Exercise 

17.2

Self­Check Exercise
SC 17-1 The Writer’s Workbench operates a chain of word-processing franchises in college towns. For
an hourly fee of $8.00, Writer’s Workbench provides access to a personal computer, word--
processing software, and a printer to students who need to prepare papers for their classes.
Paper is provided at no additional cost. The firm estimates that its hourly variable cost per
machine (principally due to paper, ribbons, electricity, and wear and tear on the computers
and printers) is about 85¢. Deborah Rubin is considering opening a Writer’s Workbench
franchise in Ames, Iowa. A preliminary market survey has resulted in the following
probability distribution of the number of machines demanded per hour during the hours she
plans to operate:
Number of machines 22 23 24 25 26 27
Probability 0.12 0.16 0.22 0.27 0.18 0.05

If she wishes to maximize her profit contribution, how many machines should Deborah
plan to have? What is the hourly expected value of perfect information in this situation?
Even if Deborah could obtain a perfectly accurate forecast of the demand for each and
every hour, why wouldn’t she be willing to pay up to the EVPI for that information in this
situation?

Applications
17-4 Center City Motor Sales has recently incorporated. Its chief asset is a franchise to sell
automobiles of a major American manufacturer. CCMS’s general manager is planning the
staffing of the dealership’s garage facilities. From information provided by the manufacturer
and from other nearby dealerships, he has estimated the number of annual mechanic hours
that the garage will be likely to need.
Hours 10,000 12,000 14,000 16,000
Probability 0.2 0.3 0.4 0.1

The manager plans to pay each mechanic $9.00 per hour and to charge customers $16.00.
Mechanics will work a 40-hour week and get an annual 2-week vacation.
(a) Determine how many mechanics Center City should hire.
(b) How much should Center City pay to get perfect information about the number of
mechanics it needs?
17-5 Airport Rent-A-Car is a locally operated business in competition with several major firms.
ARC is planning a new deal for customers who want to rent a car for only one day and return
it to the airport. For $24.95, the company will rent a small economy car to a customer, whose
only other expense is to fill the car with gas at the day’s end. ARC is planning to buy a
number of small cars from the manufacturer at a reduced price of $6,750. The big question is
how many to buy. Company executives have decided on the following estimated probability
distribution of the number of cars rented per day:
Number of cars rented 10 11 12 13 14 15
Probability 0.18 0.19 0.21 0.15 0.14 0.13

The company intends to offer the plan 6 days a week (312 days per year) and anticipates that
its variable cost per car per day will be $2.25. After using the cars for 1 year, ARC expects to
sell them and recapture 45 percent of the original cost. Ignoring the time value of money and
any noncash expenses, determine the optimal number of cars for ARC to buy.
17-6 For several years, the Madison Rhodes Department Store had featured personalized pencils as
 a Christmas special. Madison Rhodes purchased the pencils from its supplier, who provided
the embossing machine. The personalizing was done on the department store premises.
Despite the success of the pencil sales, Madison Rhodes had received comments that the
quality of the lead in the pencils was poor, and the store had found a different supplier. The
new supplier, however, would be unable to begin servicing the department store until after the
first of January. Madison Rhodes was forced to purchase its pencils one final time from its
original supplier to meet Christmas demand. It was important, therefore, that pencils not be
overstocked, and yet the manager was adamant about not losing too many customers because
of stockouts. The pencils came packed 15 to the box,72 boxes to the case. Madison Rhodes
paid $60 per case and sold the pencils for $1.50 per box. Labor costs are 37.5 ¢ per box sold.
Based on previous years’ sales, management constructed the following schedule:
Expected sales (cases) 15 16 17 18 19 20
Probability 0.05 0.20 0.30 0.25 0.10 0.10

(a) How many cases should Madison Rhodes order?

(b) What’s the expected profit?
17-7 Emily Scott, head of a small business consulting firm, must decide how many M.B.A.s to hire
as full-time consultants for the next year. (Emily has decided that she will not bother with any
part-time employees.) Emily knows from experience that the probability distribution on the
number of consulting jobs her firm will get each year is as follows:
Consulting jobs 24 27 30 33
Probability 0.3 0.2 0.4 0.1

Emily also knows that each M.B.A. hired will be able to handle exactly three consulting jobs
per year. The salary of each M.B.A. is $60,000. Each consulting job is worth $30,000 to
Emily’s firm. Each consulting job that the firm is awarded but cannot complete costs the firm
$10,000 in future business lost.
(a) How many M.B.A.s should Emily hire?
(b) What is the expected value of perfect information to Emily?
17-8 As a fund-raiser for a student organization, some students have decided to sell individual
pizzas outside the Union on Friday. Each pizza will sell for $1.75 and costs the organization
$.77. Historical sales indicated that between 55 and 60 dozen pizzas will be sold with the
probability distribution given below:
Dozens of pizzas 55 56 57 58 59 60
Probability 0.15 0.20 0.10 0.35 0.15 0.05

To maximize the profit contribution, how many pizzas should be ordered? Assume pizzas must
be ordered by the dozen. What is the expected value of perfect information in this problem?
What is the maximum amount the organization would be willing to pay for perfect
information?
17-9 Manfred Baum, merchandise manager for the Grant Shoe Company, is planning production
decisions for the coming year’s summer line of shoes. His chief concern is estimating the
sales of a new design of fashion sandals. These sandals have posed problems in the past for
two reasons: (1) the limited selling season does not provide enough time for the company to
produce a second run of a popular item, and (2) the styles change dramatically from year to
year, and unsold sandals become worthless. Manfred has discussed the newest design with
salespeople and has formulated the following estimates of how the item will sell:
Pairs (thousands) 45 50 55 60 65
Probability 0.25 0.30 0.20 0.15 0.10

Information from the production department reveals that the sandal will cost $15.25 per pair
to manufacture, and marketing has informed Manfred that the wholesale price will be $31.35
a pair. Using the expected-value decision criterion, calculate the number of pairs that Manfred
 should recommend that the company produce.

Exercise 17.3

Self­Check Exercise
SC 17-2 Floyd Guild operates a newsstand near the 53rd Street station of the IC South Shore and
Suburban line. The City Herald is the most popular of the newspapers that Floyd stocks. Over
many years, he has observed that daily demand for the Herald is well described by a normal
distribution with mean   165 and standard deviation s  40. Copies of the Herald sell for
30¢, but the publisher charges Floyd only 20¢ for each copy he orders. If any Heralds are left
over at the end of the evening commuting hours, Floyd sells them to Jesselman’s Fish Market
down the street for a dime each. If Floyd wishes to maximize his expected daily profit, how
many copies of the Herald should he order?

Applications
17-10 Highway construction in North Dakota is concentrated in the months from May through
September. To provide some protection to the crews at work on the highways, the Department
of Transportation (DOT) requires that large, orange MEN WORKING signs be placed in
advance of any construction. Because of vandalism, wear and tear, and theft, the DOT
purchases new signs each year. Although the signs are made under the auspices of the
Department of Correction, the DOT is charged a price equivalent to one it would pay were it
to buy the signs from an outside source. The interdepartmental charge for the signs is $21 if
more than 35 of the same kind are ordered. Otherwise, the cost per sign is $29. Because of
budget pressures, the DOT attempts to minimize its costs both by not buying too many signs
and by attempting to buy in sufficiently large quantity to get the $21 price. In recent years, the
department has averaged purchases of 78 signs per year, with a standard deviation of 15.
Determine the number of signs the DOT should purchase.
17-11 The town of Green Lake, Wisconsin, is preparing for the celebration of the seventy-ninth
Annual Milk and Dairy Day. As a fund-raising device, the city council once again plans to
sell souvenir T-shirts. The T-shirts, printed in six colors, will have a picture of a cow and
the words “79th Annual Milk and Dairy Day” on the front. The city council purchases heat-
transfer patches from a supplier for $0.75 and plain white cotton T-shirts for $1.50. A local
merchant supplies the appropriate heating device and also purchases all unsold white cotton
T-shirts. The council plans to set up a booth on Main Street and sell the shirts for $3.25. The
transfer of the color to the shirt will be completed when the sale is made. In the past year,
similar shirt sales have averaged 200 with a standard deviation of 34. The council knows
that there will be no market for the patches after the celebration. How many patches should
the city council buy?
17-12 Jack buys hot dogs each morning for his stand in the city. Jack prides himself on -slow-
roasted, always-fresh hot dogs. As a result, he will sell only hot dogs purchased that
morning. Each hot dog plus bun and condiments sells for $1.50 and costs Jack $0.67.
Assume Jack can -purchase any number of hot dogs. Because tomorrow is Friday, Jack
knows tomorrow’s hot dog demand will be normally distributed with mean 375 hot dogs
and variance 400. If Jack has any hot dogs left over, he either eats them or gives them away
to the less fortunate, -earning no additional revenue. If Jack wants to maximize his profits,
how many hot dogs should he purchase? How many hot dogs should he buy if leftover hot
dogs could always be sold for $0.50?
17-13 Bike Wholesale Parts was established in the early 1980s in response to demands of several
small and newly established bicycle shops that needed access to a wide variety of
inventory but were not able to finance it themselves. The company carries a wide variety
 of replacement parts and accessories but does not maintain any stock of completed
1
bicycles. Management is preparing to order 27  1 ⁄4 rims from the Flexspin Company in
anticipation of a business upturn expected in about 2 months. Flexspin makes a superior
product, but the lead time required necessitates that wholesalers make only one order,
which must last through the critical summer months. In the past, Bike Wholesale Parts has
sold an average of 120 rims per summer with a standard deviation of 28. The company
expects that its stock of rims will be depleted by the time the new order arrives. Bike
Wholesale Parts has been quite successful and plans to move its operations to a larger
plant during the winter. Management feels that the combined cost of moving some items
such as rims and the existing cost of financing them is at least equal to the firm’s purchase
cost of $7.30. Accepting management’s hypothesis that any unsold rims at the end of the
summer season are permanently unsold, determine the number of rims the company
should order if the selling price is $8.10.
17-14 The B&G Cafeteria features barbecued chicken each Thursday, and Priscilla Alden, the
cafeteria manager, wants to ensure that the cafeteria will make money on this dish. Including
labor and other costs of preparation, each portion of chicken costs $1.35. The $2.15 selling
price per portion is such a bargain that the barbecued chicken special has become a very
popular item. Data taken from the last year indicate that demand for the special is normally
distributed with mean  m  190 portions and standard deviation   32 portions. If B&G
Cafeteria prepares two portions of barbecued chicken from each whole chicken it cooks, how
many chickens should Priscilla order each Thursday?
17-15 Paige’s Tire Service stocks two types of radial tires: polyester-belted and steel-belted. The
polyester-belted radials cost the company $30 each and sell for $35. The steel-belted
radials cost the company $45 and sell for $60. For various reasons, Paige’s Tire Service
will not be able to reorder any radials from the factory this year so it must order just once
to satisfy customers’ demand for the entire year. At the end of the year, owing to new tire
models, Paige will have to sell all its inventory of radials for scrap rubber at $5 each. The
annual sales of both types of radial tires are normally distributed with the following means
and standard deviations:
Radial Tire Type Annual Mean Sales Standard Deviation
Polyester-belted 300 50
Steel-belted 200 20

(a) How many polyester-belted radials should be ordered?

(b) How many steel-belted radials should be ordered?

Exercise 17.5

Self­Check Exercise
SC 17-3 John Stein is the scheduling director of SATPlus Services, a firm that guarantees that its
preparatory course for the college board exams will increase a student’s combined score on
the verbal and quantitative parts of those exams by at least 120 points. Each student taking
the course is charged $275 in tuition, and it costs SATPlus about $3,300 in salaries, supplies,
and facility rental costs to teach the course. John will not schedule the course in any location
where he cannot be at least 90 percent certain that SATPlus will earn no less than $2,200 in
profit. Reviewing a marketing survey that he just received from Charlottesville, Virginia, he
has decided that if the course is offered there, he can expect about 30 students to enroll. He
also feels that the odds are about 8 to 5 that actual enrollment will be between 25 and 35
-students and that it is appropriate to use the normal distribution to describe course
enrollment. Should John schedule the course in Charlottesville?
Applications
17-19 Northwestern Industrial Pipe Company is considering the purchase of a new electric arc
welder for $2,100. The welder is expected to save the firm $5 an hour when it can be used in
place of the present, less efficient welder. Before making the decision, Northwestern’s
production manager noted there were only about 185 hours a year of welding on which the
new arc welder could be substituted for the present one. He gave 7 to 3 odds that the actual
outcome would be within 25 hours of this estimate. In addition, he felt secure in assuming
that the number of hours was well described by a normal distribution. Can Northwestern be
98 percent sure that the new electric arc welder will pay for itself over a 3-year period?
17-20 Relman Electric Battery Company has felt the effects of a recovering economy as demand for
its products has risen in recent months. The company is considering hiring six new people for
its assembly operation. Plant production manager Mike Casey, whose performance is
evaluated in part by cost efficiency, does not want to hire additional employees unless they
can be expected to have jobs for at least 6 months. If the employees are terminated
involuntarily before that time, the company is forced by union rules to pay a substantial
termination bonus. Additionally, if employees are laid off within 6 months after hiring, the
company’s unemployment insurance rate is raised. Relman’s corporate economist expects that
the upswing in the economy will last at least 8 months and gives 7 to 2 odds that the length of
the upswing will be within a 1-month range of that figure. Casey wants to be 95 percent sure
that he will not have to lay off any newly hired employees. Should he hire six new people at
this time?
17-21 Speedy Rabbit courier service operates a fleet of 30 cars covering many miles each day.
Currently, the cars use regular fuel at a cost of $1.059 per gallon, and the fleet fuel efficiency
is about 36 miles per gallon (mpg). A recent report indicates that if they switch to premium at
a cost of $1.229 per gallon, each car would see an increase of 6.4 mpg. The company will
switch fuel provided they can be 95 percent certain they will save money, which they will do
if the fleet fuel efficiency is less than 40 mpg. They believe that the odds are about 6 to 4 that
current fuel efficiency is between 33 and 39 mpg and that it is appropriate to use the normal
distribution to describe fuel efficiency. Should they switch fuel?
17-22 Natalie Larsen, a traveling sales representative for Nova Products, is considering the purchase
of a new car for business use. The car she has in mind has a sticker price of $13,497, but she
thinks she can bargain the dealer down to $12,250. Because her car is used solely for business
purposes, Natalie can deduct 31¢ a mile for operating expenses. She will buy the car only if
the resulting tax savings will pay for the car over its lifetime. Natalie has been in a combined
federal and state 34 percent tax bracket for some years, and it appears she will remain there
for the foreseeable future. A reputable automotive magazine states that the average life of the
car she is considering is 120,000 miles. The article further states that the odds are 4 to 3 that
the actual life of the car will be within 12,000 miles of 120,000. What is the probability that
the car will run long enough for Natalie to break even?
17-23 The Newton Pines Police Force is considering purchasing a VASCAR radar unit to be
installed on the town’s single police cruiser. The town council has balked at the idea, because
it is not certain that the unit is worth its price of $2,000. Police Chief Buren Hubbs has stated
that he is sure that the unit will pay for itself through the increased number of $20 citations
that he and his deputy will give. Buren has been overheard to say that he will give 9 to 1 odds
that the increase in citations in the first year will be between 95 and 135 if the unit is
purchased. He expects that there will be 115 more tickets given if the cruiser is equipped with
VASCAR. Can the town council be 99 percent sure that the unit will be paid for by the
increase in revenue from citations in the first year?
17-24 You are planning to invest $15,000 in Infometrics common stock if you can be reasonably
-certain that its price will rise to $60 a share within 6 months. You ask two knowledgeable
brokers the following questions:
(a) What is your best estimate of the highest price at which Infometrics will sell in the next
6 months?
(b) What odds will you give that your estimate will be off by no more than $5?
Their responses are as follow:
Broker Best Estimate Odds
A 68 2 to 1
 B 65 5 to 1

If you had decided that you would buy the stock only if each broker was at least 80 percent
certain that it would be selling for at least $60 sometime within the next 6 months, what
should you do?

Exercise 17.6

Self­Check Exercise
SC 17-4 Evelyn Parkhill is considering three possible ways to invest the $200,000 she has just
inherited.
(1) Some of her friends are considering financing a combined laundromat, video-game
arcade, and pizzeria, where the young singles in the area can meet and play while doing
their laundry. This venture is highly risky and could result in either a major loss or a
substantial gain within a year. Evelyn estimates that with probability 0.6, she will lose all
of her money. However, with probability 0.4, she will make a $200,000 profit.
(2) She can invest in some new apartments that are being built in town. Within 1 year, this
fairly conservative project will produce a profit of at least $10,000, but it might yield
$15,000, $20,000, $25,000, or possibly even $30,000. Evelyn estimates the probabilities
of these five returns at 0.20, 0.30, 0.25, 0.20, and 0.05, respectively.
(3) She can invest in some government securities that have a current yield of 8.25 percent.
(a) Construct a decision tree to help Evelyn decide how to invest her money.
(b) Which investment will maximize her expected 1-year profit?
(c) How high would the yield on the government bonds have to be before she would
decide to invest in them?
(d) How much would she be willing to pay for perfect information about the success of
the laundromat?
(e) How much would she be willing to pay for perfect information about the success of
the apartments?
Applications
17-25 The Motor City Auto Company is planning to introduce a new automobile that features a
radically new pollution-control system. It has two options. The first option is to build a new
plant, anticipating full production in 3 years. The second option is to rebuild a small existing
pilot plant for limited production for the coming model year. If the results of the limited
production show promise at the end of the first year, full-scale production in a newly
constructed plant would still be possible 3 years from now. If it decides to proceed with the
pilot plant and later analysis shows that it is unattractive to go into full production, the pilot
plant can still be operated by itself at a small profit. The expected annual profits for various
alternatives are as follows:
Production Consumer Annual Profit
Facility Acceptance ($ millions)
New plant High 14
New plant Low –6
Pilot plant High 2
Pilot plant Low 1
 Motor City’s marketing-research division has estimated that there is a 50 percent probability
that consumer acceptance will be high and 50 percent that it will be low. If the pilot plant is put
into production, with a corresponding low-keyed advertising program, the researchers feel that
the probabilities are 45 percent for high consumer acceptance and 55 percent for low
acceptance. Further, they have estimated that if the pilot plant is built and consumer acceptance
is found to be high, there is a 90 percent probability of high acceptance with full production. If
consumer acceptance with the pilot models is found to be low, however, there is only a 10
percent probability of high eventual acceptance with full production. Which plant should be
built?
17-26 Refer to Christie Stem’s problem on p. 940 and in Figure 17-9.
(a) Suppose that the operating cost of the snowmaking equipment is actually 30 percent
higher than Christie had estimated, that is, $13,000 if the snowfall is heavy, $65,000 if it
is moderate, and $117,000 if it is light. How will this affect Christie’s optimal decision
and expected profit?
(b) Answer the same questions if the actual operating cost is 20 percent higher than
Christie’s original estimate.
(c) At what percentage increase of the operating cost will Christie be indifferent between the
optimal decisions in parts (a) and (b)? At this point, what will be her expected profit?
17-27 International Pictures is trying to decide how to distribute its new movie Claws. Claws is the story
of an animal husbandry experiment at North Carolina State University that goes awry, with
tragicomic results. An effort to breed meatier turkeys somehow produces an intelligent,
1,000-pound turkey that escapes from the lab and terrorizes the campus. In a surprise ending, the
turkey is befriended by Coach Morey Robbins, who teaches it how to play basketball, and State
goes on to win the NCAA championship. Because of the movie’s controversial nature, it has the
potential to be either a smash hit, a modest success, or a total bomb. International picture is trying
to decide whether to release the picture for general distribution initially or to start out with a
“limited first-run release” at a few selected theaters, followed by general distribution after 3
months. The company has estimated the following probabilities and conditional profits for Claws:
Profits
($ millions)
General
Level Success Probability Limited Release Distribution
Smash 0.3 22 12
Modest 0.4 9 8
Bomb 0.3 –10 –2

(a) Construct a decision tree to help International decide how to release Claws.
(b) Which decision will maximize the expected profit?
(c) How much would International pay for an absolutely reliable forecast of the movie’s
level of success?
(d) International can run several sneak previews of Claws to get a better idea of the
movie’s ultimate level of success. Preview audiences rate movies as either good or
excellent, but their opinions are not completely reliable. On the basis of past
experience with previews, International has found that 90 percent of all smash
successes were rated excellent (with 10 percent of them being rated good), 65 percent
of all modest successes were rated excellent (with 35 percent of them being rated
good), and 40 percent of all bombs were rated excellent (with 60 percent of them being
rated good). If the cost of sneak previews would be about $750,000, should Claws be
previewed? How should International respond to the preview results? What is the
maximum amount International should be willing to pay for the previews?
17-28 Sam Crawford, a junior business major, lives off campus and has just missed the bus that
would have taken him to campus for his 9  A.M. test. It is now 8:45 A.M. and Sam has
several options available to get him to campus: waiting for the next bus, walking, riding
his bike, or driving his car. The bus is scheduled to arrive in 10 minutes, and it will take
Sam exactly 20 minutes to get to his test from the time he gets on the bus. However, there
is a 0.2 chance that the bus will be 5 minutes early, and a 0.3 chance that the bus will be 5
 minutes late. If Sam walks, there is a 0.8 chance he will get to his test in 30 minutes, and a
0.2 chance he will get there in 35 minutes. If Sam rides his bike, he will get to the test in
25 minutes with probability 0.5, 30 minutes with probability 0.4, and there is a 0.1 chance
of a flat tire, causing him to take 45 minutes. If Sam drives his car to campus, he will take
15 minutes to get to campus, but the time needed to park his car and get to his test is given
by the following table:
Time to park & arrive (minutes) 10 15 20 25
Probability 0.30 0.45 0.15 0.10

(a) Assuming that Sam wants to minimize his expected late time in getting to his test, draw
the decision tree and determine his best option.
(b) Suppose instead that Sam wants to maximize his expected utility as measured by the
projected test score given below. Use the same decision tree to determine his optional
decision now.
Arrival time 9:10 9:15 9:20 9:25 9:30
Projected test score 95 85 70 60 45

17-29 The North Carolina Airport Authority is trying to solve a difficult problem with the over-
crowded Raleigh–Durham airport. There are three options to consider:
(1) The airport could be totally redesigned and rebuilt at a cost of $8.2 million. The present
value of increased revenue from a new airport is in question. There is a 70 percent
probability this present value would be $11.0 million, a 20 percent probability the present
value would be $5 million, and a 10 percent probability the present value would be $1.0
million, depending on whether the airport is a success, moderate success, or a failure.
(2) The airport could be remodeled with a new runway for a cost of $4.7 million. The present
value of increased revenue would be $6.0 million (with probability 0.8) or $3.0 million
(with probability 0.2).
(3) They could do nothing with the airport and suffer a loss of revenue of either $1 million
(with probability 0.65) or $4 million (with probability 0.35).
(a) Construct a decision tree to help the Airport Authority.
(b) Which option will maximize the present value of profit?
(c) How much would we be willing to pay for perfect information about success of a
brand new airport?
(d) How much would we be willing to pay for perfect information about success of a
remodeled airport?

Chapter Concepts Test

Circle the correct answer, or fill in the blank. Answers are in the back of the book.
TF 1. Decision theory assumes that no events are beyond the control of the decision
maker.
TF 2. A conditional profit table does not reflect the profit denied a retailer because of
inability to fill all buyers' requests.
TF 3. An obsolescence loss occurs when a retailer is out of stock and buyers want to buy.
TF 4. In most stocking situations, several values of  p will solve the equation  p(MP) = (1 –
p)(ML), but only one is the best solution.
 TF 5. If stocking 19 units of a good yields an expected daily profit of $51.50, a retailer
stocking 19 units can expect average profits of $51.50 per day.
TF 6. A person can have one utility curve for one situation and quite a different one for the
next situation.
TF 7. It is always difficult to make use of other people’s knowledge about a situation
without explaining statistical techniques to them.
TF 8. If perfect information were available, a retailer would consistently make the
maximum profit possible.
TF 9. One advantage of using decision trees is that every outcome, desirable or
undesirable, must be investigated.
TF 10. On a decision tree, a circle represents a decision point.
TF 11. If a retailer can earn $100 per day with perfect information, then EVPI = $100.
TF 12. The loss that results from stocking an item that is not sold is denoted ML.
TF 13. When rolling back a decision tree, the process moves from right to left.
TF 14. Business executives with a linear utility curve can effectively use expected
monetary value as their decision criterion.
TF 15. On the graph of a normal distribution of sales, the area to the right of a vertical line
represents the probability of selling that quantity or less.
TF 16. A decision that maximizes expected profits will also minimize expected losses.
TF 17. An individual’s utility curve is based on mathematical, not behavioral,
considerations.
TF 18. The expected marginal loss is equal to the marginal loss multiplied by 1 minus the
probability of selling that unit.
TF 19. Payoffs are only the positive benefits of various alternatives.
TF 20. Perfect information, in reality, is rarely available; information to help make better,
not perfect, decisions is more often the case.
TF 21. The expected value of a random variable weights each possible value of the variable
by 1 minus the probability of taking on that value.
A B C D E 22. From which of the following can retailers immediately determine how many cases
they should stock each day to maximize profits?
(a) Expected profit from each stocking action.
(b) Expected loss from each stocking action.
(c) Conditional-profit table.
(d) (a), (b), and (c).
(e) (a) and (b) but not (c).
A B C D  23. Consider a conditional-loss table with possible sales levels listed vertically in the
first column and possible stock actions listed horizontally in the first row. Any value
in a column below a zero indicates:
(a) An opportunity loss.
(b) An obsolescence loss.
 (c) A profit.
(d) None of these.
A B C D   24. Suppose that the only two possible stocking actions for a particular product are 10
and 15 bottles. Expected profits are $3.35 for 10 bottles and $3.50 for 15 bottles. If
expected loss for 10 bottles is $1.10 and 15 bottles are stocked, we may conclude
that expected loss is:
(a) Higher than $1.10.
(b) Lower than $1.10.
(c) Higher than $2.25.
(d) Undeterminable from the information given.
A B C D   25. A businessman who is said to be averse to risk:
(a) Prefers to take large risks to earn large gains.
(b) Prefers to act any time the expected monetary value is positive.
(c) Avoids all situations but those with very high expected values.
(d) None of these.
A B C D   26. Suppose that the actual standard deviation of a normal distribution is unknown, but
that you are told, “The odds are 5 to 3 that a random observation is between 500 and
900.” You know that the mean is 700. The area under the normal curve between the
values 700 and 900 is:
(a)
(b)
(c)
(d)
A B C D   27. A certain product sells for $25 and is purchased by the retailer for $17. If it is not
sold within 2 weeks, the retailer will recoup only $8 of his original $17 investment
because of spoilage. The value of MP for this situation is:
(a) $9.
(b) $17.
(c) $8.
(d) $25.
A B C D E  28. Assume that for a particular stocking operation,  ML = $10 and MP = $30. Then, p* =
0.25. For which of the following situations would you stock the unit in question?
(a) The fifth unit when P(requests for 5 or more units) = 0.50.
(b) The third unit when P(requests for fewer than 3 units) = 0.10 and P(requests
for exactly 3 units) = 0.09.
(c) The ninth unit when P(requests for more than 9 units) = 0.16 and P(requests
for exactly 9 units) = 0.05.
(d) All of these.
(e) (a) and (b) but not (c).
A B C D   29. A manager is deciding whether to buy a new building or to rent it. If he buys, the
cost for the next year will be $5,500, which will include mortgage interest,
insurance, and other usual expenses. If he rents, the comparable expense for the next
year will be either $6,000, $5,300, or $4,200, depending on market fluctuations. The
manager wishes to make his choice based on expected monetary values for the next
year. The decision tree for this situation would have:
(a) One decision point and no chance events.
(b) One chance event and one decision point.
(c) Two decision points and three chance events.
(d) One decision point and three chance events.
A B C D E  30. For a particular decision, the total benefit of a new plant is $18,200,000. If the
expected net benefit of this plant is $11,500,000, what is the cost of the plant?
(a) $6,700,000.
(b) $8,400,000.
(c) $29,700,000.
(d) $11,500,000.
(e) Cannot be determined from the information given.
A B C D E  31. Assume that three businesswomen are questioned regarding their utilities in risk
situations. It is found that Laura is averse to risk, Lisa plays long shots, and Leslie is
so well-off financially that the amounts of money in question are negligible when
compared to her wealth. For the situations in question, utility could be used as the
decision criterion for:
(a) Laura.
(b) Lisa.
(c) Leslie.
(d) All three.
(e) (a) and (b) but not (c).
A B C D    32. A person who is attempting to maximize his expected utility would use the expected
value criterion if:
(a) He is risk-averse.
(b) He is a risk seeker.
(c) He has a nonlinear utility curve.
(e) None of these.
A B C D E  33. When a problem has a large number of possible actions, we would normally use a:
(a) Conditional table.
(b) Marginal table.
(c) Utility table.
(d) Marginal analysis.
(e) None of these.
A B C D E  34. Decision theory deals with:
 (a) Making decisions under conditions of uncertainty.
(b) Quantity-oriented decision, ignoring financial repercussions.
(c) The worth of additional information to the decision maker.
(d) (a) and (b) but not (c).
(e) (a) and (c) but not (b).
A B C D E  35. Once a decision tree is “solved,” the analyst should:
(a) Immediately go out and make the decision.
(b) Specify underlying assumptions to point out, among other things, the limits
under which the decision tree is valid.
(c) Perform sensitivity analysis to determine how the solution reacts to changes in
the inputs.
(d) (b) and (c) but not (a).
(e) All of the above.
A B C D  36. An item costs the retailer $3.25 and can be sold for $5.75. If unsold, the item can be
sold for a salvage value of $1.50. Which of the following statements are true?
(a) ML = $4.25.
(b) p* = ($3.25 – $1.50) / ($5.75 – $1.50).
(c) In order to justify the stocking of an additional item, the cumulative
probability of selling that unit or more must be 50%.
(d) None of the above.
37. Events beyond the control of the decision maker are called ____________________
or ____________________ of nature.
38. The maximum amount that a retailer will be willing to pay for a perfect predictor is
called the____________________.
39. There are two types of losses in a stocking operation: ____________________
losses and ____________________ losses.
40. The pleasure or displeasure one receives from certain outcomes is known as one’s
____________________.
41. The act of calculating expected benefits for each circle and square of a decision tree
is called ____________________.
42. If a profit increases a person’s utility by much more than a loss of the same size
would decrease her utility, that person will often act when the expected value is
____________________.
43. The loss incurred from stocking an item that is not subsequently sold is called
____________________ .
44. Observing how optimal decisions and profits change when payoffs or probabilities
vary is called ____________________.
45. Time sequencing in a decision tree occurs from 
____________________ to ____________________; rollback is accomplished from 
____________________ to___________________.