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Questions On Decision Tree

The document presents two decision tree problems faced by companies: 1. A steel manufacturer must decide whether to build a pilot plant before commercial production, or proceed directly to commercial production. Building a pilot plant has an 80% chance of high yield and 20% chance of low yield for the commercial plant. Going directly to commercial production has a 60% chance of high yield. 2. An oil company must decide whether to bid for an offshore drilling contract. If they win the bid, they can set up a new drilling operation with a 75% chance of success, or use an existing successful operation with an 85% chance of success. If they lose the bid, they can modernize current operations for a 5-8

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Pragya Chakshoo
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6K views

Questions On Decision Tree

The document presents two decision tree problems faced by companies: 1. A steel manufacturer must decide whether to build a pilot plant before commercial production, or proceed directly to commercial production. Building a pilot plant has an 80% chance of high yield and 20% chance of low yield for the commercial plant. Going directly to commercial production has a 60% chance of high yield. 2. An oil company must decide whether to bid for an offshore drilling contract. If they win the bid, they can set up a new drilling operation with a 75% chance of success, or use an existing successful operation with an 85% chance of success. If they lose the bid, they can modernize current operations for a 5-8

Uploaded by

Pragya Chakshoo
Copyright
© © All Rights Reserved
Available Formats
Download as DOCX, PDF, TXT or read online on Scribd
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Questions on Decision Tree

1. A large steel manufacturing company has three options with regard to production: (i) produce
commercially, (ii) build pilot plant, (iii) stop producing steel.

The management has estimated that their pilot plant, if built, has 80% chances of high yield and 20%
chance of low yield. If pilot plant does show a high yield, management assigns a probability of 0.75 that
the commercial plant will also have a high yield. If pilot plant shows a low yield, there is only a 0.1
chance that the commercial plant will show a high yield. Finally, management’s best assessment of the
yield on a commercial-size plant without building a pilot plant first has a 0.6 chance of high yield. A pilot
plant will cost Rs 3,00,000/-. The profits earned under high and low yield conditions are Rs 1,20,00,000/-
and –Rs 12,00,000/- respectively.

Find the optimum decision of the company.

2. The Oil India Corporation is considering whether to go for an offshore oil drilling contract to be
awarded in Bombay High. The bid value is Rs 600 million with a 65% chance of getting the contract. If
they get the contract, they may set-up a new drilling operation or move to already existing operation
which has proved successful to the new site. The probability of success and expected returns are as
follows:

Outcome New Drilling Operation Existing Operation


Prob Exp Rev (Rs million) Prob Exp Rev (Rs million)
Success 0.75 800 0.85 700
Failure 0.25 200 0.15 250

If the corporation do not bid or lose the contract, they can use the Rs 600 million to modernize their
operation. This would result in a return of either 5% or 8% on the sum invested with prob of 0.45 and
0.55. Assume that all the costs and revenues have been discounted to present value.

Find the optimum decision.


Ans: 1

The company should not build the pilot plant but should produce commercially.

Final EMV is Rs 67,20,000/-.

Ans: 2

The optimum strategy should be – the company should bi and if gets the contract, it should set up a new
drilling operation; if it does not get the contract, it should move the already existing operation. The final
return is 7.74% ((46.465/600)*100).

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