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Decision Analysis
Parameter Estimates
Cost to build (/unit) $ 6,000
Revenue (/unit) $ 14,000
Demand (units) 250
Consequence Variables
Total Revenue $ 2,100,000
Total Cost $ 900,000
Performance Measure
Net Revenue $ 1,200,000
Decision Making Under Ignorance
– Payoff Table
Kelly Construction Payoff Table (Prob. 8-17)
State of Nature
Alternative Demand
Actions Low (50 units) Medium (100 units) High (150 units)
State of Nature
Maximin
Demand Criterion
Alternative
Actions
Low (50 units) Medium (100 units) High (150 units) Min
EVPI 180,000
Using Excel to Calculate EVPI:
Formulas View
Kelly Construction
A B C D E
1
2
3 Payoffs States of Nature Expected Return
4 Alternatives Low (50 units) Medium (100 units) High (150 units) ER
5 Build 50 400000 400000 400000 =SUMPRODUCT(B5:D5,B$8:D$8)
6 Build 100 100000 800000 800000 =SUMPRODUCT(B6:D6,B$8:D$8)
7 Build 150 -200000 500000 1200000 =SUMPRODUCT(B7:D7,B$8:D$8)
8 Probability 0.2 0.5 0.3
9 Best Decision =MAX(B5:B7) =MAX(C5:C7) =MAX(D5:D7)
10
11 EVwPI = =SUMPRODUCT(B9:D9,B8:D8)
12 EVBest = =MAX(E5:E7)
13 EVPI = =E11-E12
14
The Newsvendor Model
P0 = Prob{demand = 0} = 0.1
P1 = Prob{demand = 1} = 0.3
P2 = Prob{demand = 2} = 0.4
P3 = Prob{demand = 3} = 0.2
Criteria Decision
Maximin Cash Flow Order 1 paper
A gain Utility
in 1.0
0.910
utility 0.850
of 0.06 0.775
0.680
0.524
Go from $400 to
$500 results in
To illustrate, first suppose you have $100 and someone
gives you an additional $100. Note that your utility
increases by
Summary:
Utility is a way to incorporate risk aversion into the
expected return calculation.