QAM-III

Problem Sheet 3: Decision Analysis

Problem 1. Suppose that you want to invest $10,000 in the stock market by buying shares in one of two companies:
A and B. Shares in Company A are risky but could yield a 50% return on investment during the next year
in a rising market (i.e. ``bull'' market). If the stock market conditions are not favorable i.e,``bear''
market), the stock may lose 20% of its value. Company B provides safe investments with 15% return in a
``bull'' market and only 5% in a ``bear'' market. All the publications you have consulted are predicting a
60% chance for a ``bull'' market and 40% for a ``bear'' market. Where should you invest your money
according to the EMV Criterion? Further, instead of solely relying on the publications, suppose you
have the option to consult your friend who has a great experience of stock market. The friend offers the
general opinion of ``for" or ``against" investment. This opinion is further quantified in the following
manner: If it is a ``bull" market, there is a 90% chance that vote will be ``for". If it is a ``bear" market, the
chance of a ``for" vote is 50%. Construct the complete decision tree and tell how do you make use of
this additional information?

Answer. EMV = 2200, EV|PI = 3200, EVPI = 1000, EV|SI = 2491, EVSI = 291, ENGE = 291

Problem 2. A TV Co. is considering the development of a new collection of programs. The co. has the following
options.
 Decide immediately whether to produce the series
 Produce and test market a single pilot in several representative market cities, to gauge the
audience response to the show before making the decision whether to produce the complete
series.
 Pay a professional marketing group to assess the likely outcome of the proposed series.
The program may be successful or not successful. Successful programs generate an average of $18m in
revenue, where as unsuccessful one’s generate $4m Revenue. P(S) = 0.34
Production cost is given to be $10m. A pilot costs 1m to produce but will be used as the one show in the
series, if the complete series is marketed using this strategy, this pilot cost is included in the 10m.
86% of the successful series had favorable survey findings on their pilots. However, 15% of the failed
series also received favorable surveys based on their pilots.
The professional market survey approach will cost 0.5m. In the past 62% of the series that were given
favorable reports by thus co. were successful. This co. has written unfavorable surveys in 51% of the
cases that they have served as consultants.

Answer. EMV = 0, EV|PI = 2.72, EVPI = 2.72,

For Test Market: EV|SI = 2.13, EVSI = 2.13, ENGE = 1.13
For Professional Help: EV|SI = 1.313, EVSI = 1.313, ENGE = 0.813
Problem 3. If an athlete is tested for a certain type of drug usage, then the test result will be either +ve or –ve.
However these tests are never perfect. Some athletes who are drug free test +ve and some who are
drug users test –ve. 5% of all athletes use drugs, 3% of all tests on drug free athletes yield false +ve and
7% of all tests on drug users yield false –ve. There are some difficulties in performing the tests.
 The benefit B (=25) from correctly identifying a drug user and barring him/her from sports.
 The cost C1 (=1) of the test for a single athlete.
 The cost C2 (= 50) of falsely accusing a non-user and barring him/her from sports.
 The cost C3 (= 20) of not identifying a drug user. (either by not testing or by obtaining a false –
ve.)
 The cost C4 (= 2) of violating a non users privacy by performing the test.

Answer. EMV = -1