Decision Analysis

 Decisions can be used to determine optimal strategies when a

decision maker is faced with several decision alternatives and an
uncertain or risk-filled pattern of future events.
 Example:
 Selecting best production volume decision from among several alternatives
in a seasonal goods.
 Selecting the best criteria for a service to be rendered for specific and
confined market.
Structuring the Decision Problem
 Payoff Tables
 Decision Tree
Example:
PDC has purchased land for a luxury, riverfront condominium complex. The site
provides a spectacular view of downtown and some of the most astonishing
side of the river. The individual units will be priced from 300,000 to 1,200,000,
depending on the floor of the unit is located on. The company had preliminary
architectural drawings developed for three different project sizes such as, 6
floors with 30 units, 12 floors with 60 units and 18 floors with 90 units.
Using the best information available, management has estimated the
payoffs, or profits for the PDC condominium project. Given that small, medium
and large complex will have a pay of 8, 14 and 20 in millions respectively in
high acceptance, moreover, 7, 5 and -20 for low acceptance of customer.
 Payoff Table
High acceptance Low Acceptance
Small Complex 8 7
Medium Complex 14 5
Large Complex 20 -9

Payoff – this refers to the outcome that results from a

specific decision alternative and the occurrence of a
particular state of nature.
Decision Tree – provides a graphical representation of the
decision making process.

 High
 Small

 Low

 High

 Medium
1
 Low

 High

 Large Low

 Node refers to an intersection or junction point of the decision tree.

 Branch is the connector between nodes.
Decision theory problems are
categorized by the following:
 A decision criterion
 A list of alternatives
 A list of possible future events (states of nature)
 Payoffs associated with each combination of
alternatives and events
 The degree of certainty of possible future events
Benefits of Decision Trees

 They enable to obtain a visual portrayal of sequential decisions, i.e.

they picture a series of chronological decisions. Decision tree are
universal, they make more accurate the structure of the decision
process and facilitate a communication among solvers of the
decision problem. Decision tree force the decision maker to
appreciate all consequences of his decisions. Construction and
analysis of decision trees by means of computers makes possible to
experiment with decision trees and quickly to establish the impact
of changes in the input parameters of the tree on the choice of the
best policy.
Limitations of decision trees:

 Only one decision criterion can be considered.

 The decision tree is an abstraction and simplification of
the real problem. Only the important decisions and
events are included.
 Managers cannot use decision trees if the chance event
outcomes are continuous. Instead, they must redefine
the outcomes so that there is a finite set of possibilities.
Decision Making without probabilities

 Optimistic Approach evaluates each decision alternative in terms of

the best payoff than can occur. The decision alternative that is
recommended is the one that provides the best possible payoff.
 Conservative Approach evaluates each decision alternative in
terms of the worst payoff that can occur. The decision alternative
recommended is the one that provides that best of the worst
possible payoffs.
 Minimax Regret Approach is an approach to decision making that is
neither purely optimistic nor purely conservative.
Decision Making without probabilities

 Expected Value Approach it is an approach to choosing a decision

alternative that is based upon the expected value of each decision
alternative. The recommended decision alternative is one that
provides the best expected value.
 Sensitivity Analysis – the study of how much changes in the
probability estimates for the states of nature affect the
recommended decision alternative.
 Expected Value of Perfect information – the expected value of
information that would tell the decision maker exactly which state
of nature is going to occur.
Developing a Decision Strategy

 A decision strategy is a rule that is to be followed by the decision maker.

 Decision support systems is the most systematic and comprehensive

software tools in decision making.
Steps In Decision Making

 Identify the problem

 Specify objectives and the decision criteria for choosing
a solution
 Develop alternatives
 Analyze and compare alternatives
 Select the best alternative
 Implement the chosen alternative
 Verify that desired results are achieved