Chapter 9 - Decision Making Under Uncertainty

1. All problems related to decision making under uncertainty have three common elements:
a. the mean, median, and mode
b. the set of decisions, the cost of each decision and the profit that can be made from each decision
c. the set of possible outcomes, the set of decision variables and the constraints
d. the set of decisions, the set of possible outcomes, and a value model that prescribes results
ANSWER: d
POINTS: 1
DIFFICULTY: Easy | Bloom's Comprehension
QUESTION TYPE: Multiple Choice
HAS VARIABLES: False
TOPICS: 9.2 Elements of Decision Analysis
OTHER: BUSPROG - Communication |DISC - Decision Making
DATE CREATED: 5/17/2017 3:50 PM
DATE MODIFIED: 10/21/2017 9:37 PM

2. Expected monetary value (EMV) is:

a. the average or expected value of the decision if you knew what would happen ahead of time
b. the weighted average of possible monetary values, weighted by their probabilities
c. the average or expected value of the information if it was completely accurate
d. the amount that you would lose by not picking the best alternative
ANSWER: b
POINTS: 1
DIFFICULTY: Easy | Bloom's Application
QUESTION TYPE: Multiple Choice
HAS VARIABLES: False
TOPICS: 9.2 Elements of Decision Analysis - Decision Criterion
OTHER: BUSPROG - Analytic |DISC - Decision Making
DATE CREATED: 5/17/2017 3:50 PM
DATE MODIFIED: 10/21/2017 9:37 PM

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
DIFFICULTY: Moderate | Bloom's Comprehension
QUESTION TYPE: Multiple Choice
HAS VARIABLES: False
TOPICS: 9.2 Elements of Decision Analysis - Decision Trees
OTHER: BUSPROG - Analytic |DISC - Decision Making
DATE CREATED: 5/17/2017 3:50 PM
DATE MODIFIED: 10/21/2017 9:37 PM
Copyright Cengage Learning. Powered by Cognero. Page 1
Chapter 9 - Decision Making Under Uncertainty

4. Which of the following statements is true concerning decision tree conventions?

a. Time proceeds from right to left.
b. The trees are composed of circles, triangles and ovals.
c. The nodes represent points in time.
d. Probabilities of outcomes are shown to the right of the end nodes.
ANSWER: c
POINTS: 1
DIFFICULTY: Moderate | Bloom's Comprehension
QUESTION TYPE: Multiple Choice
HAS VARIABLES: False
TOPICS: 9.2 Elements of Decision Analysis - Decision Trees
OTHER: BUSPROG - Analytic |DISC - Decision Making
DATE CREATED: 5/17/2017 3:50 PM
DATE MODIFIED: 10/21/2017 9:37 PM

5. The solution procedure for solving decision trees is called:

a. sensitivity analysis
b. policy iteration
c. risk profiling
d. folding back
ANSWER: d
POINTS: 1
DIFFICULTY: Easy | Bloom's Comprehension
QUESTION TYPE: Multiple Choice
HAS VARIABLES: False
TOPICS: 9.2 Elements of Decision Analysis - Decision Trees
OTHER: BUSPROG - Analytic |DISC - Decision Making
DATE CREATED: 5/17/2017 3:50 PM
DATE MODIFIED: 10/21/2017 9:37 PM

6. The strategy region graph is a type of sensitivity analysis chart that:

a. is useful in determining whether the optimal decision changes over the range of the input variable.
b. ranks the sensitivity of the EMV to the input variables.
c. reflects how the value of information changes over a range of probabilities.
d. None of these
ANSWER: a
POINTS: 1
DIFFICULTY: Moderate | Bloom's Comprehension
QUESTION TYPE: Multiple Choice
HAS VARIABLES: False
TOPICS: 9.5 Multistage Decision Problems - Sensitivity Analysis
OTHER: BUSPROG - Analytic |DISC - Decision Making
DATE CREATED: 5/17/2017 3:50 PM
Copyright Cengage Learning. Powered by Cognero. Page 2
Chapter 9 - Decision Making Under Uncertainty
DATE MODIFIED: 10/21/2017 9:37 PM

7. Bayes’ rule is used to:

a. update the prior probabilities once new information is observed.
b. turn the given conditional probabilities (i.e. likelihoods) around.
c. update the posterior probabilities once new information is observed.
d. All of the above are uses for Bayes’ rule.
ANSWER: d
POINTS: 1
DIFFICULTY: Moderate | Bloom's Application
QUESTION TYPE: Multiple Choice
HAS VARIABLES: False
TOPICS: 9.5 Multistage Decision Problems - Bayes' Rule: Probability Approach
OTHER: BUSPROG - Analytic |DISC - Decision Making
DATE CREATED: 5/17/2017 3:50 PM
DATE MODIFIED: 10/21/2017 9:37 PM

8. The denominator of Bayes' rule:

a. is the same as the simple probability of an outcome O.
b. decomposes the probability of the new information I into all possibilities.
c. is sometimes called the law of complementary probabilities.
d. is unique for each possible outcome.
ANSWER: b
POINTS: 1
DIFFICULTY: Moderate | Bloom's Application
QUESTION TYPE: Multiple Choice
HAS VARIABLES: False
TOPICS: 9.5 Multistage Decision Problems - Bayes' Rule: Probability Approach
OTHER: BUSPROG - Analytic |DISC - Decision Making
DATE CREATED: 5/17/2017 3:50 PM
DATE MODIFIED: 10/21/2017 9:37 PM

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
DIFFICULTY: Easy | Bloom's Comprehension
QUESTION TYPE: Multiple Choice
HAS VARIABLES: False
TOPICS: 9.5 Multistage Decision Problems - Bayes' Rule: Frequency Approach
OTHER: BUSPROG - Analytic |DISC - Decision Making
Copyright Cengage Learning. Powered by Cognero. Page 3
Chapter 9 - Decision Making Under Uncertainty
DATE CREATED: 5/17/2017 3:50 PM
DATE MODIFIED: 10/21/2017 9:37 PM

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
DIFFICULTY: Moderate | Bloom's Comprehension
QUESTION TYPE: Multiple Choice
HAS VARIABLES: False
TOPICS: 9.6 The Role of Risk Aversion
OTHER: BUSPROG - Analytic |DISC - Decision Making
DATE CREATED: 5/17/2017 3:50 PM
DATE MODIFIED: 10/21/2017 9:37 PM

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
DIFFICULTY: Easy | Bloom's Comprehension
QUESTION TYPE: True / False
HAS VARIABLES: False
TOPICS: 9.2 Elements of Decision Analysis - More about the EMV Criterion
OTHER: BUSPROG - Analytic |DISC - Decision Making
DATE CREATED: 5/17/2017 3:50 PM
DATE MODIFIED: 10/21/2017 9:37 PM

12. For each possible decision and each possible outcome, the payoff table lists the associated monetary value.
a. True
b. False
ANSWER: True
POINTS: 1
DIFFICULTY: Easy | Bloom's Comprehension
QUESTION TYPE: True / False
HAS VARIABLES: False
TOPICS: 9.2 Elements of Decision Analysis - More about the EMV Criterion
OTHER: BUSPROG - Analytic |DISC - Decision Making
DATE CREATED: 5/17/2017 3:50 PM
DATE MODIFIED: 10/21/2017 9:37 PM

Copyright Cengage Learning. Powered by Cognero. Page 4

Chapter 9 - Decision Making Under Uncertainty
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
DIFFICULTY: Moderate | Bloom's Comprehension
QUESTION TYPE: True / False
HAS VARIABLES: False
TOPICS: 9.2 Elements of Decision Analysis - More about the EMV Criterion
OTHER: BUSPROG - Analytic |DISC - Decision Making
DATE CREATED: 5/17/2017 3:50 PM
DATE MODIFIED: 10/21/2017 9:37 PM

14. The risk profile from Precision Tree shows the probability distribution of monetary outcomes in both graphical and
tabular form.
a. True
b. False
ANSWER: True
POINTS: 1
DIFFICULTY: Easy | Bloom's Comprehension
QUESTION TYPE: True / False
HAS VARIABLES: False
TOPICS: 9.5 Multistage Decision Problems -Solution
OTHER: BUSPROG - Analytic |DISC - Decision Making
DATE CREATED: 5/17/2017 3:50 PM
DATE MODIFIED: 10/21/2017 9:37 PM

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
DIFFICULTY: Moderate | Bloom's Comprehension
QUESTION TYPE: True / False
HAS VARIABLES: False
TOPICS: 9.5 Multistage Decision Problems -The Value of Information
OTHER: BUSPROG - Analytic |DISC - Decision Making
DATE CREATED: 5/17/2017 3:50 PM
DATE MODIFIED: 10/21/2017 9:37 PM

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
Copyright Cengage Learning. Powered by Cognero. Page 5
Chapter 9 - Decision Making Under Uncertainty
b. False
ANSWER: False
POINTS: 1
DIFFICULTY: Easy | Bloom's Comprehension
QUESTION TYPE: True / False
HAS VARIABLES: False
TOPICS: 9.5 Multistage Decision Problems -The Value of Information
OTHER: BUSPROG - Analytic |DISC - Decision Making
DATE CREATED: 5/17/2017 3:50 PM
DATE MODIFIED: 10/21/2017 9:37 PM

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
DIFFICULTY: Easy | Bloom's Application
QUESTION TYPE: True / False
HAS VARIABLES: False
TOPICS: 9.5 Multistage Decision Problems - Bayes' Rule: Probability Approach
OTHER: BUSPROG - Analytic |DISC - Decision Making
DATE CREATED: 5/17/2017 3:50 PM
DATE MODIFIED: 10/21/2017 9:37 PM

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
DIFFICULTY: Moderate | Bloom's Application
QUESTION TYPE: True / False
HAS VARIABLES: False
TOPICS: 9.5 Multistage Decision Problems - Bayes' Rule: Probability Approach
OTHER: BUSPROG - Analytic |DISC - Decision Making
DATE CREATED: 5/17/2017 3:50 PM
DATE MODIFIED: 10/21/2017 9:37 PM

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
ANSWER: True
POINTS: 1

Copyright Cengage Learning. Powered by Cognero. Page 6

Chapter 9 - Decision Making Under Uncertainty
DIFFICULTY: Easy | Bloom's Application
QUESTION TYPE: True / False
HAS VARIABLES: False
TOPICS: 9.6 The Role of Risk Aversion
OTHER: BUSPROG - Analytic |DISC - Decision Making
DATE CREATED: 5/17/2017 3:50 PM
DATE MODIFIED: 10/21/2017 9:37 PM

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
DIFFICULTY: Easy | Bloom's Application
QUESTION TYPE: True / False
HAS VARIABLES: False
TOPICS: 9.6 The Role of Risk Aversion
OTHER: BUSPROG - Analytic |DISC - Decision Making
DATE CREATED: 5/17/2017 3:50 PM
DATE MODIFIED: 10/21/2017 9:37 PM

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.

Copyright Cengage Learning. Powered by Cognero. Page 7

Chapter 9 - Decision Making Under Uncertainty

POINTS: 1
DIFFICULTY: Moderate | Bloom's Application
QUESTION TY Subjective Short Answer
PE:
HAS VARIABLE False
S:
PREFACE NA Exhibit 09-1
ME:
TOPICS: 9.2 Elements of Decision Analysis - Decision Trees
OTHER: BUSPROG - Analytic |DISC - Decision Making
DATE CREATE 5/17/2017 3:50 PM
D:
DATE MODIFI 10/21/2017 9:37 PM
ED:

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
DIFFICULTY: Moderate | Bloom's Application
QUESTION TYPE Subjective Short Answer
:
HAS VARIABLES: False

PREFACE NAME Exhibit 09-1

:
Copyright Cengage Learning. Powered by Cognero. Page 8
Chapter 9 - Decision Making Under Uncertainty
TOPICS: 9.2 Elements of Decision Analysis - Decision Trees
OTHER: BUSPROG - Analytic |DISC - Decision Making
DATE CREATED: 5/17/2017 3:50 PM

DATE MODIFIE 10/21/2017 9:37 PM

D:

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
DIFFICULTY: Moderate | Bloom's Application

QUESTION T Subjective Short Answer

YPE:
HAS VARIABL False
ES:
PREFACE NA Exhibit 09-1
ME:
TOPICS: 9.2 Elements of Decision Analysis - Decision Trees
OTHER: BUSPROG - Analytic |DISC - Decision Making
DATE CREAT 5/17/2017 3:50 PM
ED:
DATE MODIF 10/21/2017 9:37 PM
IED:

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.
Copyright Cengage Learning. Powered by Cognero. Page 9
Chapter 9 - Decision Making Under Uncertainty

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
DIFFICULTY: Moderate | Bloom's Application
QUESTION TYPE Subjective Short Answer
:
HAS VARIABLES: False

PREFACE NAME Exhibit 09-1

:
TOPICS: 9.2 Elements of Decision Analysis - Decision Trees
OTHER: BUSPROG - Analytic |DISC - Decision Making
DATE CREATED: 5/17/2017 3:50 PM

DATE MODIFIE 10/21/2017 9:37 PM

D:

Copyright Cengage Learning. Powered by Cognero. Page 10

Chapter 9 - Decision Making Under Uncertainty
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
DIFFICULTY: Moderate | Bloom's Application
QUESTION TYP Subjective Short Answer
E:
HAS VARIABLES False
:
PREFACE NAM Exhibit 09-1
E:
TOPICS: 9.6 The Role of Risk Aversion - Exponential Utility
OTHER: BUSPROG - Analytic |DISC - Decision Making
DATE CREATED 5/17/2017 3:50 PM
:
DATE MODIFIE 10/21/2017 9:37 PM
D:

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.

Copyright Cengage Learning. Powered by Cognero. Page 11

Chapter 9 - Decision Making Under Uncertainty
ANSWER:

POINTS: 1
DIFFICULTY: Moderate | Bloom's Application

QUESTION T Subjective Short Answer

YPE:
HAS VARIABLFalse
ES:
PREFACE NA Exhibit 09-2
ME:
TOPICS: 9.2 Elements of Decision Analysis - Decision Trees
OTHER: BUSPROG - Analytic |DISC - Decision Making
DATE CREAT 5/17/2017 3:50 PM
ED:
DATE MODIF 10/21/2017 9:37 PM
IED:

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
DIFFICULTY: Easy | Bloom's Application
QUESTION TYPE Subjective Short Answer
:
HAS VARIABLES: False

PREFACE NAME Exhibit 09-2

:
TOPICS: 9.2 Elements of Decision Analysis - Decision Trees
OTHER: BUSPROG - Analytic |DISC - Decision Making
DATE CREATED: 5/17/2017 3:50 PM

Copyright Cengage Learning. Powered by Cognero. Page 12

Chapter 9 - Decision Making Under Uncertainty
DATE MODIFIE 10/21/2017 9:37 PM
D:

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 $1960-$1200 = $760, which is the most the credit union should be
willing to pay.
POINTS: 1
DIFFICULTY:Challenging | Bloom's Application

QUESTION T Subjective Short Answer

YPE:
HAS VARIAB False
LES:
PREFACE NA Exhibit 09-2
ME:
TOPICS: 9.5 Multistage Decision Problems -The Value of Information
OTHER: BUSPROG - Analytic |DISC - Decision Making
DATE CREAT 5/17/2017 3:50 PM
ED:
DATE MODIF 10/21/2017 9:37 PM
IED:

29. Refer to Exhibit 9-2. Should the credit union purchase the report if it costs $150?
Copyright Cengage Learning. Powered by Cognero. Page 13
Chapter 9 - Decision Making Under Uncertainty
ANSWER:

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
DIFFICULTY: Challenging | Bloom's Application

QUESTION TYSubjective Short Answer

PE:
HAS VARIABL False
ES:
PREFACE NA Exhibit 09-2
ME:
TOPICS: 9.5 Multistage Decision Problems -The Value of Information
OTHER: BUSPROG - Analytic |DISC - Decision Making
DATE CREAT 5/17/2017 3:50 PM
ED:
DATE MODIF 10/21/2017 9:37 PM
IED:

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?

Copyright Cengage Learning. Powered by Cognero. Page 14

Chapter 9 - Decision Making Under Uncertainty
ANSWER:

The worksheet above shows that if the report predicts default, the probabilities of actual default and no
default are 0.165 and 0.835, respectively, while if the report predicts no default, the probabilities of default
and no default are 0.016 and 0.984, respectively.
POINTS: 1
DIFFICULTY: Challenging | Bloom's Application
QUESTION TY Subjective Short Answer
PE:
HAS VARIABL False
ES:
PREFACE NA Exhibit 09-2
ME:
TOPICS: 9.5 Multistage Decision Problems - Bayes' Rule: Probability Approach
OTHER: BUSPROG - Analytic |DISC - Decision Making
DATE CREAT 5/17/2017 3:50 PM
ED:
DATE MODIFI10/21/2017 9:37 PM
ED:

Copyright Cengage Learning. Powered by Cognero. Page 15