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Test Bank For Practical Management Science 5th Edition Full Download
Test Bank For Practical Management Science 5th Edition Full Download
3. Probabilities on the branches of a chance node may be ____ events that have occurred earlier in the decision tree.
a. marginal due to
b. conditional on
c. averaged with
d. increased by
ANSWER: b
POINTS: 1
9. Which of the following are probabilities that are conditioned on information that is obtained?
a. Prior probabilities
b. Posterior probabilities
c. Marginal probabilities
d. Objective probabilities
ANSWER: b
POINTS: 1
10. A utility function for risk averse individuals is ____ and/or ____.
a. decreasing, linear
b. decreasing, convex
c. increasing, linear
d. increasing, concave
ANSWER: d
POINTS: 1
11. In general, the expected monetary value (EMV) of a decision will be equal to one of the possible payoffs.
a. True
b. False
ANSWER: False
POINTS: 1
12. For each possible decision and each possible outcome, the payoff table lists the associated monetary value.
a. True
b. False
ANSWER: True
Cengage Learning Testing, Powered by Cognero Page 2
Chapter 9 - Decision Making under Uncertainty
POINTS: 1
13. The expected monetary value (EMV) criterion represents the long-run average of uncertain outcomes, so it should
only be used for recurring decisions.
a. True
b. False
ANSWER: False
POINTS: 1
14. The risk profile shows the probability distribution of monetary outcomes in both graphical and tabular form.
a. True
b. False
ANSWER: True
POINTS: 1
15. The expected value of information (EVI) is the difference between the EMV obtained with free sample information
and the EMV obtained without any information.
a. True
b. False
ANSWER: True
POINTS: 1
16. The expected value of perfect information (EVPI) is a largely irrelevant concept since perfect information is almost
never available at any price.
a. True
b. False
ANSWER: False
POINTS: 1
17. Bayes' rule is used for updating the probability of an uncertain outcome after observing the results of a test or study.
a. True
b. False
ANSWER: True
POINTS: 1
18. Prior probabilities are sometimes called likelihoods, the probabilities that are influenced by information about the
outcome of an earlier uncertainty.
a. True
b. False
ANSWER: False
POINTS: 1
19. The certainty equivalent is the certain dollar amount a risk-averse decision maker would accept in order to avoid a
gamble altogether.
a. True
b. False
20. For a risk averse decision maker, the certainty equivalent is less than the expected monetary value (EMV).
a. True
b. False
ANSWER: True
POINTS: 1
Exhibit 9-1
A farmer must decide whether to take protective action to limit damage to his grapefruit crop in the event that the
overnight temperature falls to a level well below freezing. If the temperature drops too low he runs the risk of losing his
entire crop, valued at $75,000. Based on the National Weather Service, the probability of such a temperature drop is 60%.
He can insulate his crop by spraying water on all the trees, which will cost $20,000. This action might succeed in
protecting the crop, with the following possible outcomes:
Probability Damage
0.30 $0
0.15 $5,000
0.10 $10,000
0.15 $15,000
0.30 $20,000
21. Refer to Exhibit 9-1. Construct a decision tree to help the farmer make his decision. What should he do? Explain your
answer.
ANSWER: The solved decision tree below shows that it is optimal for the farmer to insulate, since the expected cost is
$26,000 if he insulates, versus $45,000 if he doesn't insulate.
22. Refer to Exhibit 9-1. Find the highest cost of insulating the grapefruits for which the farmer prefers to insulate his
crop.
ANSWER: By trial and error (or by looking at the difference in expected values) the decision would switch to "No" (don't
insulate) if the cost exceeds $39,000.
POINTS: 1
23. Refer to Exhibit 9-1. Suppose the farmer is uncertain about the reliability of the National Weather Service forecast. If
he thinks the probability of a freeze occurring could be anywhere between 40% and 80%, would that change his decision?
ANSWER: No, the strategy region chart below shows the best option is to insulate over this entire range of probability.
POINTS: 1
24. Refer to Exhibit 9-1. Construct a risk profile and from that determine the probability that no additional cost is incurred
if the decision to insulate at a cost of $20,000 is made.
ANSWER: The risk profile is shown below. The probability of incurring no additional cost once the decision to insulate
is made is 58%.
POINTS: 1
25. Refer to Exhibit 9-1. Suppose the farmer is not risk-neutral, but instead his behavior can be modeled using an
exponential utility function with a risk tolerance parameter of 100,000. What is the most he would be willing to pay for
insulation in that case?
ANSWER: The risk averse decision tree below shows he would be willing to pay more (˜$45,000).
POINTS: 1
Exhibit 9-2
A customer has approached a local credit union for a $20,000 1-year loan at a 10% interest rate. If the credit union does
not approve the loan application, the $20,000 will be invested in bonds that earn a 6% annual return. Without additional
information, the credit union believes that there is a 5% chance that this customer will default on the loan, assuming that
the loan is approved. If the customer defaults on the loan, the credit union will lose the $20,000.
26. Refer to Exhibit 9-2. Construct a decision tree to help the credit union decide whether or not to make the loan. Make
sure to label all decision and chance nodes and include appropriate costs, payoffs and probabilities.
ANSWER:
POINTS: 1
27. Refer to Exhibit 9-2. What should the credit union do? What is their expected profit?
ANSWER: The tree shows that the best alternative is not to make the loan, and to invest the funds in bonds earning 6%
interest instead. The EMV of this option is $1,200.
POINTS: 1
28. Refer to Exhibit 9-2. The bank can thoroughly investigate the customer's credit record and obtain a favorable or
unfavorable recommendation. If the credit report is perfectly reliable, what is the most the credit union should be willing
to pay for the report?
ANSWER:
The tree above shows that if the credit report is favorable, the credit union should make the loan, and if the
report is unfavorable, it should not make the loan. This increases the expected value to $1,960 with the credit
information. Thus, the EVPI is $760, which is the most the credit union should be willing to pay.
POINTS: 1
29. Refer to Exhibit 9-2. Should the credit union purchase the report if it costs $150?
The tree above shows that the credit report is still valuable, even in the imperfect case. The information
increases the expected value to $1,543, thus, the EVSI is $343 ($1,543 − $1,200). Therefore, the credit union
would be justified in purchasing the report for $150.
POINTS: 1
30. Refer to Exhibit 9-2. Suppose that an actual (not perfectly reliable) credit report has the following characteristics
based on historical data; in cases where the customer did not default on the approved loan, the probability of receiving a
favorable recommendation on the basis of the credit investigation was 80%, while in cases where the customer defaulted
on the approved loan, the probability of receiving a favorable recommendation on the basis of the credit investigation was
25%. Given this information, what are the posterior probabilities that default will and will not occur, given the credit
report?
ANSWER: