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    Chapter 5S Decision Theory Discussion

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    purpcom 1a19
    This document contains three problems regarding decision theory. Problem 1 asks the reader to identify the optimal choice under maximax, maximin, and expected value criteria given a payoff matrix with four alternatives. Problem 2 provides another payoff matrix and asks which alternative is best under maximin, minimax regret, maximax, and Laplace decision rules. Problem 3 presents a decision between a small or large facility with costs and revenues given probabilities of high or low demand, drawing the decision tree and finding the highest expected value.

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    Chapter 5S Decision Theory Discussion

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    purpcom 1a19
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    This document contains three problems regarding decision theory. Problem 1 asks the reader to identify the optimal choice under maximax, maximin, and expected value criteria given a payoff matrix with four alternatives. Problem 2 provides another payoff matrix and asks which alternative is best under maximin, minimax regret, maximax, and Laplace decision rules. Problem 3 presents a decision between a small or large facility with costs and revenues given probabilities of high or low demand, drawing the decision tree and finding the highest expected value.

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    Ch5S-DIS

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    This document contains three problems regarding decision theory. Problem 1 asks the reader to identify the optimal choice under maximax, maximin, and expected value criteria given a payoff matrix with four alternatives. Problem 2 provides another payoff matrix and asks which alternative is best under maximin, minimax regret, maximax, and Laplace decision rules. Problem 3 presents a decision between a small or large facility with costs and revenues given probabilities of high or low demand, drawing the decision tree and finding the highest expected value.

    Copyright:

    © All Rights Reserved
    Download as DOC, PDF, TXT or read online from Scribd
    Download as doc, pdf, or txt
    10 views2 pages

    Chapter 5S Decision Theory Discussion

    Uploaded by

    purpcom 1a19
    This document contains three problems regarding decision theory. Problem 1 asks the reader to identify the optimal choice under maximax, maximin, and expected value criteria given a payoff matrix with four alternatives. Problem 2 provides another payoff matrix and asks which alternative is best under maximin, minimax regret, maximax, and Laplace decision rules. Problem 3 presents a decision between a small or large facility with costs and revenues given probabilities of high or low demand, drawing the decision tree and finding the highest expected value.

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    © All Rights Reserved
    Download as DOC, PDF, TXT or read online from Scribd
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    of 2

    Chapter 5S Decision Theory Discussion

    Problem 1. A manager's staff has compiled the information below which pertains to four
    capacity alternatives. Values in the matrix are present value in thousands of dollars.

    (A) Assuming a maximax strategy, which alternative would be chosen?


    (B) If maximin were used, which alternative would be chosen?
    (C) If states of nature are equally likely and an expected value criterion of maximization is used,
    which alternative would be chosen?

    Problem 2. A manager has developed a payoff table that indicates the profits associated with a set
    of alternatives under two possible states of nature. Answer the following questions.

    (A) If the manager uses maximin as the decision criterion, which of the alternatives would be
    indicated?
    (B) If the manager uses minimax regret as the criterion, which alternative would be indicated?
    (C) If the manager uses maximax as the criterion, which alternative would be indicated?
    (D) If the manager uses Laplace as the criterion, which alternative would be indicated?
    (E) Determine the expected value of perfect information if P(S2) = .30

    Problem 3. A firm that plans to expand its product line must decide whether to build a
    small or a large facility to produce the new products. If it builds a small facility and
    demand is low with a probability of 0.4, the net present value after deducting for building
    costs will be $ 400,000. If demand is high with a probability of 0.6, the firm can either
    maintain the small facility or expand it. Expansion would have a net present value of $
    450,000, and maintaining the small facility would have a net present value of $ 50,000. If
    it builds a large facility, when the demand is low, the net present value is $-10,000, and
    when the demand is high, the net present value is $800,000.
    (A) Draw a decision tree.
    (B) Determine the course of action that has the highest expected net present value.

    1
    Answers to Problem 1.
    (A) Maximax is A ($50 is the largest value for any alternative).
    (B) Maximin is either B or C (Both have the largest minimum values of $30).
    (C) A: $35; B: $33.75; C: $31.25; D: $27.50. Hence, choose A.

    Answers to Problem 2.

    (A) Maximin: Alt. 3


    (B) Regret matrix is:

    Minmax regret: Alt. 3.


    (C) Maximax: Alt. 1
    (D) Laplace: Alt. 3
    (E) EMV for Alt. 1 is: 10*0.7+2*0.3 = 7.6 , EMV for Alt. 2 is : (-2)*0.7+8*0.3 = 1
    EMV for Alt. 3 is : (8)*0.7+5*0.3 = 7.1, EMV under certainty: 10* 0.7 + 8 *0.3 = 9.4
    Therefore, Alternative 1 would be selected under risk, with an EVPI = 9.4-7.6 = 1.8.

    Answers to Problem 3.
    (A) Draw the tree diagram:

    Demand Low (.4) $400,000 (1)

    Maintain $50,000 (2)


    Build Small
    2
    Demand High (.6) Expand
    1 $450,000 (3)
    Demand Low (.4) $-10,000 (4)
    Build Large

    Demand High (.6) $800,000 (5)

    (B) If build small is chosen, the expected net present value is $430,000. If build large is chosen,
    the expected net present value is $476,000. Therefore, select the large plant alternative.

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