DECISION ANALYSIS CHAPTER TWO

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INTRODUCTION
▪ Decision analysis can be used to develop an optimal
strategy when a decision maker is faced with several
decision alternatives and an uncertain or risk-filled
pattern of future events.
▪ Decision theory is an analytic and systematic
approach to the study of decision-making.
▪ A good decision is one that is based on logic and
considers all available data and possible
alternatives, and the quantitative approach
described in this chapter.
02/04/2023 DECISION ANALYSIS 2
CONT’D
Making a decision requires an enumeration of
feasible and viable alternatives, the consequences
associated with different alternatives, and the
measure of effectiveness by which the most preferred
alternative is identified.
It provides a method of natural decision-making
wherein data concerning the occurrence of different
outcomes may be evaluated to enable the decision-
maker to identify suitable alternatives.
02/04/2023 DECISION ANALYSIS 3
CONT’D
Decision models useful in helping decision-makers
make the best possible decisions are classified
according to the degree of certainty;
• complete certainty
• complete uncertainty
• risk or probabilistic problems.

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SOME IMPORTANT TERMINOLOGIES
The decision maker is the individual or group
responsible for making the decision (or sequence of
decisions) under consideration.
List of Alternatives: a set of mutually exclusive and
collectively exhaustive decisions that are available to
the decision maker.

02/04/2023 DECISION ANALYSIS 5

CONT’D
States of Nature: the set of possible future conditions,
or events, beyond the control of the decision maker.
This information may be in the form of just subjective
estimates based on the experience or intuition of an
individual, or there may be some degree of hard
evidence.
Payoffs: the payoffs might be profits, revenues, costs,
or other measures of value. The number of payoffs
depends on the number of alternative/state-of-nature
combinations.

02/04/2023 DECISION ANALYSIS 6

CONT’D
Degree of Certainty: the approach often used by a
decision-maker depends on the degree of certainty
that exists.
one extreme is complete certainty and the other is
complete uncertainty. Between these two extreme,
there is a risk.
Decision Criteria: the decision maker’s attitude toward
the decision as well as the degree of certainty that
surrounds a decision. For example; maximize the
expected payoffs.

02/04/2023 DECISION ANALYSIS 7

CONT’D

The Payoff Table: a payoff table is a device that a

decision maker can use to summarize information
relevant to a particular decision.
It includes:
✓List of alternative
✓ Possible future state of nature
✓ The payoffs associated with each of the
alternative/state-of-nature combinations.
✓ Probabilities

02/04/2023 DECISION ANALYSIS 8

THE PAYOFF TABLE
State of Nature
S1 S2 S3
P1 P2 P3
A1 V11 V12 V13

Alternatives A2 V21 V22 V23

A3 V31 V32 V33

Where:
Ai = the ith alternative
Sj = the jth states of nature
Pi = probability under each state of nature
Vij = the value or payoff that will be realized if
alternative i is chosen and event j occur.
02/04/2023 DECISION ANALYSIS 9
 DECISION-MAKING PROCESS
1. Identification of the various possible outcomes, called the state
of nature or events, Ei’s for the decision problem. The events are
beyond the control of the decision-maker.
2. Identification of all the courses of action, Aj’s, or the strategies
that are available to the decision maker. The decision-maker
has control over the choice of these.
3. Determination of the payoff function which describes the
consequence resulting from the different combinations of the
acts and events. The payoff may be designed as Vij’s. The
payoff resulting from ith events and jth strategy.
4. Choosing from among the various alternatives on the basis of
some criterion, which may involve the information given in step 3
only or which may require and incorporate some additional
information.
02/04/2023 DECISION ANALYSIS 10
EXAMPLE
Suppose Mr. Abemelek a real estate developer must decide on a plan for
developing a certain piece of property. After careful consideration, Mr.
Abemelek has left with the following list of acceptable alternatives.
✓ Residential proposal
✓ Commercial proposal #1
✓ Commercial proposal #2
The main factor that will influence the profitability of the development is
whether or not a shopping center built, and the size of the shopping center, if
one is built. Suppose that developer views the possibilities as:
✓ No-shopping center
✓ Medium –size shopping center
✓ Large shopping center

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PAYOFF TABLE

State of Nature
No SC MS SC LS SC

Residential 400,000 1,600,000 1,200,000

Alternatives
Commercial #1 600,000 500,000 1,400,000

Commercial #2 -100,000 400,000 1,500,000

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DECISION MAKING WITHOUT PROBABILITIES
In this section we consider approaches to decision-making
that do not require knowledge of the probabilities of the
states of nature.
These approaches are appropriate in situations in which the
decision maker has little confidence in his or her ability to
assess the probabilities, or in which a simple best-case and
worst-case analysis is desirable.
Because different approaches sometimes lead to different
decision recommendations, the decision maker must
understand the approaches available and then select the
specific approach that, according to the judgment of the
decision maker, is the most appropriate.
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DECISION MAKING WITHOUT PROBABILITIES
There are several criteria for making decisions making
without probabilities
1. Maximax (optimistic)
2. Maximin (pessimistic)
3. Criterion of realism (Hurwicz)
4. Equally likely (principle of insufficient reason/
Laplace)
5. Minimax regret
02/04/2023 DECISION ANALYSIS 14
OPTIMISTIC APPROACH
The optimistic approach (MaxiMax) evaluates each
decision alternative in terms of the best payoff that
can occur.
For a problem in which maximum profit is desired, the
optimistic approach would lead the decision maker to
choose the alternative corresponding to the largest
profit.
Whereas, for problems involving minimization, this
approach leads to choosing the alternative with the
smallest payoff.
02/04/2023 DECISION ANALYSIS 15
 CONT’D
The maximax criterion is the decision criterion for the
eternal optimist. Here is how this criterion works: Identify the
maximum payoff from any state of nature for each decision
alternative. Find the maximum of these maximum payoffs and
choose the corresponding decision alternative.

State of Nature
No SC MS SC LS SC Max. in
Row
Residential 400,000 1,600,000 1,200,000 1,600,000

Commercial #1 600,000 500,000 1,400,000 1,400,000

Alternatives
Commercial #2 -100,000 400,000 1,500,000 1,500,000

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CONSERVATIVE APPROACH
The maximin (pessimistic) criterion chooses the action
with the “best” worst outcome. The maximin criterion
always chooses the decision alternative that provides
the best guarantee for its minimum possible payoff.

State of Nature
No SC MS SC LS SC Min. in
Row
Residential 400,000 1,600,000 1,200,000 400,000

Commercial #1 600,000 500,000 1,400,000 500,000

Alternatives
Commercial #2 -100,000 400,000 1,500,000 -100,000

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MINIMAX REGRET APPROACH
In decision analysis, regret is the difference between the
payoff associated with a particular decision alternative and
the payoff associated with the decision that would yield the
most desirable payoff for a given state nature. This is why
regret is often referred to as opportunity loss.

As its name implies, under the minimax regret approach to

decision making one would choose the decision alternative that
minimizes the maximum state of regret that could occur over all
possible states of nature. This approach is neither purely
optimistic nor purely conservative.

02/04/2023 DECISION ANALYSIS 18

CONT’D
An approach that takes all payoffs into account. To
use this approach, it is necessary to develop an
opportunity loss table that reflects the difference
between each payoff and the best possible payoff in
a column (i.e., given a state of nature).

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CONT’D
Original Payoff Table State of Nature
No SC MS SC LS SC

Residential 400,000 1,600,000 1,200,000

Commercial #1 600,000 500,000 1,400,000

Alternatives
Commercial #2 -100,000 400,000 1,500,000

Opportunity Loss Table State of Nature

No SC MS SC LS SC

Residential 200,000 0 300,000

Commercial #1 0 1,100,000 100,000

Alternatives
Commercial #2 700,000 1,200,000 0

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CONT’D
State of Nature
No SC MS SC LS SC Max Loss

Residential 200,000 0 300,000 300,000

Commercial #1 0 1,100,000 100,000 1,100,000

Alternatives
Commercial #2 700,000 1,200,000 0 1,200,000

Since the objective is to minimize maximum loss the

decision-makers will choose a residential alternative.

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 PRINCIPLE OF INSUFFICIENT REASON/
EQUAL LIKELIHOOD/ LAPLACE
Considers all the payoffs for each alternative
 Find the average payoff for each alternative
 Select the alternative with the highest average

State of Nature
No SC MS SC LS SC Raw
Average
Residential 400,000 1,600,000 1,200,000 1066,666.67

Commercial #1 600,000 500,000 1,400,000 833,333.3

Alternatives
Commercial #2 -100,000 400,000 1,500,000 600,000

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THE HURWITZ CRITERION
The approach offers the decision maker a compromise
between the maximax and the maximin criteria.
Requires the decision maker to specify a degree of
optimism, in the form of a coefficient of optimism α,
with possible values of α ranging from 0 to 1 (0< <
1).
The closer the selected value of α is to 1, the more
optimistic the decision maker is, and the closer the
value of α is to 0, the more pessimistic the decision
maker is.

02/04/2023 DECISION ANALYSIS 23

CONT’D
If  = 1, then the decision maker is said to be
completely optimistic,
If = 0, then the decision maker is completely
pessimistic. Given this definition, if  is coefficient of
optimism,
1- is coefficient of pessimism.
The Hurwitz criterion requires that for each
alternative, the maximum payoff is multiplied by 
and the minimum payoff be multiplied by 1-.
02/04/2023 DECISION ANALYSIS 24
CONT’D
If  = 0.4 for the above example,
State of Nature
No SC MS SC LS SC

Residential 400,000 1,600,000 1,200,000

Alternatives
Commercial #1 600,000 500,000 1,400,000

Commercial #2 -100,000 400,000 1,500,000

A1 = (0.4x1600000) + (0.6x400000) = 880,000

A2 = (0.4x1400000) + (0.6x500000)= 860,000
A3 = (0.4x1500000) – (0.6x100000)= 540,000

02/04/2023 DECISION ANALYSIS 25

 DECISION MAKING WITH PROBABILITIES
• In many decision-making situations, we can obtain
probability assessments for the states of nature.
• Decision making when there are several possible
states of nature and we know the probabilities
associated with each possible state
• Most popular method is to choose the alternative with
the highest Expected Monetary Value (EMV)

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EXPECTED MONETARY VALUE (EMV)
The EMV approach provides the decision maker with
a value which represents an average payoff for each
alternative. The best alternative is, then, the one that
has the highest EMV. The average or expected
payoff of each alternative is a weighted average:
EMV (alternative i) = (payoff of first state of nature)
x (probability of first state of nature)
+ (payoff of second state of nature)
x (probability of second state of nature)
+ … + (payoff of last state of nature)
x (probability of last state of nature)
02/04/2023 DECISION ANALYSIS 27
CONT’D
State of Nature
No SC MS SC LS SC
Expected
Probability Payoff

0.2 0.5 0.3

Residential 400,000 1,600,000 1,200,000 1,240,000

Alternatives Commercial #1 600,000 500,000 1,400,000 790,000

Commercial #2 -100,000 400,000 1,500,000 630,000

EMV (A1) = 0.20(400000) + 0.50(1600000) + 0.30(1200000) =

1,240,000,* Max
EMV (A2) = 0.20(6) + 0.50(5) + 0.30(14) = 790,000
EMV (A3) = 0.20(-1) + 0.50(4) + 0.30(15) = 630,000
02/04/2023 DECISION ANALYSIS 28
EXPECTED OPPORTUNITY LOSS (EOL)
EOL is the cost of not picking the best solution
• First construct an opportunity loss table
• For each alternative, multiply the opportunity loss by
the probability of that loss for each possible outcome
and add these together
• Minimum EOL will always result in the same decision
as Maximum EMV
• Minimum EOL will always equal EVPI

02/04/2023 DECISION ANALYSIS 29

CONT’D
State of Nature
No SC MS SC LS SC

Probability

0.2 0.5 0.3

Residential 200,000 0 300,000

Commercial #1 0 1,100,000 100,000

Alternatives
Commercial #2 700,000 1,200,000 0

EOL (A1) = 0.20(2) + 0.50(0) + 0.30(3) = 130,000 *Minimum

EOL (A2) = 0.20(0) + 0.50(11) + 0.30(1) = 580,000
EOL (A3) = 0.20(7) + 0.50(12) + 0.30(0) = 740,000
The EOL approach resulted in the same alternative as the EMV approach
(Maximizing the payoffs is equivalent to minimizing the opportunity losses).
02/04/2023 DECISION ANALYSIS 30
EXPECTED VALUE OF PERFECT INFORMATION
(EVPI)
The EVPI is the measure of the difference between the certainty
payoffs that could be realized under a condition involving risk.
If the decision maker knows that S1 will occur, A2 would be
chosen with a payoff of $600,000. Similarly, for S2
$1600,000 (for A1), and for S3, $1500,000 (with A3) would
be chosen.
Hence, the expected payoff under certainty (EPC) would be:
EPC = 0.20 (600,000)+0.50 (1,600,000) + 0.30 (1,500,000)
= 1,370,000

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CONT’D
The difference between this figure and the expected
payoff under risk (i.e., the EMV) is the expected value
of perfect information. Thus:
EVPI = EPC – EMV
= 1,370,000 – 1,240,000 = 130,000
The EOL indicates the expected opportunity loss due to
imperfect information, which is another way of saying
the expected payoff that could be achieved by having
perfect information.
02/04/2023 DECISION ANALYSIS 32
DECISION TREES
Decision tree, like a probability tree, is composed of
squares, circles, and lines:
The squares indicate decision points and circles
represent chance events (circles and squares are
called nodes)
The lines (branches) emanating from squares
represent alternatives. The lines from circles represent
states of nature
The tree is read from right to left.
02/04/2023 DECISION ANALYSIS 33
FOLDING BACK A DECISION TREE
• For identifying the best decision in the tree
• Work from right to left
• Calculate the expected payoff at each outcome
node
• Choose the best alternative at each decision node
(based on expected payoff)

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CONT’D

02/04/2023 DECISION ANALYSIS 35

CONT’D

02/04/2023 DECISION ANALYSIS 36

 EXERCISE
Warren Buffy is an enormously wealthy investor who has built his fortune through his legendary
investing acumen. He currently has been offered three major investments and he would like to
choose one. The first one is a conservative investment that would perform very well in an improving
economy and only suffer a small loss in a worsening economy. The second is a speculative investment
that would perform extremely well in an improving economy but would do very badly in a
worsening economy. The third is a countercyclical investment that would lose some money in an
improving economy but would perform well in a worsening economy. Warren believes that there are
three possible scenarios over the lives of these potential investments: (1) an improving economy, (2)
a stable economy, and (3) a worsening economy. He is pessimistic about where the economy is
headed, and so has assigned prior probabilities of 0.1, 0.5, and 0.4, respectively, to these three
scenarios. He also estimates that his profits under these respective scenarios are those given in the
following table.

He estimated a payoff value of 30 million, 5 million, and -10 million under improving economy,
stable economy, and worsening economy respectively in his conservative investment. In his
speculative investment decision, his estimated payoff value is 40 million, 10 million, and -30 million
under an improving economy, stable economy, and worsening economy respectively. Furthermore, he
estimated a payoff value of -10 million, 0, and 15 million in his countercyclical investment in
improving economy, stable economy, and worsening economy respectively.

02/04/2023 DECISION ANALYSIS 37

REQUIRED
Which investment should Warren make under each of the following
criteria?
1. Maximax
2. Maximin
3. Maximum likelihood criterion
4. Hurwitz Criterion if α = .4
5. Minimax regret
5. Construct the decision tree

02/04/2023 DECISION ANALYSIS 38

PAY OFF TABLE FOR REAL ESTATE
INVESTMENT
State of Nature
Good Economic Poor Economic
Condition Condition
Probability

0.6

Appartement Building 50,000 30,000

Alternatives
Office Building 100,000 -40,000

Warehouse 30,000 10,000

02/04/2023 DECISION ANALYSIS 39

RISK ANALYSIS AND SENSITIVITY ANALYSIS
Risk analysis helps the decision maker recognize
the difference between the expected value of a
decision alternative and the payoff that may actually
occur. Sensitivity analysis also helps the decision
maker by describing how changes in the state-of-
nature probabilities and/ or changes in the payoffs
affect the recommended decision alternative.

02/04/2023 DECISION ANALYSIS 40

EXAMPLE
PAYOFF TABLE FOR THE ABC CONDOMINIUM PROJECT
($ MILLIONS)
State of Nature
Strong Demand Weak Demand
Alternatives/Prob. P1= .8 P2 = .2
Small Complex (d1) 8 7
Medium Complex (d2) 14 5
Large Complex (d3) 20 -9

02/04/2023 DECISION ANALYSIS 41

RISK ANALYSIS
A decision alternative and a state of nature combine to
generate the payoff associated with a decision. The
risk profile for a decision alternative shows the
possible payoffs along with their associated
probabilities.

02/04/2023 DECISION ANALYSIS 42

CONT’D
A review of the risk profile associated with an optimal
decision alternative may cause the decision maker to
choose another decision alternative even though the
expected value of the other decision alternative is not as
good.
For example, the risk profile for alternative (d2) shows a
0.8 probability for a $14 million payoff and a 0.2
probability for a $5 million payoff. Because no probability
of a loss is associated with decision alternative d2 it would
be judged less risky than d3. As a result, a decision maker
might prefer the d2 even though it has an expected value
of $2 million less than the d3.
02/04/2023 DECISION ANALYSIS 43
SENSITIVITY ANALYSIS
SA can be used to determine how changes in the
probabilities for the states of nature or changes in the
payoffs affect the recommended decision alternative.
In many cases, the probabilities for the states of
nature and the payoffs are based on subjective
assessments.
Sensitivity analysis helps the decision maker
understand which of these inputs are critical to the
choice of the best decision alternative.

02/04/2023 DECISION ANALYSIS 44

CONT’D
One approach to sensitivity analysis is to select
different values for the probabilities of the states of
nature and the payoffs and then resolve the decision
analysis problem. If the recommended decision
alternative changes, we know that the solution is
sensitive to the changes made.

02/04/2023 DECISION ANALYSIS 45

CONT’D
The best alternative for ABC, the real state developer
will select based on EMV is the large complex.
EMV A1: = 0.8(8) + 0.2(7) = 7.8
A2: = 0.8(14) + 0.2(5) = 12.2
A3: = 0.8(20) + 0.2(-9) = 14.2* maximum
One approach to sensitivity analysis is to select
different values for the probabilities of the states of
nature and the payoffs and then resolve the decision
analysis problem.
02/04/2023 DECISION ANALYSIS 46
CONT’D
For the special case of two states of nature, a
graphical procedure can be used to determine how
changes for the probabilities of the states of nature
affect the recommended decision alternative.
To demonstrate this procedure, we let P denote the
probability of state of nature S1; that is, P(S1) = P.
With only two states of nature, the probability of state
of nature S2 is P(S2) = 1-P(S1)= 1-P.

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EXPECTED VALUE FOR THE ABC DECISION
ALTERNATIVES AS A FUNCTION OF P

02/04/2023 DECISION ANALYSIS 48

CONT’D
Conclusion: decision alternative d1 provides the
largest expected value for P ≤ 0.25, decision
alternative d2 provides the largest expected value
for 0.25 ≤ P ≤ 0.70, and decision alternative d3
provides the largest expected value for P ≥ 0.70.

02/04/2023 DECISION ANALYSIS 49

COMPUTING BRANCH PROBABILITIES
WITH BAYS' THEOREM
• Allows probability values to be revised based on
new information (from a survey or test market)
• Prior probabilities are the probability values before
new information
• Revised probabilities are obtained by combining the
prior probabilities with the new information

02/04/2023 DECISION ANALYSIS 50

CONT’D
The steps used to develop this table are as follows:
Step 1. In column 1 enter the states of nature. In column 2 enter the
prior probabilities for the states of nature. In column 3 enter the
conditional probabilities of a favourable market research report (F)
given each state of nature.
Step 2. In column 4 compute the joint probabilities by multiplying the
prior probability values in column 2 by the corresponding conditional
probability values in column 3.
Step 3. Sum the joint probabilities in column 4 to obtain the
probability of a favourable market research report, P(F).
Step 4. Divide each joint probability in column 4 by P(F) = 0.77 to
obtain the revised or posterior probabilities, P(S1/F) and P(S1/F).
02/04/2023 DECISION ANALYSIS 51
CONT’D

In the ABC problem we assume that the following

assessments are available for these conditional
probabilities:
Market Research
State of Nature Favourable, F Unfavourable, U
Strong demand, S1 P(F/S1)= 0.90 P(U/S1)= 0.10
Weak demand, S2 P(F/S2)= 0.25 P(U/S2)= 0.75
02/04/2023 DECISION ANALYSIS 52
CONT’D

Branch Probabilities for The ABC Condominium Project Based

On A Favourable Market Research Report
State of Prior Conditional Joint Posterior
Nature Probabilities Probabilities Probabilities Probabilities
Sj P(Sj) P(F/Sj) P(F ∏ Sj) P(Sj/F)
S1 0.8 0.90 0.72 0.94
S2 0.2 0.25 0.05 0.06
1 P(F) = 0.77 1

Note that the probability of obtaining an favourable market research

report is P(F) = 0.77. If an favourable report is obtained, the posterior
probability of a strong market demand, S1 is 0.94 and of a weak
market demand, S2, is 0.06.
02/04/2023 DECISION ANALYSIS 53
CONT’D
Branch probabilities for the ABC condominium project based
on an unfavourable market research report
State of Prior Conditional Joint Posterior
Nature Probabilities Probabilities Probabilities Probabilities
Sj P(Sj) P(U/Sj) P(U ∏ Sj) P(Sj/U)
S1 0.8 0.10 0.08 0.35
S2 0.2 0.75 0.15 0.65
1 P(U) = 0.23 1

Note that the probability of obtaining an unfavourable market research

report is P(U) = 0.23. If an unfavourable report is obtained, the
posterior probability of a strong market demand, S1 is 0.35 and of a
weak market demand, S2, is 0.65.
02/04/2023 DECISION ANALYSIS 54
DECISION-MAKING WITH UTILITIES

Thus far, when applying Bayes’ decision rule, we have assumed

that the expected payoff in monetary terms is the appropriate
measure of the consequences of taking an action. However, in
many situations this assumption is inappropriate.

The term utility is the measure of preference for various

alternatives in terms of relative value for money. The utility of a
given alternative is unique to the individual decision-makers and
unlike a simple monetary amount, can incorporate intangible
factors or subjective standards from their own value systems.

02/04/2023 DECISION ANALYSIS 55

CONT’D
The utility provides a way of incorporating the
decision maker’s attitude toward risk in arriving at a
decision and hence measures the true value of an
outcome.
•An alternative to EMV
• People view risk and money differently, so EMV is
not always the best criterion
• Utility theory incorporates a person’s attitude toward
risk
• A utility function converts a person’s attitude toward
money and risks into a number between 0 and 1
02/04/2023 DECISION ANALYSIS 56
CONT’D

Monetary value is not always a true indicator of the

overall value of the result of a decision
The overall value of a decision is called UTILITY
Rational people make decisions to maximize their
utility

02/04/2023 DECISION ANALYSIS 57

CONT’D

Utility assessment assigns the worst outcome a utility

of 0, and the best outcome, a utility of 1
A standard gamble is used to determine utility values
When you are indifferent, the utility values are equal

02/04/2023 DECISION ANALYSIS 58

GENERAL PROCEDURES
Step 1. Develop a payoff table using monetary values
Step 2. Identify the best and worst payoff values in the
table and assign each a utility, with U(best payoff) >
U(worst payoff)
Step 3. For every other monetary value M in the original
payoff table, do the following to determine its utility:
a. Define the lottery such that there is a probability p of
the best payoff and a probability (1- p) of the worst
payoff
02/04/2023 DECISION ANALYSIS 59
CONT’D
b. Determine the value of p such that the decision maker is
indifferent between a guaranteed payoff of M and the lottery
defined in step 3(a)
c. Calculate the utility of M as follows:
U(M) = pU(best payoff) + (1- p) U(worst payoff)
Step 4. Convert each monetary value in the payoff table to a
utility
Step 5. Apply the expected utility approach to the utility
table developed in step 4 and select the decision alternative
with the highest expected utility
02/04/2023 DECISION ANALYSIS 60
EXAMPLE CONT’D
PAYOFF TABLE FOR SWOFFORD, INC.

Decision State of Nature

Alternative
Prices Go Ups S1 Prices Stable S2 Prices go Down S3
P = .3 P = .5 P = .2
Investment A, d1 30000 20000 -50000
Investment B, d2 50000 -20000 -30000
Investment C, d3 0 0 0

EMV A1: = 0.3(30000) + 0.5(20000) + .2(-50,000)= 9000

A2: = 0.3(50000) + 0.5(-20000) + .2(-30,000)= 2000
A3: = 0.3(0) + 0.5(0) + .2(0) = 0

02/04/2023 DECISION ANALYSIS 61

CONT’D
Best Payoff = 50, 000 10
Worst Payoff = -50, 000 0
Monetary Value Indifference Utility
Value of P
50,000 Doesn’t apply 10
30,000 .95 9.5
20,000 .90 9
0 .75 7.5
-20,000 .55 5.5
-30,000 .40 4.0
-50,000 Doesn’t apply 0

02/04/2023 DECISION ANALYSIS 62

CONT’D
UTILITY TABLE FOR SWOFFORD, INC.
Decision State of Nature
Alternative
Prices Go Ups S1 Prices Stable S2 Prices go Down S3
P = .3 P = .5 P = .2
Investment A, d1 9.5 9.0 0
Investment B, d2 10 5.5 4
Investment C, d3 7.5 7.5 7.5

EU A1: = 0.3(9.5) + 0.5(9) + .2(0)= 7.35

A2: = 0.3(10) + 0.5(5.5) + .2(4)= 6.55
A3: = 0.3(7.5) + 0.5(7.5) + .2(7.5) = 7.5
02/04/2023 DECISION ANALYSIS 63
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02/04/2023 DECISION ANALYSIS 64

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02/04/2023 DECISION ANALYSIS 65