Exercise 1.

DECISION TREES, EVPI and EVMI

A textile company that has a productive experience in the foreign market of 25 years, must decide if it manufactures a new p
or if on the contrary the purchase from an external supplier. The profits depend on the demand of the product. The table sh
millions of dollars.

Table 1. Decision process for the commercialization of the product

States of nature

Decision alternative
Demand low-utility Demand low average - Demand High - utility

Manufacture 421 452 467

Subcontract 435 453 481
Buy 418 461 475
Probabilities Ʃ = 1 0.4 0.25 0.35

Questions

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

Probabilities
Manufacture
Low (0,4)

Node 2 Low average(0,25)

High(0,35)
Node 1

Low (0,4)

Node 3 Low average(0,25)

Buy
High(0,35)

VEsIP
Node 2 = 444.85 Node1= (Max Node2 Vs Node3)
Node 3 = 448.7 Node 3 448,7 = VEsIP
The recommended decision is …

VEIP= I VEcIP - VEsIP I

VEIP= I 449,9 - 448,7 I
VEIP= 1.19999999999993

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

Teorema de Bayes

P(F/low) = 0,3 P(D/low) = 0,7

P(F/low average) = 0,35 P(D/ low average) = 0,65
P(F/high) = 0,4 P(D/high) = 0,6

FAVORABLE

States of Prior Conditional probabilities Posterior probabilities P

Joint probabilities P (F n Sj)
nature probabilities P (F/sj) (sj/F)
P(Sj)
Low 0.4 0.3 0.12 0.35
Low average 0.25 0.35 0.0875 0.25
High 0.35 0.4 0.14 0.40
P(F) 0.3475

UNFAVORABLE

States of Prior Conditional probabilities Posterior probabilities P

nature probabilities P (U/sj) Joint probabilities P (U n Sj) (sj/U)
P(Sj)
Low 0.4 0.7 0.28 0.43
Low average 0.25 0.65 0.1625 0.25
High 0.35 0.6 0.21 0.32
P(U) 0.6525

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

 FAVORABLE 0.34
NODE 2

Node 1

UNFAVORABLE 0.65 NODE 3

VEIM= I VEcIM-VEsIM I
VEcIM= 444.1
VEsIM= 448.7
VEIM= -4.6

d. What is the efficiency of the information?

 VEIM
E X 100
VEIP

-4.6
E = -383.333333333333
1.2
MI

cide if it manufactures a new product in its main plant,

d of the product. The table shows projected profits, in

Demand
421 168.4

452 113

467 163.45

418 167.2

461 115.25

475 166.25

Max Node2 Vs Node3)

3 448,7 = VEsIP
 VEsIP = 448.7
VEcIP = 449.9

vorable (U) condition. The relevant conditional probabilities are:

Low(0,35) 421

Manufacture Low
Node 4 average(0,25) 452 447.15

High(0,40) 467
 451.55

Low(0,35) 418

Low
Buy Node 5 average(0,25) 461 451.55

High(0,40) 475

444.0705
Low(0,43) 421

Manufacture Low
Node 6 average(0,25) 452 443.47

High(0,32) 467

446.99

Low(0,43) 418

Low
Buy Node 7 average(0,25) 461 446.99

High(0,32) 475
 Exercise 2. DECISION TREES, EVPI and EVMI

Fabcom, a company that manufactures electronic components for the introduction in its product catalog, must decide whet
product in its main plant, subcontract it with company supervision or if it buys it from an external supplier. The profits depe
product. The table shows projected profits, in millions of dollars.

Table 2. Decision process for the commercialization of the product

States of nature

Decision alternative Demand high medium-

Demand low-utility Demand low average-utility
utility

Manufacture 438 466 495

Subcontract 426 462 487
Buy 430 469 487
Lease 451 474 487
Outsource 436 470 488
Probabilities Ʃ = 1 0.17 0.29 0.21

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

Probabilities
Low (0,17)

Low average(0,29)
Manufacture Node 2
High medium(0,21)

High(0,33)

Low (0,17)

Low average(0,29)
Node 1 Subcontract Node 3
High medium(0,21)

High(0,33)

Low (0,17)

Low average(0,29)

Buy Node 4 High medium(0,21)

 High(0,33)

The recommended decision is …

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

Teorema de Bayes
P(F/low) = 0,25
P(F/low average) = 0,4
P(F/high medium) = 0,5
P(F/high) = 0,32

FAVORABLE

States of Prior Conditional probabilities Posterior probabilities P

Joint probabilities P (F n Sj)
nature probabilities P (F/sj) (sj/F)
P(Sj)
Low 0.17 0.25 0.0425 0.12
Low average 0.29 0.4 0.116 0.31
High medium 0.21 0.5 0.105 0.28
High 0.33 0.32 0.1056 0.29
P(F) 0.3691

UNFAVORABLE

States of Prior Conditional probabilities Posterior probabilities P

nature probabilities P (U/sj) Joint probabilities P (U n Sj) (sj/U)
P(Sj)
Low 0.17 0.75 0.1275 0.20
Low average 0.29 0.6 0.174 0.28
High medium 0.21 0.5 0.105 0.17
High 0.33 0.68 0.2244 0.36
P(U) 0.6309

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

 FAVORABLE 0.36
NODE 2

Node 1

UNFAVORABLE 0.63 NODE 3

 VEIM= I VEcIM-VEsIM I
VEcIM= 477.7
VEsIM= 479.35
VEIM= -1.7

d. What is the efficiency of the information?

VEIM
E X 100
VEIP

-1.7
E = -42.1836228287841
4.03
MI

uct catalog, must decide whether to manufacture a new

rnal supplier. The profits depend on the demand of the
ons of dollars.

Demand high-
utility

500
512
509
503
508
0.33

Demand
438 74.46 VEsIP
Node 2
466 135.14 Node 3
Node 4
495 103.95 The recommended decisio

500 165

426 72.42

462 133.98

487 102.27

512 168.96

430 73.1

469 136.01

487 102.27
 509 167.97

vorable (U) condition. The relevant conditional probabilities are:

P(D/low) = 0,75
P(D/ low average) = 0,6
P(D/ high medium) = 0,5
P(D/high) = 0,68

Low(0,12) 438

Low
average(0,31) 466
Manufacture
High
Node 4 medium(0,28) 495 480.62

High(0,29) 500
 Low(0,12) 426

Low
average(0,31) 462
Subcontract Node 5 479.18 480.96
High
medium(0,28) 487

High(0,29) 512

Low(0,12) 430

Low
average(0,31) 469

High
Buy Node 6 medium(0,28) 487 480.96

High(0,29) 509

Low(0,20) 438

Low
average(0,28) 466
Manufacture
High
Node 7 medium(0,17) 495 482.23

High(0,36) 500

Low(0,20) 426

Low
average(0,28) 462

High
Subcontract Node 8 medium(0,17) 487 481.67 483.35

High(0,36) 512

Low(0,20) 430
 Low
average(0,28) 469

High
medium(0,17) 487 483.35
Buy Node 9
High(0,36) 509
 VEsIP
= 478.55 Node1= (Max Node2 Vs Node3 Vs Node 4)
= 477.63 Node 4 479,35 = VEsIP
= 479.35
he recommended decision is …

VEIP= I VEcIP - VEsIP I VEsIP = 479.35

VEIP= I 479,35 - 483,38 I VEcIP = 483.38
VEIP= 4.03
477.6561
 Exercise 3. DECISION TREES, EVPI and EVMI

Teratextyl, a textile company that has a productive experience in the foreign market of 30 years, must decide if it manufactu
main plant, or if on the contrary the purchase from an external supplier. The profits depend on the demand of the product. T
profits, in millions of dollars.

Table 3. Decision process for the commercialization of the product

States of nature

Decision alternative Demand high medium-

Demand low-utility Demand low average-utility
utility

Manufacture 527 574 589

Subcontract 537 568 586
Buy 540 568 587
Lease 549 565 593
Outsource 536 571 592
Probabilities Ʃ = 1 0.17 0.29 0.21

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

Probabilities
Manufacture Low (0,17)

Low average(0,29)

Node 2
High medium(0,21)

High(0,33)
Node 1

Low (0,17)

Low average(0,29)

Node 3
High medium(0,21)
Buy
High(0,33)

VEsIP
Node 2 = 578.39 Node1= (Max Node2 Vs Node3)
Node 3 = 578.78 Node 3 478,8 = VEsIP
The recommended decision is …

VEIP= I VEcIP - VEsIP I

VEIP= I580,9 -578,7 I
VEIP= 2.16000000000008

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

Teorema de Bayes
P(F/low) = 0,3
P(F/low average) = 0,4
P(F/high medium) = 0,32
P(F/high) = 0,35

FAVORABLE

States of Prior Conditional probabilities Posterior probabilities P

Joint probabilities P (F n Sj)
nature probabilities P (F/sj) (sj/F)
P(Sj)
Low 0.17 0.3 0.051 0.15
Low average 0.29 0.4 0.116 0.33
High medium 0.21 0.32 0.0672 0.19
High 0.33 0.35 0.1155 0.33
P(F) 0.3497

UNFAVORABLE

States of Prior Conditional probabilities Posterior probabilities P

nature probabilities P (U/sj) Joint probabilities P (U n Sj) (sj/U)
P(Sj)
Low 0.17 0.7 0.119 0.18
Low average 0.29 0.6 0.174 0.27
High medium 0.21 0.68 0.1428 0.22
High 0.33 0.65 0.2145 0.33
P(U) 0.6503

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

 FAVORABLE 0.34
NODE 2

Node 1

UNFAVORABLE 0.65 NODE 3

 VEIM= I VEcIM-VEsIM I
VEcIM= 573.0
VEsIM= 578.78
VEIM= -5.7

d. What is the efficiency of the information?

VEIM
E X 100
VEIP

-5.7
E = -263.888888888889
2.16
MI

rs, must decide if it manufactures a new product in its

the demand of the product. The table shows projected

Demand high-
utility

603
610
603
602
602
0.33

Demand
525 89.25

574 166.46

589 123.69

603 198.99

540 91.8

568 164.72

587 123.27

603 198.99

Max Node2 Vs Node3)

3 478,8 = VEsIP
 VEsIP = 578.78
VEcIP = 580.94

vorable (U) condition. The relevant conditional probabilities are:

P(D/low) = 0,7
P(D/ low average) = 0,6
P(D/ high medium) = 0,68
P(D/high) = 0,65

Low(0,15) 525

Manufacture Low
Node 4 average(0,33) 574 579.07

High
medium(0,19) 589
 High(0,33) 603

579.07

Low(0,15) 540

Low
average(0,33) 568
Buy Node 5 391.52
High
medium(0,19) 587

High(0,33) 603
573.0323

Low(0,18) 525
Manufacture
Node 6 Low 578.05
average(0,27) 574

High
medium(0,22) 589

High(0,33) 603
578.69

Low(0,18) 540

Low
Buy Node 7 average(0,27) 568 578.69

High
medium(0,22) 587

High(0,33) 603