OPERATIONS MANAGEMENT

Unit 2: Decision Analysis

[This Nation, 2018]

UEF | Operations Management | Unit 2: Decision Analysis | Tran Hoang Nam | 1

Lecture Outline

Sequential
Decision Analysis Practice
Decision Tree

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What is Decision Analysis?

Decision Analysis: A quantitative method:

A set of quantitative ▪ A tool for operations managers.
decision-making
A generic technique:
techniques for
▪ Can be applied to a number of different
decision situations
types of operational decision-making
in which uncertainty
areas.
exists.
Example of an uncertain situation:
▪ Demand for a product may vary between 0
and 200 units, depending on the state of
market.

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Decision Analysis

States of Nature: Events that may occur in the future.

Payoff: The outcome of the decision.
Payoff Table: A method for organizing and illustrating the payoffs from
different decisions given various states of nature.

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Example: Should I Accept a New Job Offer?

Suppose that you have a job as an assistant for the CEO of a

company, this job helps you earn $30,000 every month. Due to the
recruitment need, your boss nominates you as the director of a branch
and raises your salary by $20,000. If you get this position, you will
have to commute for 1 hour and a half every day to get to your new
workplace. You need to consider your extra benefits.

Decline offer Accept offer

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Decision Tree: Should I Accept a New Job Offer?

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Lecture Outline

Sequential
Decision Analysis Practice
Decision Tree

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Sequential Tree Decision

Sequential Decision Decision tree consists of:

Tree: A graphical
▪ Square nodes: Indicating decision points.
method for analyzing
1 …
decision situations that
require a sequence of ▪ Circles nodes: Indicating states of nature.
decisions over time. 2 …
Expected Value (EV): A ▪ Arcs: Connecting nodes.
weighted average of
decision outcomes in
which each future state
of nature is assigned a
probability of occurrence.

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Example S1.3: A Sequential Tree Decision

The Southern Textile Company is considering two alternatives: to expand its existing
production operation to manufacture a new line of lightweight material or to purchase
land on which to construct a new facility in the future. Each of these decisions has
outcomes based on product market growth in the future that result in another set of
decisions (during a 10-year planning horizon).
The first decision facing the company is whether to expand or buy land. If the company
expands, two states of nature are possible. Either the market will grow (with a probability
of .60) or it will not grow (with a probability of .40). Either state of nature will result in a
payoff. On the other hand, if the company chooses to purchase land, three years in the
future another decision will have to be made regarding the development of the land.
If the plant is expanded, two states of nature are possible. Whether the market will grow,
with a probability of .60, or it will not grow or will decline, with a probability of .40. If the
market grows, the company will achieve a payoff of $2,000,000 over a 10-year period.
However, if no growth occurs, a payoff of only $225,000 will result. [ ... ]

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Example S1.3: A Sequential Tree Decision

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Example S1.3: Solutions

Compute EV at nodes 6 and 7:

▪ EV (6) = 0.80 x $3,000,000 + 0.20 x $700,000 = $2,540,000.
▪ EV (7) = 0.30 x $2,300,000 + 0.70 x $1,000,000 = $1,390,000.
Compute EV at node 4:
▪ Consider between expand ($2,540,000 - $800,000) and sell land ($450,000).
▪ Since expand will result the greatest EV, the decision is to expand.
▪ EV (4) = $1,740,000.
Compute EV at node 5:
▪ Consider between build a warehouse ($1,390,000 - $600,000) and sell land ($210,000).
▪ Since build a warehouse will result the greatest EV, the decision is to build a warehouse.
▪ EV (5) = $790,000.

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Example S1.3: Solutions

Compute EV at nodes 2 and 3:

▪ EV (2) = 0.60 x $2,000,000 + 0.40 x $225,000 = $1,290,000.
▪ EV (3) = 0.60 x $1,740,000 + 0.40 x $790,000 = $1,360,000.
Compute EV at node 1:
▪ Consider between expand ($1,290,000 - $800,000) and purchase land ($1,360,000 -
$200,000).
▪ Since purchase land will result the highest EV, the decision is to purchase land.
▪ EV (1) = $1,160,000.
In conclusion, the Southern Textile Company should purchase land.

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Example S1.3: Solutions

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Lecture Outline

Sequential
Decision Analysis Practice
Decision Tree

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Problem S1.32: Page 47

The management of State Union Bank was concerned about the potential loss that might
occur in the event of a physical catastrophe such as a power failure or a fire. The bank
estimated that the loss from one of these incidents could be as much as $100 million,
including losses due to interrupted service and customer relations. One project the bank
is considering is the installation of an emergency power generator at its operations
headquarters. The cost of the emergency generator is $900,000, and if it is installed no
losses from this type of incident will be incurred. However, if the generator is not installed,
there is a 10% chance that a power outage will occur during the next year. If there is an
outage, there is a .04 probability that the resulting losses will be very large, or
approximately $90 million in lost earnings. Alternatively, it is estimated that there is a .96
probability of only slight losses of around $2 million.
Using decision tree analysis, determine whether the bank should install the new
power generator

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Problem S1.36: Page 48

Mary Decker is suing the manufacturer of her car because of a defect that she
believes caused her to have an accident and kept her out of work for a year.
She is suing the company for $3.5 million. The company has offered her a
settlement of $700,000, of which Mary would receive $600,000 after attorneys’
fees. Her attorney has advised her that she has a 50% chance of winning her
case. If she loses she will incur attorneys’ fees and court costs of $75,000. If
she wins she is not guaranteed her full requested settlement. Her attorney
believes that if she wins, there is a 50% chance she could receive the full
settlement, in which case Mary would get $2 million after her attorney takes his
cut, and a 50% chance that the jury will award her a lesser amount of
$1,000,000, of which Mary would get $500,000.
Using decision-tree analysis, decide if Mary should sue the manufacturer.

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Problem S1.38: Pages 48-49

The Orchard Wine Company purchases grapes
from one of two nearby growers each season to
produce a particular red wine. It purchases enough
grapes to produce 3000 bottles of the wine. Each
grower supplies a certain portion of poor-quality
grapes that will result in a percentage of bottles
being used as fillers for cheaper table wines
according to the following probability distribution:
The two grapes and because of differences in taste,
the company charges different prices for their wine
depending on which grapes they use. The annual
profit from the wine produced from each grower’s
grapes for each percentage defective is as follows:
growers charge a different price for their

Use decision-tree analysis to determine from which grower the company should purchase grapes.

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Problem S1.39: Page 49

Huntz Food Products is attempting to decide if it should introduce a new line of salad dressings
called Special Choices. The company can test market the salad dressings in selected
geographic areas or bypass the test market and introduce the product nationally. The cost of
the test market is $150,000. If the company conducts the test market, it must wait to see the
results before deciding whether or not to introduce the salad dressings nationally. The
probability of a positive test market result is estimated to be .6. Alternatively, the company
cannot conduct the test market and make the decision to introduce the dressings or not. If the
salad dressings are introduced nationally and are a success, the company estimates it will
realize an annual profit of $1,600,000, while if the dressings fail it will incur a loss of $700,000.
The company believes the probability of success for the salad dressings is .50 if they are
introduced without the test market. If the company does conduct the test market and it is
positive, the probability of successfully introducing the salad dressings increases to .8. If the
test market is negative and the company introduces the salad dressings anyway, the probability
of success drops to .30.
Using decision-tree analysis, determine if the company should conduct the test market.

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 OPERATIONS MANAGEMENT
Unit 2: Decision Analysis

[ThisNation.com, 2018]

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