Decisions

Recognizing Risk and

Decisions Admitting
Uncertainty
SEA – General Engineering Department
 Risk, Uncertainty and Sensitivity

• Certainty – assumptions that the given data and

the estimated values had high degree of accuracy
• Uncertainty – deviations in actual values caused
by various factors, such as errors of analysis,
misinterpretation of available data, and changing
external economic environment which invalidates
past experience
 Risk, Uncertainty and Sensitivity

• Risk – deviations of actual outcomes from the

predicted outcomes due to chance causes
• Sensitivity – measure of the degree of changes
in the factors or parameters used in an
economic analysis which will affect an
investment decision
 Risk and Uncertainty

Causes of Risk and Uncertainty:

• Insufficiency of available data
• Misinterpretation of data
• Changes in economic conditions
 Sensitivity Analysis
Sensitivity analysis determines the effect of
variation or uncertainty in parameter estimates of
any project. Usually, one factor at a time is varied,
and independence with other factors is assumed.
Sensitivity analysis determines how a measure
of worth (PW, AW, ROR or B/C) and the
alternative may be altered if a particular
parameter varies over a stated range of values.
 Sensitivity Analysis
Types of sensitivity analysis:
• Variation of one parameter at a time for a single
project or for selecting mutually exclusive
alternatives
• Variation of more than one parameter for a single
project
• Sensitivity of mutually exclusive alternative selection
to variation of more than one parameter
 Sensitivity Analysis
Procedures to conduct sensitivity analysis:
• Determine which parameter(s) of interest might vary from the most
likely estimated value.
• Select the probable range (numerical or percentage) and an
increment of variation for each parameter.
• Select the measure of worth.
• Compute the results for each parameter using the measure of
worth.
• To better interpret the sensitivity, graphically display the parameter
versus the measure of worth.
Sensitivity Analysis of Multiple Parameters
for Multiple Alternatives
• The economic advantages and disadvantages among
two or more mutually exclusive alternatives can be
studied by making three estimates for each parameter
expected to vary enough to affect the selection: a
pessimistic (lowest value), a most likely and an
optimistic estimate (largest value).
• It analyzes the measure of worth and alternative
selection sensitivity within a predicted range of
variation for each parameter.
 States of Nature

• States of nature concerns future events or

outcomes beyond the control of the decision
maker.
• They may represent values of certain random
variables such as annual income, salvage
value, purchase price or useful lives of
equipment.
 Payoff Matrix
• A payoff matrix is a way of indicating the relationship
among possible decision alternatives and the various
states of nature.
• Quantitative payoffs result if the payoff value are monetary
in character such as present worth or equivalent annual
amounts.
• Qualitative payoffs occur if the payoff values are non-
monetary in nature but the payoff values must be
expressed in terms of comparable quantities.
 Dominance and Satisficing

• Dominance is a useful screening method for

eliminating inferior alternatives from the
analysis.
• Satisficing, method of feasible ranges, requires
the establishment of minimum or maximum
acceptable values (the standard) for each
attribute.
 Decisions under Uncertainty
To guide the decision maker in his choice of the best
alternative the following decision rules, based on the
premise that probabilities cannot be assigned, are
employed.
• The Laplace Principle
• Maximin and Minimax Principles
• Maximax and Minimin Principles
• Hurwicz Principle
• Minimax Regret Principle
 The Laplace Principle

This rule is based on the philosophy that if

probabilities cannot be assigned to the states of
nature, then the states should be considered
equally probable. It is assumed that all possible
outcomes are equally likely, and there is no basis
for one state of nature to be more likely than any
other.
 Maximin and Minimax Principles
The maximin rule involves the determination of the
minimum profit for each alternative and then selecting
the alternative which will give the maximum of these
minimum profits. If 𝑃𝑖𝑗 is the payoff for the ith
alternative 𝐴𝑖 and the jth state of nature 𝑆𝑗 , then the
maximin principle may be stated as:
𝑚𝑎𝑥 min 𝑃𝑖𝑗
select the alternative 𝐴𝑖 with the .
𝑖 𝑗
 Maximin and Minimax Principles
In case of losses or costs, apply the minimax
principle. The maximum loss or cost for each
alternative is determined, and from this set of
maximum values the minimum loss or cost is chosen.
The minimax principle involving loss or cost value is:
𝑚𝑖𝑛 max 𝑃𝑖𝑗
select the alternative 𝐴𝑖 with the .
𝑖 𝑗
Where 𝑃𝑖𝑗 is the payoff for the alternative 𝐴𝑖 and the
state 𝑆𝑗 .
 Maximax and Minimin Principles
If the matrix values are gains or profits for different
alternatives, apply the maximax rule, where the maximum
gain is determined for each alternative and then choosing
that alternative which gives the largest value of the
maximum profits. The maximax rule may be stated as:
𝑚𝑎𝑥 max 𝑃𝑖𝑗
select the alternative 𝐴𝑖 with the .
𝑖 𝑗
Where 𝑃𝑖𝑗 is the payoff for the alternative 𝐴𝑖 and the state
𝑆𝑗 .
 Maximax and Minimin Principles
In case the matrix values are losses or costs, the
minimin principle is applied. For each alternative in
the matrix, we determine the minimum loss or cost,
and from these minimum values, choose the
alternative with the least or minimum value. The
minimin principle involving loss or cost values is:
𝑚𝑖𝑛 min 𝑃𝑖𝑗
select the alternative 𝐴𝑖 with the .
𝑖 𝑗
 Hurwicz Principle

It allows the decision maker to select an index

of optimism, 𝛼, whose value ranges from 0 to 1. A
value of 𝛼 = 0 indicates zero optimism or extreme
pessimism, while 𝛼 = 1 will indicate extreme
optimism or zero pessimism.
The alternative with the maximum Hurwicz
value is selected.
 Hurwicz Principle
The Hurwicz principle involving gain values is:
select the alternative 𝐴𝑖 which maximizes Hurwicz
value
max 𝑃𝑖𝑗 min 𝑃𝑖𝑗
𝐻𝑖 = 𝛼 + 1−𝛼 .
𝑖 𝑖
For decision problems involving costs or losses, the
Hurwicz principle may be stated as:
min 𝑃𝑖𝑗 m𝑎𝑥 𝑃𝑖𝑗
𝐻𝑖 = 𝛼 + 1−𝛼 .
𝑖 𝑖
 Minimax Regret Principle

The decision maker wishes to minimize the

maximum regret about a particular decision. This
regret is the difference between the best payoff
which could have been achieved and the actual
payoff which the decision maker selected. The
alternative with the minimum regret value is the
desired alternative.
 Minimax Regret Principle
Procedure for developing the regret matrix for gain values:
1. For a particular state of nature 𝑆𝑗 , determine the largest
gain, which is denoted by 𝐺𝑗 . This gain is given a zero
regret value.
2. Subtract the other lesser gain values in 𝑆𝑗 from 𝐺𝑗 . The
differences are considered as units of regret values for the
different alternatives.
3. Complete the regret matrix for each state by repeating
steps 1 and 2.
 Minimax Regret Principle
Procedure for developing the regret matrix for loss or cost values:
1. For a particular state of nature 𝑆𝑗 , determine the least loss or
cost, which is denoted by 𝐶𝐿 . This loss or cost is assigned a
zero regret value.
2. Subtract 𝐶𝐿 from each of the other loss or cost values in 𝑆𝑗 . The
differences are units of regret values for the other alternatives.
3. Complete the regret matrix for each state by repeating steps 1
and 2.
Decisions Recognizing Risk and Decisions Admitting Uncertainty
1-1] A company is uncertain how many units of a new product can be sold each
year. To determine its sensitivity to varying annual sales volumes, cost estimates for
manufacturing the product were found to be as follows:
Direct materials P4.50 per unit
Direct labor P10.25 per unit
Overhead P25,000 + P3.10 per unit
In addition, new equipment costing P150,000 will be needed. It is expected that
it would be used for 10 years with a salvage value of P25,000 at the end of that
time. A market study indicates that the product will sell P25.00 per unit. If money is
worth 12% to the company before taxes, determine the rate of return for annual
sales volume of (a) 5,000 units, (b) 7,000 units and (c) 10,000 units. What is the
sales volume to just break even?
Decisions Recognizing Risk and Decisions Admitting Uncertainty
𝐴. 5,000 𝑢𝑛𝑖𝑡𝑠
𝑃25
𝐴𝑛𝑛𝑢𝑎𝑙 𝑖𝑛𝑐𝑜𝑚𝑒 = ∙ 5,000𝑢𝑛𝑖𝑡𝑠 = 𝑷𝟏𝟐𝟓, 𝟎𝟎𝟎
𝑢𝑛𝑖𝑡
𝑃150,000 − 𝑃25,000
𝐷𝑒𝑝𝑟𝑒𝑐𝑖𝑎𝑡𝑖𝑜𝑛 = 10
0.12 = 𝑃7,123.02
1 + 0.12 −1
𝑃4.50
𝑀𝑎𝑡𝑒𝑟𝑖𝑎𝑙𝑠 𝑐𝑜𝑠𝑡 = ∙ 5,000𝑢𝑛𝑖𝑡𝑠 = 𝑃22,500
𝑢𝑛𝑖𝑡
𝑃10.25
𝐿𝑎𝑏𝑜𝑟 𝑐𝑜𝑠𝑡 = ∙ 5,000𝑢𝑛𝑖𝑡𝑠 = 𝑃51,250
𝑢𝑛𝑖𝑡
𝑃3.10
𝑂𝑣𝑒𝑟ℎ𝑒𝑎𝑑 𝑐𝑜𝑠𝑡 = 𝑃25,000 + ∙ 5,000𝑢𝑛𝑖𝑡𝑠 = 𝑃40,500
𝑢𝑛𝑖𝑡
𝑇𝑜𝑡𝑎𝑙 𝑐𝑜𝑠𝑡 = 𝑃7,123.02 + 𝑃22,500 + 𝑃51,250 + 𝑃40,500 = 𝑷𝟏𝟐𝟏, 𝟑𝟕𝟑. 𝟎𝟐
𝐴𝑛𝑛𝑢𝑎𝑙 𝑛𝑒𝑡 𝑝𝑜𝑓𝑖𝑡 = 𝐼𝑛𝑐𝑜𝑚𝑒 − 𝐶𝑜𝑠𝑡 = 𝑃125,000 − 𝑃121,373.02 = 𝑷𝟑, 𝟔𝟐𝟔. 𝟗𝟖
𝐴𝑛𝑛𝑢𝑎𝑙 𝑛𝑒𝑡 𝑝𝑟𝑜𝑓𝑖𝑡 𝑃3,626.98
𝑅𝑎𝑡𝑒 𝑜𝑓 𝑅𝑒𝑡𝑢𝑟𝑛 = = ∙ 100% = 𝟐. 𝟒𝟐%
𝐶𝑎𝑝𝑖𝑡𝑎𝑙 𝑖𝑛𝑣𝑒𝑠𝑡𝑚𝑒𝑛𝑡 𝑃150,000
Decisions Recognizing Risk and Decisions Admitting Uncertainty
𝐵. 7,000 𝑢𝑛𝑖𝑡𝑠
𝑃25
𝐴𝑛𝑛𝑢𝑎𝑙 𝑖𝑛𝑐𝑜𝑚𝑒 = ∙ 7,000𝑢𝑛𝑖𝑡𝑠 = 𝑷𝟏𝟕𝟓, 𝟎𝟎𝟎
𝑢𝑛𝑖𝑡
𝑃150,000 − 𝑃25,000
𝐷𝑒𝑝𝑟𝑒𝑐𝑖𝑎𝑡𝑖𝑜𝑛 = 10
0.12 = 𝑃7,123.02
1 + 0.12 −1
𝑃4.50
𝑀𝑎𝑡𝑒𝑟𝑖𝑎𝑙𝑠 𝑐𝑜𝑠𝑡 = ∙ 7,000𝑢𝑛𝑖𝑡𝑠 = 𝑃31,500
𝑢𝑛𝑖𝑡
𝑃10.25
𝐿𝑎𝑏𝑜𝑟 𝑐𝑜𝑠𝑡 = ∙ 7,000𝑢𝑛𝑖𝑡𝑠 = 𝑃71,750
𝑢𝑛𝑖𝑡
𝑃3.10
𝑂𝑣𝑒𝑟ℎ𝑒𝑎𝑑 𝑐𝑜𝑠𝑡 = 𝑃25,000 + ∙ 7,000𝑢𝑛𝑖𝑡𝑠 = 𝑃46,700
𝑢𝑛𝑖𝑡
𝑇𝑜𝑡𝑎𝑙 𝑐𝑜𝑠𝑡 = 𝑃7,123.02 + 𝑃31,500 + 𝑃71,750 + 𝑃46,700 = 𝑷𝟏𝟓𝟕, 𝟎𝟕𝟑. 𝟎𝟐
𝐴𝑛𝑛𝑢𝑎𝑙 𝑛𝑒𝑡 𝑝𝑜𝑓𝑖𝑡 = 𝐼𝑛𝑐𝑜𝑚𝑒 − 𝐶𝑜𝑠𝑡 = 𝑃175,000 − 𝑃157,073.02 = 𝑷𝟏𝟕, 𝟗𝟐𝟔. 𝟗𝟖
𝐴𝑛𝑛𝑢𝑎𝑙 𝑛𝑒𝑡 𝑝𝑟𝑜𝑓𝑖𝑡 𝑃17,926.98
𝑅𝑎𝑡𝑒 𝑜𝑓 𝑅𝑒𝑡𝑢𝑟𝑛 = = ∙ 100% = 𝟏𝟏. 𝟗𝟓%
𝐶𝑎𝑝𝑖𝑡𝑎𝑙 𝑖𝑛𝑣𝑒𝑠𝑡𝑚𝑒𝑛𝑡 𝑃150,000
Decisions Recognizing Risk and Decisions Admitting Uncertainty
𝐶. 10,000 𝑢𝑛𝑖𝑡𝑠
𝑃25
𝐴𝑛𝑛𝑢𝑎𝑙 𝑖𝑛𝑐𝑜𝑚𝑒 = ∙ 10,000𝑢𝑛𝑖𝑡𝑠 = 𝑷𝟐𝟓𝟎, 𝟎𝟎𝟎
𝑢𝑛𝑖𝑡
𝑃150,000 − 𝑃25,000
𝐷𝑒𝑝𝑟𝑒𝑐𝑖𝑎𝑡𝑖𝑜𝑛 = 10
0.12 = 𝑃7,123.02
1 + 0.12 −1
𝑃4.50
𝑀𝑎𝑡𝑒𝑟𝑖𝑎𝑙𝑠 𝑐𝑜𝑠𝑡 = ∙ 10,000𝑢𝑛𝑖𝑡𝑠 = 𝑃45,000
𝑢𝑛𝑖𝑡
𝑃10.25
𝐿𝑎𝑏𝑜𝑟 𝑐𝑜𝑠𝑡 = ∙ 10,000𝑢𝑛𝑖𝑡𝑠 = 𝑃102,500
𝑢𝑛𝑖𝑡
𝑃3.10
𝑂𝑣𝑒𝑟ℎ𝑒𝑎𝑑 𝑐𝑜𝑠𝑡 = 𝑃25,000 + ∙ 10,000𝑢𝑛𝑖𝑡𝑠 = 𝑃56,000
𝑢𝑛𝑖𝑡
𝑇𝑜𝑡𝑎𝑙 𝑐𝑜𝑠𝑡 = 𝑃7,123.02 + 𝑃45,000 + 𝑃102,500 + 𝑃56,000 = 𝑷𝟐𝟏𝟎, 𝟔𝟐𝟑. 𝟎𝟐
𝐴𝑛𝑛𝑢𝑎𝑙 𝑛𝑒𝑡 𝑝𝑜𝑓𝑖𝑡 = 𝐼𝑛𝑐𝑜𝑚𝑒 − 𝐶𝑜𝑠𝑡 = 𝑃250,000 − 𝑃210,623.02 = 𝑷𝟑𝟗, 𝟑𝟕𝟔. 𝟗𝟖
𝐴𝑛𝑛𝑢𝑎𝑙 𝑛𝑒𝑡 𝑝𝑟𝑜𝑓𝑖𝑡 𝑃39,376.98
𝑅𝑎𝑡𝑒 𝑜𝑓 𝑅𝑒𝑡𝑢𝑟𝑛 = = ∙ 100% = 𝟐𝟔. 𝟐𝟓%
𝐶𝑎𝑝𝑖𝑡𝑎𝑙 𝑖𝑛𝑣𝑒𝑠𝑡𝑚𝑒𝑛𝑡 𝑃150,000
Decisions Recognizing Risk and Decisions Admitting Uncertainty
𝑃25
𝐴𝑛𝑛𝑢𝑎𝑙 𝑖𝑛𝑐𝑜𝑚𝑒 = ∙ 𝑋 𝑢𝑛𝑖𝑡𝑠 = 𝑷𝟐𝟓𝑿
𝑢𝑛𝑖𝑡
𝑃150,000 − 𝑃25,000
𝐷𝑒𝑝𝑟𝑒𝑐𝑖𝑎𝑡𝑖𝑜𝑛 = 10
0.12 = 𝑃7,123.02
1 + 0.12 −1
𝑃4.50
𝑀𝑎𝑡𝑒𝑟𝑖𝑎𝑙𝑠 𝑐𝑜𝑠𝑡 = ∙ 𝑋 𝑢𝑛𝑖𝑡𝑠 = 𝑃4.50𝑋
𝑢𝑛𝑖𝑡
𝑃10.25
𝐿𝑎𝑏𝑜𝑟 𝑐𝑜𝑠𝑡 = ∙ 𝑋 𝑢𝑛𝑖𝑡𝑠 = 𝑃10.25𝑋
𝑢𝑛𝑖𝑡
𝑃3.10
𝑂𝑣𝑒𝑟ℎ𝑒𝑎𝑑 𝑐𝑜𝑠𝑡 = 𝑃25,000 + ∙ 𝑋 𝑢𝑛𝑖𝑡𝑠 = 𝑃25,000 + 𝑃3.10𝑋
𝑢𝑛𝑖𝑡
𝑇𝑜𝑡𝑎𝑙 𝑐𝑜𝑠𝑡 = 𝑷𝟑𝟐, 𝟏𝟐𝟑. 𝟎𝟐 + 𝑷𝟏𝟕. 𝟖𝟓𝑿
𝐼𝑛𝑐𝑜𝑚𝑒 = 𝐶𝑜𝑠𝑡
𝑃25𝑋 = 𝑃32,123.02 + 𝑃17.85𝑋
32,123.02
𝑋= = 𝟒, 𝟒𝟗𝟐. 𝟕𝟑~𝟒, 𝟒𝟗𝟑 𝒖𝒏𝒊𝒕𝒔
25 − 17.85
Decisions Recognizing Risk and Decisions Admitting Uncertainty

1-2] Referring from the previous problem (Problem 1-1),

if there is uncertainty as to the selling price per unit,
determine the rate of return if the price per unit is (a)
P23.00, (b) P23.50, (c) P24.00 and (d) P24.50.
Decisions Recognizing Risk and Decisions Admitting Uncertainty
For 5,000 units

Unit Price P23.00 P23.50 P24.00 P24.50

𝑃23 𝑃23.50 𝑃24 𝑃24.50
∙ 5,000𝑢𝑛𝑖𝑡𝑠 ∙ 5,000𝑢𝑛𝑖𝑡𝑠 ∙ 5,000𝑢𝑛𝑖𝑡𝑠 ∙ 5,000𝑢𝑛𝑖𝑡𝑠
Annual Income 𝑢𝑛𝑖𝑡 𝑢𝑛𝑖𝑡 𝑢𝑛𝑖𝑡 𝑢𝑛𝑖𝑡
= 𝑃115,000 = 𝑃117,500 = 𝑃120,000 = 𝑃122,500

Annual Costs P121,373.02 P121,373.02 P121,373.02 P121,373.02

𝑃115,000 𝑃117,500 𝑃120,000 𝑃122,500
Annual Profit − 𝑃121,373.02 − 𝑃121,373.02 − 𝑃121,373.02 − 𝑃121,373.02
= −𝑃6,373.02 = −𝑃3,873.02 = −𝑃1,373.02 = 𝑃1,126.98
−𝑃6,373.02 −𝑃3,873.02 −𝑃1,373.02 𝑃1,126.98
∙ 100% ∙ 100% ∙ 100% ∙ 100%
Rate of Return 𝑃150,000 𝑃150,000 𝑃150,000 𝑃150,000
= −4.25% = −2.58% = −0.92% = 0.75%
Decisions Recognizing Risk and Decisions Admitting Uncertainty
For 7,000 units

Unit Price P23.00 P23.50 P24.00 P24.50

𝑃23 𝑃23.50 𝑃24 𝑃24.50
∙ 7,000𝑢𝑛𝑖𝑡𝑠 ∙ 7,000𝑢𝑛𝑖𝑡𝑠 ∙ 7,000𝑢𝑛𝑖𝑡𝑠 ∙ 7,000𝑢𝑛𝑖𝑡𝑠
Annual Income 𝑢𝑛𝑖𝑡 𝑢𝑛𝑖𝑡 𝑢𝑛𝑖𝑡 𝑢𝑛𝑖𝑡
= 𝑃161,000 = 𝑃164,500 = 𝑃168,000 = 𝑃171,500

Annual Costs P157,073.02 P157,073.02 P157,073.02 P157,073.02

𝑃161,000 𝑃164,500 𝑃168,000 𝑃171,500
Annual Profit − 𝑃157,073.02 − 𝑃157,073.02 − 𝑃157,073.02 − 𝑃157,073.02
= 𝑃3,926.98 = 𝑃7,426.98 = 𝑃10,926.98 = 𝑃14,426.98
𝑃3,926.98 𝑃7,426.98 𝑃10,926.98 𝑃14,426.98
∙ 100% ∙ 100% ∙ 100% ∙ 100%
Rate of Return 𝑃150,000 𝑃150,000 𝑃150,000 𝑃150,000
= 2.62% = 4.95% = 7.28% = 9.62%
Decisions Recognizing Risk and Decisions Admitting Uncertainty
For 10,000 units

Unit Price P23.00 P23.50 P24.00 P24.50

𝑃24.50
𝑃23 𝑃23.50 𝑃24
∙ 10,000𝑢𝑛𝑖𝑡𝑠 ∙ 10,000𝑢𝑛𝑖𝑡𝑠 ∙ 10,000𝑢𝑛𝑖𝑡𝑠 𝑢𝑛𝑖𝑡
Annual Income 𝑢𝑛𝑖𝑡 𝑢𝑛𝑖𝑡 𝑢𝑛𝑖𝑡 ∙ 10,000𝑢𝑛𝑖𝑡𝑠
= 𝑃230,000 = 𝑃235,000 = 𝑃240,000
= 𝑃245,000

Annual Costs P210,623.02 P210,623.02 P210,623.02 P210,623.02

𝑃230,000 𝑃235,000 𝑃240,000 𝑃245,000
Annual Profit − 𝑃210,623.02 − 𝑃210,623.02 − 𝑃210,623.02 − 𝑃210,623.02
= 𝑃19,376.98 = 𝑃24,376.98 = 𝑃29,376.98 = 𝑃34,376.98
𝑃19,376.98 𝑃24,376.98 𝑃29,376.98 𝑃34,376.98
∙ 100% ∙ 100% ∙ 100% ∙ 100%
Rate of Return 𝑃150,000 𝑃150,000 𝑃150,000 𝑃150,000
= 12.92% = 16.25% = 19.58% = 22.92%
Decisions Recognizing Risk and Decisions Admitting Uncertainty
For 5,000 units:
Manufacturing the new product is not worthwhile if only 5,000 units
can be sold annually at the given prices.

For 7,000 units:

For the production of 7,000 units sold at the given reduced prices,
the new product should not be manufactured since the rates of return
as calculated are all less than the required rate of 12%.

For 10,000 units:

For a production of 10,000 units annually, the company can afford to
reduce the selling price to P23.00 per unit.
Decisions Recognizing Risk and Decisions Admitting Uncertainty

1-3] Using the previous problem (Problem 1-1), if there

is uncertainty as to the economic life of the equipment,
determine the rate of return if the economic life is (a) 5
years, (b) 7 years and (c) 9 years.
Decisions Recognizing Risk and Decisions Admitting Uncertainty
𝐹𝑜𝑟 5 − 𝑦𝑒𝑎𝑟 𝑙𝑖𝑓𝑒:
𝑃150,000−𝑃25,000
𝐷𝑒𝑝𝑟𝑒𝑐𝑖𝑎𝑡𝑖𝑜𝑛 = 0.12 = 𝑃19,676.22
1+0.12 5 −1

𝐷𝑒𝑐𝑟𝑒𝑎𝑠𝑒 𝑖𝑛 𝑎𝑛𝑛𝑢𝑎𝑙 𝑛𝑒𝑡 𝑝𝑟𝑜𝑓𝑖𝑡 = 𝑃19,676.22 − 𝑃7,123.02 = 𝑃12,553.20

𝑃12,553.20
𝐷𝑒𝑐𝑟𝑒𝑎𝑠𝑒 𝑖𝑛 𝑟𝑎𝑡𝑒 𝑜𝑓 𝑟𝑒𝑡𝑢𝑟𝑛 = ∙ 100% = 𝟖. 𝟑𝟕%
𝑃150,000

𝐹𝑜𝑟 7 − 𝑦𝑒𝑎𝑟 𝑙𝑖𝑓𝑒:

𝑃150,000−𝑃25,000
𝐷𝑒𝑝𝑟𝑒𝑐𝑖𝑎𝑡𝑖𝑜𝑛 = 0.12 = 𝑃12,389.72
1+0.12 7 −1

𝐷𝑒𝑐𝑟𝑒𝑎𝑠𝑒 𝑖𝑛 𝑎𝑛𝑛𝑢𝑎𝑙 𝑛𝑒𝑡 𝑝𝑟𝑜𝑓𝑖𝑡 = 𝑃12,389.72 − 𝑃7,123.02 = 𝑃5,266.70

𝑃5,266.70
𝐷𝑒𝑐𝑟𝑒𝑎𝑠𝑒 𝑖𝑛 𝑟𝑎𝑡𝑒 𝑜𝑓 𝑟𝑒𝑡𝑢𝑟𝑛 = ∙ 100% = 𝟑. 𝟓𝟏%
𝑃150,000
Decisions Recognizing Risk and Decisions Admitting Uncertainty
𝐹𝑜𝑟 9 − 𝑦𝑒𝑎𝑟 𝑙𝑖𝑓𝑒:
𝑃150,000−𝑃25,000
𝐷𝑒𝑝𝑟𝑒𝑐𝑖𝑎𝑡𝑖𝑜𝑛 = 0.12 = 𝑃8,459.86
1+0.12 9 −1
𝐷𝑒𝑐𝑟𝑒𝑎𝑠𝑒 𝑖𝑛 𝑎𝑛𝑛𝑢𝑎𝑙 𝑛𝑒𝑡 𝑝𝑟𝑜𝑓𝑖𝑡 = 𝑃8,459.86 − 𝑃7,123.02 = 𝑃1,336.84
𝑃1,336.84
𝐷𝑒𝑐𝑟𝑒𝑎𝑠𝑒 𝑖𝑛 𝑟𝑎𝑡𝑒 𝑜𝑓 𝑟𝑒𝑡𝑢𝑟𝑛 = ∙ 100% = 𝟎. 𝟖𝟗%
𝑃150,000
The rates of return for different economic lives:
Annual Sales (units)
Life (years)
5,000 7,000 10,000
5 -5.95% 3.58% 17.88%
7 -1.09% 8.44% 22.74%
9 1.53% 11.06% 25.36%
10 2.42% 11.95% 26.25%
Decisions Recognizing Risk and Decisions Admitting Uncertainty

2-1] To control excessive seepage in a mining tunnel, the

company has to install several pumps. Pump A costs P32,000
and pump B costs P21,000. It is estimated , however, that the
annual operation cost for pump A would be P2,500 less than
that for pump B. These pumps are expected to have no
salvage value when they are replaced. There is considerable
uncertainty as to the length of time the pumps will be needed.
Prepare a sensitivity analysis to determine which pump will be
more economical if the economic life is (a) 4 years, (b) 6 years
and (c) 8 years. Capital invested by the company should earn
at least 15% rate of return.
Decisions Recognizing Risk and Decisions Admitting Uncertainty
𝐹𝑜𝑟 4 − 𝑦𝑒𝑎𝑟 𝑙𝑖𝑓𝑒:
𝐴𝑛𝑛𝑢𝑎𝑙 𝑠𝑎𝑣𝑖𝑛𝑔𝑠 𝑜𝑛 𝑜𝑝𝑒𝑟𝑎𝑡𝑖𝑜𝑛𝑠 = 𝑃2,500
𝑃11,000
𝐴𝑑𝑑𝑖𝑡𝑖𝑜𝑛𝑎𝑙 𝑑𝑒𝑝𝑟𝑒𝑐𝑖𝑎𝑡𝑖𝑜𝑛 𝑜𝑛 𝑝𝑢𝑚𝑝 𝐴 = 0.15 = 𝑃2,202.92
1+0.15 4 −1
𝑃2,500−𝑃2,202.92
𝑅𝑎𝑡𝑒 𝑜𝑓 𝑟𝑒𝑡𝑢𝑟𝑛 𝑜𝑛 𝑎𝑑𝑑 ′ 𝑙 𝑖𝑛𝑣𝑒𝑠𝑡𝑚𝑒𝑛𝑡 = ∙ 100% = 𝟐. 𝟕𝟎%
𝑃32,000−𝑃21,000
𝐹𝑜𝑟 6 − 𝑦𝑒𝑎𝑟 𝑙𝑖𝑓𝑒:
𝐴𝑛𝑛𝑢𝑎𝑙 𝑠𝑎𝑣𝑖𝑛𝑔𝑠 𝑜𝑛 𝑜𝑝𝑒𝑟𝑎𝑡𝑖𝑜𝑛𝑠 = 𝑃2,500
𝑃11,000
𝐴𝑑𝑑𝑖𝑡𝑖𝑜𝑛𝑎𝑙 𝑑𝑒𝑝𝑟𝑒𝑐𝑖𝑎𝑡𝑖𝑜𝑛 𝑜𝑛 𝑝𝑢𝑚𝑝 𝐴 = 0.15 = 𝑃1,256.61
1+0.15 6 −1
𝑃2,500−𝑃1,256.61
𝑅𝑎𝑡𝑒 𝑜𝑓 𝑟𝑒𝑡𝑢𝑟𝑛 𝑜𝑛 𝑎𝑑𝑑 ′ 𝑙 𝑖𝑛𝑣𝑒𝑠𝑡𝑚𝑒𝑛𝑡 = ∙ 100% = 𝟏𝟏. 𝟑𝟎%
𝑃32,000−𝑃21,000
𝐹𝑜𝑟 8 − 𝑦𝑒𝑎𝑟 𝑙𝑖𝑓𝑒:
𝐴𝑛𝑛𝑢𝑎𝑙 𝑠𝑎𝑣𝑖𝑛𝑔𝑠 𝑜𝑛 𝑜𝑝𝑒𝑟𝑎𝑡𝑖𝑜𝑛𝑠 = 𝑃2,500
𝑃11,000
𝐴𝑑𝑑𝑖𝑡𝑖𝑜𝑛𝑎𝑙 𝑑𝑒𝑝𝑟𝑒𝑐𝑖𝑎𝑡𝑖𝑜𝑛 𝑜𝑛 𝑝𝑢𝑚𝑝 𝐴 = 0.15 = 𝑃801.35
1+0.15 8 −1
𝑃2,500−𝑃801.35
𝑅𝑎𝑡𝑒 𝑜𝑓 𝑟𝑒𝑡𝑢𝑟𝑛 𝑜𝑛 𝑎𝑑𝑑 ′ 𝑙 𝑖𝑛𝑣𝑒𝑠𝑡𝑚𝑒𝑛𝑡 = ∙ 100% = 𝟏𝟓. 𝟒𝟒%
𝑃32,000−𝑃21,000
𝑼𝒔𝒆 𝒑𝒖𝒎𝒑 𝑨 𝒇𝒐𝒓 𝟖 𝒚𝒆𝒂𝒓𝒔 𝒐𝒓 𝒎𝒐𝒓𝒆, 𝒇𝒐𝒓 𝒔𝒉𝒐𝒓𝒕𝒆𝒓 𝒍𝒊𝒗𝒆𝒔 𝒖𝒔𝒆 𝒑𝒖𝒎𝒑 𝑩.
Decisions Recognizing Risk and Decisions Admitting Uncertainty

2-2] if money is worth 12% to the mining company

in the previous problem (Problem 2-1), determine
the life for which each pump would be more
economical.
Decisions Recognizing Risk and Decisions Admitting Uncertainty
𝐹𝑜𝑟 4 − 𝑦𝑒𝑎𝑟 𝑙𝑖𝑓𝑒:
𝐴𝑛𝑛𝑢𝑎𝑙 𝑠𝑎𝑣𝑖𝑛𝑔𝑠 𝑜𝑛 𝑜𝑝𝑒𝑟𝑎𝑡𝑖𝑜𝑛𝑠 = 𝑃2,500
𝑃11,000
𝐴𝑑𝑑𝑖𝑡𝑖𝑜𝑛𝑎𝑙 𝑑𝑒𝑝𝑟𝑒𝑐𝑖𝑎𝑡𝑖𝑜𝑛 𝑜𝑛 𝑝𝑢𝑚𝑝 𝐴 = 0.12 = 𝑃2,301.58
1+0.12 4 −1
𝑃2,500−𝑃2,301.58
𝑅𝑎𝑡𝑒 𝑜𝑓 𝑟𝑒𝑡𝑢𝑟𝑛 𝑜𝑛 𝑎𝑑𝑑 ′ 𝑙 𝑖𝑛𝑣𝑒𝑠𝑡𝑚𝑒𝑛𝑡 = ∙ 100% = 𝟏. 𝟖𝟎%
𝑃32,000−𝑃21,000
𝐹𝑜𝑟 6 − 𝑦𝑒𝑎𝑟 𝑙𝑖𝑓𝑒:
𝐴𝑛𝑛𝑢𝑎𝑙 𝑠𝑎𝑣𝑖𝑛𝑔𝑠 𝑜𝑛 𝑜𝑝𝑒𝑟𝑎𝑡𝑖𝑜𝑛𝑠 = 𝑃2,500
𝑃11,000
𝐴𝑑𝑑𝑖𝑡𝑖𝑜𝑛𝑎𝑙 𝑑𝑒𝑝𝑟𝑒𝑐𝑖𝑎𝑡𝑖𝑜𝑛 𝑜𝑛 𝑝𝑢𝑚𝑝 𝐴 = 0.15 = 𝑃1,355.48
1+0.15 6 −1
𝑃2,500−𝑃1,355.48
𝑅𝑎𝑡𝑒 𝑜𝑓 𝑟𝑒𝑡𝑢𝑟𝑛 𝑜𝑛 𝑎𝑑𝑑 ′ 𝑙 𝑖𝑛𝑣𝑒𝑠𝑡𝑚𝑒𝑛𝑡 = ∙ 100% = 𝟏𝟎. 𝟒𝟎%
𝑃32,000−𝑃21,000
𝐹𝑜𝑟 8 − 𝑦𝑒𝑎𝑟 𝑙𝑖𝑓𝑒:
𝐴𝑛𝑛𝑢𝑎𝑙 𝑠𝑎𝑣𝑖𝑛𝑔𝑠 𝑜𝑛 𝑜𝑝𝑒𝑟𝑎𝑡𝑖𝑜𝑛𝑠 = 𝑃2,500
𝑃11,000
𝐴𝑑𝑑𝑖𝑡𝑖𝑜𝑛𝑎𝑙 𝑑𝑒𝑝𝑟𝑒𝑐𝑖𝑎𝑡𝑖𝑜𝑛 𝑜𝑛 𝑝𝑢𝑚𝑝 𝐴 = 0.15 = 𝑃894.33
1+0.15 8 −1
𝑃2,500−𝑃894.33
𝑅𝑎𝑡𝑒 𝑜𝑓 𝑟𝑒𝑡𝑢𝑟𝑛 𝑜𝑛 𝑎𝑑𝑑 ′ 𝑙 𝑖𝑛𝑣𝑒𝑠𝑡𝑚𝑒𝑛𝑡 = ∙ 100% = 𝟏𝟒. 𝟔𝟎%
𝑃32,000−𝑃21,000
𝑼𝒑 𝒕𝒐 𝒂 𝒍𝒊𝒇𝒆 𝒐𝒇 𝟔 𝒚𝒆𝒂𝒓𝒔, 𝒑𝒖𝒎𝒑 𝑩 𝒘𝒐𝒖𝒍𝒅 𝒃𝒆 𝒎𝒐𝒓𝒆 𝒆𝒄𝒐𝒏𝒐𝒎𝒊𝒄𝒂𝒍. 𝑭𝒐𝒓 𝟖 𝒚𝒆𝒂𝒓𝒔 𝒐𝒓 𝒎𝒐𝒓𝒆, 𝒄𝒉𝒐𝒐𝒔𝒆 𝒑𝒖𝒎𝒑 𝑨.
Decisions Recognizing Risk and Decisions Admitting Uncertainty

3] The decision matrix shown consists of cost elements.

Determine the alternative to be chosen using the following
principles of choice: Laplace, minimax, minimin and Hurwicz
with 𝛼 = 0.3.
States of Nature
Alternatives
𝑆1 𝑆2 𝑆3 𝑆4
𝐴1 P40 P50 P20 P15
𝐴2 P35 P45 P30 P20
𝐴3 P20 P60 P50 P10
𝐴4 P50 P20 P40 P30
Decisions Recognizing Risk and Decisions Admitting Uncertainty
𝐿𝑎𝑝𝑙𝑎𝑐𝑒 𝑃𝑟𝑖𝑛𝑐𝑖𝑝𝑙𝑒: 𝐷𝑒𝑡𝑒𝑟𝑚𝑖𝑛𝑒 𝑡ℎ𝑒 𝑎𝑣𝑒𝑟𝑎𝑔𝑒 𝑝𝑎𝑦𝑜𝑓𝑓 𝑓𝑜𝑟 𝑒𝑎𝑐ℎ 𝑎𝑙𝑡𝑒𝑟𝑛𝑎𝑡𝑖𝑣𝑒 𝑎𝑛𝑑 𝑐ℎ𝑜𝑜𝑠𝑒 𝑡ℎ𝑒 𝑚𝑖𝑛𝑖𝑚𝑢𝑚 𝑝𝑎𝑦𝑜𝑓𝑓.
𝑷𝟒𝟎+𝑷𝟓𝟎+𝑷𝟐𝟎+𝑷𝟏𝟓 𝑃35+𝑃45+𝑃30+𝑃20
𝑨𝟏 = = 𝑷𝟑𝟏. 𝟐𝟓 𝐴2 = = 𝑃32.50
𝟒 4
𝑃20+𝑃60+𝑃50+𝑃10 𝑃50+𝑃20+𝑃40+𝑃30
𝐴3 = = 𝑃35.00 𝐴4 = = 𝑃35.00
4 4
𝑪𝒉𝒐𝒐𝒔𝒆 𝒂𝒍𝒕𝒆𝒓𝒏𝒂𝒕𝒊𝒗𝒆 𝑨𝟏 𝒘𝒊𝒕𝒉 𝒂𝒗𝒆𝒓𝒂𝒈𝒆 𝒄𝒐𝒔𝒕 𝒐𝒇 𝑷𝟑𝟏. 𝟐𝟓.
𝑀𝑖𝑛𝑖𝑚𝑎𝑥 𝑃𝑟𝑖𝑛𝑐𝑖𝑝𝑙𝑒: 𝑆𝑒𝑙𝑒𝑐𝑡 𝑡ℎ𝑒 𝑚𝑎𝑥𝑖𝑚𝑢𝑚 𝑐𝑜𝑠𝑡 𝑓𝑜𝑟 𝑒𝑎𝑐ℎ 𝑎𝑙𝑡𝑒𝑟𝑛𝑎𝑡𝑖𝑣𝑒 𝑎𝑛𝑑 𝑐ℎ𝑜𝑜𝑠𝑒 𝑡ℎ𝑒 𝑚𝑖𝑛𝑖𝑚𝑢𝑚 𝑣𝑎𝑙𝑢𝑒.
𝐴1 = 𝑃50 𝑨𝟐 = 𝑷𝟒𝟓 𝐴3 = 𝑃60 𝐴4 = 𝑃50
𝑺𝒆𝒍𝒆𝒄𝒕 𝒂𝒍𝒕𝒆𝒓𝒏𝒂𝒕𝒊𝒗𝒆 𝑨𝟐 𝒘𝒊𝒕𝒉 𝒎𝒊𝒏𝒊𝒎𝒂𝒙 𝒗𝒂𝒍𝒖𝒆 𝒐𝒇 𝑷𝟒𝟓.
𝑀𝑖𝑛𝑖𝑚𝑖𝑛 𝑃𝑟𝑖𝑛𝑐𝑖𝑝𝑙𝑒: 𝐷𝑒𝑡𝑒𝑟𝑚𝑖𝑛𝑒 𝑡ℎ𝑒 𝑚𝑖𝑛𝑖𝑚𝑢𝑚 𝑐𝑜𝑠𝑡 𝑓𝑜𝑟 𝑒𝑎𝑐ℎ 𝑎𝑙𝑡𝑒𝑟𝑛𝑎𝑡𝑖𝑣𝑒 𝑎𝑛𝑑 𝑠𝑒𝑙𝑒𝑐𝑡 𝑡ℎ𝑒 𝑚𝑖𝑛𝑖𝑚𝑢𝑚 𝑐𝑜𝑠𝑡.
𝐴1 = 𝑃15 𝐴2 = 𝑃20 𝑨𝟑 = 𝑷𝟏𝟎 𝐴4 = 𝑃20
𝑪𝒉𝒐𝒐𝒔𝒆 𝒂𝒍𝒕𝒆𝒓𝒏𝒂𝒕𝒊𝒗𝒆 𝑨𝟑 𝒘𝒊𝒕𝒉 𝒎𝒊𝒏𝒊𝒎𝒊𝒏 𝒗𝒂𝒍𝒖𝒆 𝒐𝒇 𝑷𝟏𝟎.
𝐻𝑢𝑟𝑤𝑖𝑐𝑧 𝑃𝑟𝑖𝑛𝑐𝑖𝑝𝑙𝑒: 𝑆𝑜𝑙𝑣𝑒 𝑡ℎ𝑒 𝐻𝑢𝑟𝑤𝑖𝑐𝑧 𝑣𝑎𝑙𝑢𝑒 𝑎𝑛𝑑 𝑐ℎ𝑜𝑜𝑠𝑒 𝑡ℎ𝑒 𝑚𝑖𝑛𝑖𝑚𝑢𝑚.
𝐻1 = 0.3 𝑃15 + 1 − 0.3 𝑃50 = 𝑃39.50 𝑯𝟐 = 𝟎. 𝟑 𝑷𝟐𝟎 + 𝟏 − 𝟎. 𝟑 𝑷𝟒𝟓 = 𝑷𝟑𝟕. 𝟓𝟎
𝐻3 = 0.3 𝑃10 + 1 − 0.3 𝑃60 = 𝑃45.00 𝐻4 = 0.3 𝑃20 + 1 − 0.3 𝑃50 = 𝑃41.00
𝑺𝒆𝒍𝒆𝒄𝒕 𝒂𝒍𝒕𝒆𝒓𝒏𝒂𝒕𝒊𝒗𝒆 𝑨𝟐 𝒘𝒊𝒕𝒉 𝑯𝒖𝒓𝒘𝒊𝒄𝒛 𝒗𝒂𝒍𝒖𝒆 𝒐𝒇 𝑷𝟑𝟕. 𝟓𝟎.
Decisions Recognizing Risk and Decisions Admitting Uncertainty

4] The decision matrix shown indicates the profit expected from

four alternatives under four states of nature. Select the preferred
alternative by applying each of the following criteria: Laplace,
maximin, maximax, minimax regret and Hurwicz with 𝛼 = 0.6.
States of Nature
Alternatives
𝑆1 𝑆2 𝑆3 𝑆4
𝐴1 P21 P17 P25 P30
𝐴2 P18 P16 P12 P28
𝐴3 P13 P32 P15 P22
𝐴4 P40 P36 P27 P35
Decisions Recognizing Risk and Decisions Admitting Uncertainty
𝐿𝑎𝑝𝑙𝑎𝑐𝑒 𝑃𝑟𝑖𝑛𝑐𝑖𝑝𝑙𝑒: 𝐷𝑒𝑡𝑒𝑟𝑚𝑖𝑛𝑒 𝑡ℎ𝑒 𝑎𝑣𝑒𝑟𝑎𝑔𝑒 𝑝𝑎𝑦𝑜𝑓𝑓 𝑓𝑜𝑟 𝑒𝑎𝑐ℎ 𝑎𝑙𝑡𝑒𝑟𝑛𝑎𝑡𝑖𝑣𝑒 𝑎𝑛𝑑 𝑐ℎ𝑜𝑜𝑠𝑒 𝑡ℎ𝑒 𝑚𝑎𝑥𝑖𝑚𝑢𝑚 𝑝𝑎𝑦𝑜𝑓𝑓.
𝑃21+𝑃17+𝑃25+𝑃30 𝑃18+𝑃16+𝑃12+𝑃28
𝐴1 = = 𝑃23.25 𝐴2 = = 𝑃18.50
4 4
𝑃13+𝑃32+𝑃15+𝑃22 𝑷𝟒𝟎+𝑷𝟑𝟔+𝑷𝟐𝟕+𝑷𝟑𝟓
𝐴3 = = 𝑃20.50 𝑨𝟒 = = 𝑷𝟑𝟒. 𝟓𝟎
4 𝟒
𝑪𝒉𝒐𝒐𝒔𝒆 𝒂𝒍𝒕𝒆𝒓𝒏𝒂𝒕𝒊𝒗𝒆 𝑨𝟒 𝒘𝒊𝒕𝒉 𝑳𝒂𝒑𝒍𝒂𝒄𝒆 𝒗𝒂𝒍𝒖𝒆 𝒐𝒇 𝑷𝟑𝟒. 𝟓𝟎.
𝑀𝑎𝑥𝑖𝑚𝑖𝑛 𝑃𝑟𝑖𝑛𝑐𝑖𝑝𝑙𝑒: 𝑆𝑒𝑙𝑒𝑐𝑡 𝑡ℎ𝑒 𝑚𝑖𝑛𝑖𝑚𝑢𝑚 𝑝𝑟𝑜𝑓𝑖𝑡 𝑓𝑜𝑟 𝑒𝑎𝑐ℎ 𝑎𝑙𝑡𝑒𝑟𝑛𝑎𝑡𝑖𝑣𝑒 𝑎𝑛𝑑 𝑐ℎ𝑜𝑜𝑠𝑒 𝑡ℎ𝑒 𝑚𝑎𝑥𝑖𝑚𝑢𝑚 𝑣𝑎𝑙𝑢𝑒.
𝐴1 = 𝑃17 𝐴2 = 𝑃12 𝐴3 = 𝑃13 𝑨𝟒 = 𝑷𝟐𝟕
𝑺𝒆𝒍𝒆𝒄𝒕 𝒂𝒍𝒕𝒆𝒓𝒏𝒂𝒕𝒊𝒗𝒆 𝑨𝟒 𝒘𝒊𝒕𝒉 𝒎𝒂𝒙𝒊𝒎𝒊𝒏 𝒗𝒂𝒍𝒖𝒆 𝒐𝒇 𝑷𝟐𝟕.
𝑀𝑎𝑥𝑖𝑚𝑎𝑥 𝑃𝑟𝑖𝑛𝑐𝑖𝑝𝑙𝑒: 𝐷𝑒𝑡𝑒𝑟𝑚𝑖𝑛𝑒 𝑡ℎ𝑒 𝑚𝑎𝑥𝑖𝑚𝑢𝑚 𝑝𝑟𝑜𝑓𝑖𝑡 𝑓𝑜𝑟 𝑒𝑎𝑐ℎ 𝑎𝑙𝑡𝑒𝑟𝑛𝑎𝑡𝑖𝑣𝑒 𝑎𝑛𝑑 𝑠𝑒𝑙𝑒𝑐𝑡 𝑡ℎ𝑒 𝑚𝑎𝑥𝑖𝑚𝑢𝑚 𝑝𝑟𝑜𝑓𝑖𝑡.
𝐴1 = 𝑃30 𝐴2 = 𝑃28 𝐴3 = 𝑃32 𝑨𝟒 = 𝑷𝟒𝟎
𝑪𝒉𝒐𝒐𝒔𝒆 𝒂𝒍𝒕𝒆𝒓𝒏𝒂𝒕𝒊𝒗𝒆 𝑨𝟒 𝒘𝒊𝒕𝒉 𝒎𝒂𝒙𝒊𝒎𝒂𝒙 𝒗𝒂𝒍𝒖𝒆 𝒐𝒇 𝑷𝟒𝟎.
𝐻𝑢𝑟𝑤𝑖𝑐𝑧 𝑃𝑟𝑖𝑛𝑐𝑖𝑝𝑙𝑒: 𝑆𝑜𝑙𝑣𝑒 𝑡ℎ𝑒 𝐻𝑢𝑟𝑤𝑖𝑐𝑧 𝑣𝑎𝑙𝑢𝑒 𝑎𝑛𝑑 𝑐ℎ𝑜𝑜𝑠𝑒 𝑡ℎ𝑒 𝑚𝑎𝑥𝑖𝑚𝑢𝑚.
𝐻1 = 0.6 𝑃30 + 1 − 0.6 𝑃17 = 𝑃24.80 𝐻2 = 0.6 𝑃28 + 1 − 0.6 𝑃12 = 𝑃21.60
𝐻3 = 0.6 𝑃32 + 1 − 0.6 𝑃13 = 𝑃24.40 𝑯𝟒 = 𝟎. 𝟔 𝑷𝟒𝟎 + 𝟏 − 𝟎. 𝟔 𝑷𝟐𝟕 = 𝑷𝟑𝟒. 𝟖𝟎
𝑺𝒆𝒍𝒆𝒄𝒕 𝒂𝒍𝒕𝒆𝒓𝒏𝒂𝒕𝒊𝒗𝒆 𝑨𝟒 𝒘𝒊𝒕𝒉 𝑯𝒖𝒓𝒘𝒊𝒄𝒛 𝒗𝒂𝒍𝒖𝒆 𝒐𝒇 𝑷𝟑𝟒. 𝟖𝟎.
Decisions Recognizing Risk and Decisions Admitting Uncertainty
𝑀𝑖𝑛𝑖𝑚𝑎𝑥 𝑅𝑒𝑔𝑟𝑒𝑡 𝑃𝑟𝑖𝑛𝑐𝑖𝑝𝑙𝑒: 𝐷𝑒𝑣𝑒𝑙𝑜𝑝 𝑡ℎ𝑒 𝑟𝑒𝑔𝑟𝑒𝑡 𝑚𝑎𝑡𝑟𝑖𝑥 𝑏𝑦 𝑠𝑢𝑏𝑡𝑟𝑎𝑐𝑡𝑖𝑛𝑔 𝑒𝑎𝑐ℎ 𝑒𝑙𝑒𝑚𝑒𝑛𝑡 𝑢𝑛𝑑𝑒𝑟 𝑎 𝑠𝑡𝑎𝑡𝑒 𝑜𝑓
𝑛𝑎𝑡𝑢𝑟𝑒 𝑓𝑟𝑜𝑚 𝑡ℎ𝑒 𝑔𝑟𝑒𝑎𝑡𝑒𝑠𝑡 𝑒𝑙𝑒𝑚𝑒𝑛𝑡 𝑖𝑛 𝑡ℎ𝑎𝑡 𝑠𝑡𝑎𝑡𝑒. 𝑁𝑒𝑥𝑡 𝑤𝑟𝑖𝑡𝑒 𝑡ℎ𝑒 𝑝𝑎𝑦𝑜𝑓𝑓 𝑚𝑎𝑡𝑟𝑖𝑥 𝑤ℎ𝑒𝑟𝑒 𝑡ℎ𝑒 𝑒𝑙𝑒𝑚𝑒𝑛𝑡
𝑐𝑜𝑟𝑟𝑒𝑠𝑝𝑜𝑛𝑑𝑖𝑛𝑔 𝑡𝑜 𝑒𝑎𝑐ℎ 𝑎𝑙𝑡𝑒𝑟𝑛𝑎𝑡𝑖𝑣𝑒 𝑖𝑠 𝑡ℎ𝑒 𝑙𝑎𝑟𝑔𝑒𝑠𝑡 𝑒𝑙𝑒𝑚𝑒𝑛𝑡 𝑓𝑜𝑟 𝑒𝑎𝑐ℎ 𝑎𝑙𝑡𝑒𝑟𝑛𝑎𝑡𝑖𝑣𝑒 𝑖𝑛𝑡ℎ𝑒 𝑟𝑒𝑔𝑟𝑒𝑡 𝑚𝑎𝑡𝑟𝑖𝑥.
𝑇ℎ𝑒𝑛 𝑐ℎ𝑜𝑜𝑠𝑒 𝑡ℎ𝑒 𝑚𝑖𝑛𝑖𝑚𝑢𝑚 𝑣𝑎𝑙𝑢𝑒 𝑓𝑟𝑜𝑚 𝑡ℎ𝑒 𝑝𝑎𝑦𝑜𝑓𝑓 𝑚𝑎𝑡𝑟𝑖𝑥.

Regret Matrix Payoff Matrix

States of Nature 𝑀𝑎𝑥 𝑃𝑖𝑗
Alternatives Alternatives
𝑆1 𝑆2 𝑆3 𝑆4 𝑗
𝐴1 19 19 2 5 𝐴1 19
𝐴2 22 20 15 7 𝐴2 22
𝐴3 27 4 12 13 𝐴3 27
𝐴4 0 0 0 0 𝐴4 0
𝑪𝒉𝒐𝒐𝒔𝒆 𝒂𝒍𝒕𝒆𝒓𝒏𝒂𝒕𝒊𝒗𝒆 𝑨𝟒 𝒘𝒊𝒕𝒉 𝒎𝒊𝒏𝒊𝒎𝒂𝒙 𝒓𝒆𝒈𝒓𝒆𝒕 𝒗𝒂𝒍𝒖𝒆 𝒐𝒇 𝟎.
 References
Blank, L. & Tarquin, A. (2018). Engineering Economy (8th Ed.).
McGraw-Hill Education.
Sullivan, W., Wicks, E. & Koelling, C. P. (2014). Engineering
Economy (16th Ed.). Pearson Education South Asia Pte
Ltd.
Sta. Maria, H. (2000). Engineering Economy (3rd Ed.). National
Book Store.
Arreola, M. (1993). Engineering Economy (3rd Ed.). Ken
Incorporated.