.
When survey results are high, the probabilities are P(L) = Small M
0.046; P(M) = 0.123; and P(H) = 0.831. This results in HL 450,000
EMV(Small) = 450,000; EMV(Medium) = 710,100; and
EMV(Large) = 821,000. 450,000
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
results are medium, the best decision is also to build the medium HL 650,000
plant with an expected return of $646,000. On the other hand, if
the survey results are high, the best decision is to build the large 750,000
facility with an expected monetary value of $821,000. The ex- –250,000
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)
+ 0.325(821,000) = 656,065 H
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.
 CHAPTER 3 D E C I S I O N A N A LY S I S 33

3-45. a.

Payoff
Succeed (0.5)
$75,000 $250,000
1

Don’t Succeed (0.5)

–$100,000

Succeed (0.6)
$140,000 $300,000
Mall 2

Don’t Succeed (0.4)

–$100,000

Succeed (0.75)
$250,000 $400,000
3

Don’t 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; P(S¯¯D¯¯ | SRP) =
EMV(10) = $250,000
0.22 P(SM | SRP) = 0.84; P(¯S¯M¯¯¯ | EMV(no grocery — C) = $0
SRP) = 0.16 P(SC | SRP) = 0.91;
EMV(A) = (best of four alternatives) =
P(S¯¯C¯¯ | SRP) = 0.09 P(SD | SRN) = 0.27;
$316,000 EMV(B) = (best of four alternatives) =
P(S¯¯D¯¯ | SRN) = 0.73 P(SM | SRN) = 0.36; $88,000 EMV(C) = (best of four alternatives) =
P(¯S¯M¯¯¯ | SRN) = 0.64 P(SC | SRN) = 0.53; $250,000 EMV(1) = (0.6)($316,000) + (0.4)
P(S¯¯C¯¯ | SRN) = 0.47 ($88,000)
Example computations: = $224,800

P(SM | SRP)  P(SRP | SM )P(SM ) EMV(D) = (best of two alternatives)

P(SRP | SM )P(SM )  P(SRP | SM ) = $250,000
P(SM ) c. EVSI = [EMV(1) + cost] — (best EMV without
P(SM | SRP)  0.7(0.6)  0.84 sample information)
0.3(0.75) = $254,800 – $250,000 = $4,800.
0.3(0.75) 
P(SC | SRN )  0.8(0.25)  0.53
0.7(0.6)  0.2(0.4)
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
34 CHAPTER 3 DECISION ANALYSIS

First
Second
Decision
Decision
Point
Point
Payoff
SD (0.78)
Downtown SD (0.22) $220,000
2 SM (0.84)
–$130,000

Mall $270,000
A 3 SM (0.16)
SC (0.91) –$130,000

Circle $370,000
4 SC (0.09)
–$230,000
1 No Grocery Store
–$30,000
SD (0.27)
Downtown $220,000
SD (0.73)
5
SM (0.36) –$130,000

Mall $270,000
D B 6 SM (0.64)
–$130,000
SC (0.53)
Circle $370,000
7 SC (0.47)
–$230,000
No Grocery Store
–$30,000
SD (0.5)
Downtown SD (0.5) $250,000
8 SM (0.6)
–$100,000
Mall SM (0.4) $300,000
C 9 SC (0.75)
–$100,000
SC (0.25) $400,000
Circle
10
–$200,000
No Grocery Store
$0

3-46. a. Sue can use decision tree analysis to find the best solu-
information, Branch 10 (6–10) is a bad market given favorable in-
tion. The results are presented below. In this case, the best
formation, Branch 11 (5–7) is the decision to build the retail store
decision is to get information. If the information is favorable, she
given unfavorable information, Branch 12 (5–14) is the decision
should build the retail store. If the information is not favorable,
not to build the retail store given unfavorable information, Branch
she should not build the retail store. The EMV for this decision is
13 (7–12) is a successful retail store given unfavorable
$29,200.
information, Branch 14 (7–13) is an unsuccessful retail store given
In the following results (using QM for Windows), Branch 1
unfavorable information, Branch 15 (8–15) is a successful retail
(1–2) is to get information, Branch 2 (1–3) is the decision to not
store given that no information is obtained, and Branch 16 (8–16)
get information, Branch 3 (2–4) is favorable information, Branch
is an unsuccess- ful retail store given no information is obtained.
4 (2–5) is unfavorable information, Branch 5 (3–8) is the decision
to build the retail store and get no information, Branch 6 (3–17) is
the decision to not build the retail store and to get no information,
Branch 7 (4–6) is the decision to build the retail store given
favorable information, Branch 8 (4–11) is the decision to not build
given favor- able information, Branch 9 (6–9) is a good market
given favorable
 CHAPTER 3 D E C I S I O N A N A LY S I S 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 Endin Branch Profit Use Node Nod
Node g Probabilit (End Node) Branch Type e
Node y ? Valu
e
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 Endin Branch Profi Use Node Node
g t
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
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, Sue’s 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 Endin Branch Profit Use Node Nod
Node g Probabilit (End Node) Branch Type e
Node y ? Valu
e
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, Sue’s decision would change from her original decision. With the higher cost of information, Sue’s 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 Endin Branch Profit Use Node Nod

Node g Probabilit (End Node) Branch Type e
Node y ? Valu
e
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
 CHAPTER 3 D E C I S I O N A N A LY S I S 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 Endin Branch Profit Use Endin Node Nod
Node g Probabilit (End Node) Branch g Type e
Node y ? Node Valu
e
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 Endin Branch Profit Use Node Nod
Node g Probabilit (End Node) Branch Type e
Node y ? Valu
e
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

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.
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
 CHAPTER 3 D E C I S I O N A N A LY S I S 39

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

are shown below.

Return in $1,000:
Event 1 Event Event Event Event 5
2 3 4
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
2 131,500 minutes Time saved is 31⁄3; minutes.
3 126,300
3-51. a. EMV can be used to determine the best strategy to min-
4 139,700
5 133,900
imize costs. The QM for Windows solution is shown on
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 a = 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
40 CHAPTER 3 DECISION ANALYSIS

Solution to 3-51a
Expecte Row Row
d Value Minimu Maximu
($) m ($) m ($)
Probabilities 0.2 0.8
Maint. No Maint.
Cost ($) 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
Sim’s 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 $500. The results are
shown below.
Solution to 3-51b
Does Not Expected
Needs Need Value
Repair Repair
($) ($ ($)
)
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
3-52. Webest
can use QM for Windows to solve this decision 500
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.
 CHAPTER 3 D E C I S I O N A N A LY S I S 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 Month—Adopt the 6-month program: if a competitor’s 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 Month—Adopt 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: Ok
Alternative 4 0 30,000 30,000
—Development effort ultimately a success
a. Sue Pansky is a risk avoider and should use the maximin No—Development effort ultimately a failure
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. R—Research and development expenditures
The best decision is to do nothing. E—Equipment costs
c. Lila Battle should eliminate alternative 1 of doing noth- I—Introduction 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- Competitio Competitio
terion. The best decision for George is to invest in common n n
stock. S—Substantial (P = 0.1) $800,000 $400,000
e. Pete Metarko is a risk seeker. He should invest in com- M—Moderate (P = 0.6) $600,000 $300,000
mon stock. L—Low (P = 0.3) $500,000 $250,000
f. Julia Day can eliminate the preferred stock alternative
and still offer alternatives to risk seekers (common stock) Competition:
and risk avoiders (doing nothing or investing in corporate C6—Competition at end of 6 months (P = .5)
bonds). No C6—No competition at end of 6 months (P = .
5)
SOLUTIONS TO INTERNET CASES C8—Competition at end of 8 months (P = .6)
No C8—No competition at end of 8 months (P = .
Drink-at-Home, Inc. Case 4)
Abbreviations and values used in the following decision trees: C12—Competition at end of 12 months (P = .8)
No C12—No competition at end of 12 months (P = .
Normal—proceed with research and development at a normal 2)
pace.
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 M (.6)
600 – 100 – 100 – 150 = 250
(.2) L (.3)
500 – 100 – 100 – 150 = 150
No (.1) (Stop)
C8 (.6) – 100 = –100

S (.1) – 80 = – 80

8 Month 400 – 140 – 100 – 150 = 10

Ok (.9) M (.6)
300 – 140 – 100 – 150 = –90
No C8 L (.3)
250 – 140 – 100 – 150 = –140
(.4) S (.1)
800 – 140 – 100 – 150 = 410
No (.1) M (.6)
600 – 140 – 100 – 150 = 210
L (.3)
500 – 140 – 100 – 150 = 110
S (.1)
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)
250 – 100 – 100 – 150 = –100
Ok (.9) S (.1)
No C6 800 – 100 – 100 – 150 = 450
No C12 M (.6)
(.5) 600 – 100 – 100 – 150 = 250
(.2) 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)
110
S (.1)
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
 CHAPTER 3 D E C I S I O N A N A LY S I S 43

Drink-at-Home, Inc. Case

(continued)

Mkt
S (.1) 50
C (.8) M (.6)
12 –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)
110
S (.1)
C6 (.5) 60
M (.6)
–40
–45 L (.3)
–90
S (.1)
50
C12 (.8) M (.6)
–50
–55 L (.3)
Ok (.9) –100
S (.1)
450
No C6 (.5) 240 M (.6)
(19.3) 250
No C12 (.2) L (.3)
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

Eight Years .10 8 .80

2.7 years

0 Years .05 0 0.0

One Year .45 1 .45

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
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 1—PP —5,000 —2,000 2,000 5,000 700
Option 2—LB and PP —10,000 —4,000 6,000 12,000 2,600
Option 3—TR and PP —15,000 —10,000 7,000 13,000 900
Option 4—CC and PP —30,000 —20,000 10,000 30,000 1,000
Option 5—LB, 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. 0.3 0.4 0.2
1
Option 1—PP 0 0 18,000 50,000
Option 2—LB and PP 5,000 2,000 14,000 43,000
Option 3—TR and PP 10,000 8,000 13,000 42,000
Option 4—CC and PP 25,000 18,000 10,000 25,000
Option 5—LB, CC, and 55,000 33,000 0 0
TR

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 (let’s 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
 CHAPTER 3 D E C I S I O N A N A LY S I S 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.