Case Exercise

An engineer who works at compay of equipment

for the food processing industry has been asked to
consider the development of a new type of
processor.

 There are two alternative power sources could be

used for the processor, namely gas and electricity,
 There are technical reasons each power source would
require a fundamentally different design.
 Resource constraints mean that the company will only
be able to pursue one of the designs, and because the
processor would be more advanced than others which
have been developed it is by no means certain that
either design would be a success.
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 Estimation
 The engineer estimates that
there is a 75% chance that
the electricity-powered
design would be
successful.
1. If success will get
profit $10 M and
2. If fail then it loses $3M
 only a 60% chance that the
gas-powered design
would be a success.
1. If success will get
profit $15 M and
2. If fail then it loses $7M

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 Answer

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 Constructing a decision tree:
An initial tree...

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 Constructing a decision tree:

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 Case Exercice Cont..
 After considering this tree the engineer realizes that if either
design failed then the company would still consider
modifying the design, though this would involve more
investment and would still not guarantee success.
 He estimates that the probability that the electrical design
could be successfully modified is only 30%.
1. If success will get profit $6 M and
2. If fail then it loses $7M
 The probability of the gas design would have an 80% chance of
being modified successfully.
1. If success will get profit $10 M and
2. If fail then it loses $12M

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 A new decision tree for the food-processor
problem

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 Calculating Payoff at Each Branch

(0.3*6000000) + (0.7 * -7000000) = -3100000

-3000000 > -3100000  choose Abandon Project

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 Determining Optimal Policy

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 Thank You

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