Module A: Decision Making Tools

answers
1) A plant manager wants to know how much he should be willing to pay for perfect
market research. Currently there are two states of nature facing his decision to expand
or do nothing. Under favorable market conditions the manager would make $100,000
for the large plant and $5,000 for the small plant. Under unfavorable market conditions
the large plant would lose $50,000 and the small plant would make $0. If the two states
of nature are equally likely, how much should he pay for perfect information?
A. $0
B. $25,000
C. $50,000
D. $100,000
E. unable to determine
Answer: B

EMV Large = 0.5*($100,000) + (0.5)*($-50,000) = $25,000

EMV Small = 0.5*($5,000) + (0.5)*($0) = $2,500
EVwPI = 0.5*($100,000) + (0.5)*($0) = $50,000
EVPI = $50,000 - $25,000 = $25,000

2) A decision-maker using the maximax criterion on the problem below would choose
Alternative __________ because the maximum of the row maximums is __________.

States of Nature
1 2 3
Alternative A 50 55 60
Alternative B 30 50 80
Alternative C 70 80 70
Alternative D -100 -10 140

A. A; 60
B. B; 80
C. C; 70
D. D; -100
E. D; 140
Answer: E

Row A Max: 60
Row B Max: 80
Row C Max: 80
Row D Max: 140
Max of row maximums: D, 140

3) The campus bookstore sells highlighters that it purchases by the case. Cost per case,
including shipping and handling, is $200. Revenue per case is $350. Any cases unsold
will be discounted and sold at $175. The bookstore has estimated that demand will
follow the pattern below. How many cases should the bookstore stock in order to
maximize profit?

Demand level Probability

10 cases 20 percent
11 cases 20 percent
12 cases 40 percent
13 cases 15 percent
14 cases 5 percent

A. 10
B. 11
C. 12
D. 13
E. 14

Answer:
Deman Demand Demand Demand Demand
Profit d 10 11 12 13 14 EMV
Probability 0.2 0.2 0.4 0.15 0.05
Stock 10 1500 1500 1500 1500 1500 1500
Stock 11 1475 1650 1650 1650 1650 1615
Stock 12 1450 1625 1800 1800 1800 1695
Stock 13 1425 1600 1775 1950 1950 Maximum 1705
Stock 14 1400 1575 1750 1925 2100 1688.75

4) A toy manufacturer makes stuffed kittens and puppies which have relatively life-like
motions. There are three different mechanisms which can be installed in these "pets."
These toys will sell for the same price regardless of the mechanism installed, but each
mechanism has its own variable cost and setup cost. Profit, therefore, is dependent
upon the choice of mechanism and upon the level of demand. The manufacturer has in
hand a forecast of demand that suggests a 0.45 probability of light demand, a 0.2
probability of moderate demand, and a probability of 0.35 of heavy demand. Payoffs for
each mechanism-demand combination appear in the table below.

Demand Wind-up action Pneumatic action Electronic action

Light $250,000 $90,000 -$100,000
Moderate 400,000 440,000 400,000
Heavy 650,000 740,000 780,000

What is the EMV of the optimal decision for a risk neutral decision maker (Hint You may
want to draw out the decision tree)?

A. $475,000
B. $456,700
C. $433,000
 D. $740,000
E. $420,000
Answer: E

EMV Windup: (0.45)*($250,000) + (0.2)*($400,000) + (0.35)*($650,000) = $420,000

EMV Pneumatic: (0.45)*($90,000) + (0.2)*($440,000) + (0.35)*($740,000) = $387,500
EMV Electronic: (0.45)*(-$100,000) + (0.2)*($400,000) + (0.35)*($780,000) = $308,000
For a risk-neutral decision maker, the optimal choice is Windup with an EMV of
$420,000

5) A company manufactures specialty pollution-sensing devices for the offshore oil

industry. One particular device has reached maturity, and the company is considering
whether to replace it with a newer model. Technologies have not changed dramatically,
so the new device would have similar functionality to the existing one, but would be
smaller and lighter in weight. The firm's three choices are: keep the old model; design a
replacement device with internal resources; and purchase a new design from a firm that
is one of its suppliers. The market for these devices will be either "receptive" or "neutral"
of the replacement model. The financial estimates are as follows: Keeping the old
design will yield a profit of $6 million dollars. Designing the replacement internally will
yield $10 million if the market is "receptive," but a $3 million loss if the market is
"neutral." Acquiring the new design from the supplier will profit $4 million under
"receptive," $1 million under "neutral." The company feels that the market has a 70
percent chance of being "receptive" and a 30 percent chance of being "neutral." What
action yields the highest expected value?

A. Develop a replacement internally

B. Purchase a new design
C. Stay with the current Design

Answer:

The three expected monetary values are:

Develop replacement internally: $10,000,000 x .7 -$3,000,000 x .3 = $6.1 million
Purchase new design: $4,000,000 x .7 + $1,000,000 x .3 = $3.1 million
Stay with current design: $6 million
The company should choose the highest value, and develop a replacement
product design with internal resources.

6) Earl Shell owns his own Sno-Cone business and lives 30 miles from a beach resort.
The sale of Sno-Cones is highly dependent upon his location and upon the weather. At
the resort, he will profit $110 per day in fair weather, $20 per day in foul weather. At
home, he will profit $70 in fair weather, $50 in foul weather. Assume that on any
particular day, the weather service suggests a 60% chance of fair weather. What is the
maximum earl would be willing to pay for perfect information about the weather each
day?

A. $74
B. $62
C. $86
D. $12
E. $24
Answer: The payoff table is

Profit Fair weather Foul weather

Probability = 0.6 Probability = .4
Sell at the resort 110 20
Sell at home 70 50

the EMV for sell at the resort = .6*110 + .4*20 = 74; The EMV for sell at home
= .6*70 + .3*50 = 62. The better value is $74, so Earl should sell at the resort.
(c) EVwPI = .6*110 + .4*50 = $86; EVPI = $86 - $74 = $12.

7) The campus bookstore sells stadium blankets embroidered with the university crest.
The blankets must be purchased in bundles of one dozen each. Each blanket in the
bundle costs $65, and will sell for $90. Blankets unsold by homecoming will be clearance
priced at $20. The bookstore estimates that demand patterns will follow the table below.
How many bundles should be purchased?

Demand level Probability

1 bundle 10 percent
2 bundles 30 percent
3 bundles 50 percent
4 bundles 10 percent

a. Build the decision table.

b. What is the maximum expected value?
c. How many bundles should be purchased?

A. 1
B. 2
 C. 3
D. 4
E. 5
Answer: (a) See the table below; (b) the maximum expected value is $516; (c)
the bookstore should order 2 bundles.

Profit Demand 1 Demand 2 Demand 3 Demand 4 EMV

Probabilit
y 0.1 0.3 0.5 0.1
Order 1 300 300 300 300 300
Order 2 -240 600 600 600 Maximum 516
Order 3 -780 60 900 900 480
Order 4 -1320 -480 360 1200 24

8) A plant manager wants to know how much he should be willing to pay for perfect
market research. Currently there are two states of nature facing his decision to expand
or do nothing. Under favorable market conditions the manager would make $125,000
for the large plant and $15,000 for the small plant. Under unfavorable market conditions
the large plant would lose $50,000 and the small plant would make $5,000. If the
favorable conditions are expected to have a 60% likelihood of occurrence, how much
should he pay for perfect information?

A. $22,000
B. $25,000
C. $55,000
D. $15,000
E. unable to determine
Answer: A

EMV Large = 0.6*($125,000) + 0.4*(-$50,000) = $55,000

EMV Small = 0.6*($15,000) + 0.4*($5,000) = $11,000

EMV Large > EMV Small, so you will choose the large plant

EVwPI = 0.6*($125,000) + 0.4*(5,000) = $77,000

EVPI = $77,000 - $55,000 =$22,000

9) A decision-maker using the maximax criterion on the problem below would choose
Alternative __________.

States of Nature
1 2 3
Alternative A 150 55 -10
Alternative B 30 90 180
Alternative C 75 80 70
Alternative D -100 -10 140
 A. A
B. B
C. C
D. D
Answer: B

Max of A: 150
Max of B: 180
Max of C: 80
Max of D: 140
Max of maximums: B, 180

10) The campus bookstore sells highlighters that it purchases by the case. Cost per
case, including shipping and handling, is $200. Revenue per case is $350. Any cases
unsold will be discounted and sold at $175. The bookstore has estimated that demand
will follow the pattern below. How many cases should the bookstore stock in order to
maximize profit?

Demand level Probability

5 cases 20 percent
6 cases 20 percent
7 cases 40 percent
8 cases 15 percent
9 cases 05 percent

Demand Demand Demand Demand Demand

Profit 5 6 7 8 9 EMV
Probability 0.2 0.2 0.4 0.15 0.05
Stock 5
Stock 6
Stock 7
Stock 8
Stock 9

A. 5
B. 6
C. 7
D. 8
E. 9
Answer: D

Profit Demand 5 Demand 6 Demand 7 Demand 8 Demand 9   EMV

Probability 0.2 0.2 0.4 0.15 0.05   1
Stock 5 750 750 750 750 750   750
Stock 6 725 900 900 900 900   865
Stock 7 700 875 1050 1050 1050   945
 Stock 8 675 850 1025 1200 1200   955
Stock 9 650 825 1000 1175 1350   938.75

11) Suppose a manufacturing plant is considering three options for expansion. The first
one is to expand into a new plant (large) , the second to add on third-shift to the daily
schedule (medium) , and the third to do nothing (small) . There are three possibilities for
demand. These are high, medium, and low and each has a 40%, 40% and 20%
likelihood of occurring, respectively. Suppose that the profits for the expansion plans are
as follows (respective to high, medium, low demand). The large expansion profits are
$100000, $10000, -$10000, the medium expansion choice $50000, $20000, $5000 and
the small expansion choice $15000, $15000, $15000. Calculate the EMV of each
choice. Which of the expansion plans should the manager choose?

A. $29,000
B. $15,000
C. $33,000
D. $42,000
E. $47,000

Answer: Student responses may include a decision tree to organize their

thoughts (not required).
EMV large expansion is .4(100000) + .4(10000) + .2(-10000) = $42,000
EMV medium expansion is .4(50000) + .4 (20000) + .2(5000) = $29,000
EMV small expansion is $15,000
The plant manager should choose the large expansion.
Diff: 2

12) A company manufactures specialty pollution-sensing devices for the offshore oil
industry. One particular device has reached maturity, and the company is considering
whether to replace it with a newer model. Technologies have not changed dramatically,
so the new device would have similar functionality to the existing one, but would be
smaller and lighter in weight. The firm's three choices are: keep the old model; design a
replacement device with internal resources; and purchase a new design from a firm that
is one of its suppliers. The market for these devices will be either "receptive" or "neutral"
of the replacement model. The financial estimates are as follows: Keeping the old
design will yield a profit of $6 million dollars. Acquiring the new design from the supplier
will yield $10 million if the market is "receptive," but a $3 million loss if the market is
"neutral." Designing the replacement internally will profit $4 million under "receptive," $1
million under "neutral." The company feels that the market has a 70 percent chance of
being "receptive" and a 30 percent chance of being "neutral." Draw the appropriate
decision tree and calculate expected monetary value for all courses of action. What
action yields the highest expected value? (2 pts)

A. Develop replacement internally

B. Purchase new design
C. Stay with current design
D. Choose a receptive market
E. Choose a neutral market
Answer: B
 The three expected monetary values are:
Purchase new design$10,000,000 x .7 -$3,000,000 x .3 = $6.1 million
Develop replacement internally: $4,000,000 x .7 + $1,000,000 x .3 = $3.1 million
Stay with current design: $6 million
The company should choose the highest value, and develop a replacement
product design with internal resources.

13) What is the expected value of perfect information of the following decision table? (1
pts)

States of Nature
Alternatives S1 S2
p .6 .4
Option 1 200 300
Option 2 50 350

A. 0
B. 20
C. 50
D. 150
E. 200
Answer: B

EMV Option 1: (0.6)*(200) + (0.4)*(300) = 240

EMV Option 2: (0.6)*(50) + (0.4)*(350) = 170
EVwPI = (0.6)*(200) + (0.4)*(350) = 260
EVPI = 260-240 = 20

14) An operations manager's staff has compiled the information below for four
manufacturing alternatives (A, B, C, and D) that vary by production technology and the
capacity of the machinery. All choices enable the same level of total production and
have the same lifetime. The four states of nature represent four levels of consumer
acceptance of the firm's products. Values in the table are net present value of future
profits in millions of dollars. (1 pts)

States of Nature
1 2 3 4
Alternative A 50 55 60 65
Alternative B 30 50 80 130
Alternative C 70 80 70 65
Alternative D -100 -10 150 220

Assuming maximin were used, which would be chosen? (1 pts)

A. A
B. B
C. C
D. D
 Answer: C

Min A: 50
Min B: 30
Min C: 65
Min D: -100
Max of mins: C, 65

15 -17) Endrink, an energy drink company in Gainesville, has been experiencing an

increased demand. In order to satisfy the demand it can either expand its current plant
or build a new plant, as shown below:

15) Which of the choices has the highest EMV?

A. Build a new large plant

B. Build a new small plant
C. Build a new plant
D. Expand the current plant
E. Do nothing
Answer: D

EMV Large = (0.5)*($120,000) +(0.5)*(-$80,000) = $20,000

EMV Small = (0.4)*($60,000) + (0.6)*(-$30,000) = $6,000
EMV Expand = (0.6)*($45,000) + (0.4) *(-$10,000) = $23,000
EMV Do Nothing = $0
EMV Expand, $23,000

16) The marketing department can conduct a survey that will provide the company with
Perfect Information. What should be the cost of the survey?

A. $60,000
B. $23,000
 C. $26,000
D. $34,000
E. $37,000
Answer: E

EVwPI = 0.5*($120,000) + (0.5)*($0) = $60,000

EVPI = $60,000 - $23,000 = $37,000

17) Assuming that the probabilities are not given and all options are equally likely. Which
would be the best choice?

A. Build a new large plant

B. Build a new small plant
C. Build a new plant
D. Expand the current plant
E. Do nothing
Answer: A

EMV Large = (0.5)*($120,000) +(0.5)*(-$80,000) = $20,000

EMV Small = (0.5)*($60,000) + (0.5)*(-$30,000) = $15,000
EMV Expand = (0.5)*($45,000) + (0.5) *(-$10,000) = $17,500
EMV Do Nothing = $0
EMV Large, $20,000

The following information is needed to answer questions 18 to 20

18-20) Sprockets, Corp. is attempting to decide whether or not to open a new factory,
expand operations at their current factory, or maintain their current capacity. To build a
new factory will cost $2.5 million, to expand operations will cost $900,000, and to
maintaining the current capacity will incur no additional cost. If the market is good, a
new factory will yield $5 million in increased revenue, an expanded factory will yield $1.5
million in increased revenue, and doing nothing will yield no additional revenue. If the
market is poor no additional revenue will be generated regardless of the capacity choice
made. There is an 80% chance of there being a good market, and a 20% chance of
there being a poor market. Construct a decision tree and answer the following
questions.

18) What is the Expected Value of expanding operations at the current factory?

A. $750,000
B. $1,500,000
C. $480,000
D. $300,000
E. -$180,000
Answer: D

EMV Expanded Factory = -$900,000 + (0.8)*($1,500,000) + (0.2)*($0) = $300,000

19) Using the decision tree, what is the best option for Sprockets, Corp. to pursue?
 A. Do nothing
B. Build a new factory
C. Expand operations at the current factory
Answer: B

EMV New Factory = -$2,500,000 + (0.8)*($5,000,000)+(0.2)*($0) = $1,500,000

EMV Expanded Factory = -$900,000 + (0.8)*($1,500,000) + (0.2)*($0) = $300,000
EMV Do Nothing: $0
EMV New Factory

20) What is the maximum the firm would be willing to pay for Perfect Information:

A. $1,200,000
B. $1,000,000
C. $2,000,000
D. $300,000
E. $500,000
Answer: E

EMV New Factory > EMV Expanded Factory, so without perfect information you would
choose the new factory.
With perfect information that the poor conditions will occur, you would choose to do
nothing and save the initial input cost.
(0.2)*($2,500,000) = $500,000

21 and 22) An operations manager's staff has compiled the information below for four
manufacturing alternatives (A, B, C, and D) that vary by production technology and the
capacity of the machinery. All choices enable the same level of total production and
have the same lifetime. The four states of nature represent four levels of consumer
acceptance of the firm's products. Values in the table are net present value of future
profits in millions of dollars.

States of Nature
1 2 3 4
Alternative A 50 55 60 65
Alternative B 30 50 80 130
Alternative C 70 80 70 65
Alternative D -100 -10 150 220

21) If maximin were used, which would be chosen?

A. Alternative A
B. Alternative B
C. Alternative C
D. Alternative D
E. Cannot be determined with the information provided.
Answer: C

The maximin strategy selects the best of the worsts; the worsts are A=50,
 B=30, C=65, and D=-100. The best of these is 65, associated with Alternative C.

22) If the states of nature were equally likely, which alternative should be chosen?

A. Alternative A
B. Alternative B
C. Alternative C
D. Alternative D
E. Cannot be determined with the information provided.
Answer: B

The averages for the four alternatives are A=57.5, B=72.5, C=71.25, and D=65.
The highest of these is 72.5, associated with Alternative B.

23) The bakery sells bread that it produces in batches of 120 loafs. Cost per batch,
including delivery to local restaurants, is $200. Revenue per batch is $350. Any batches
unsold will be discounted and sold at $175 the next day for local restaurants needing
less fresh bread for crotons, bread pudding and other uses. The bakery has estimated
that demand will follow the pattern below

Demand level Probability

10 batches 30 percent
11 batches 35 percent
12 batches 25 percent
13 batches 5 percent
14 batches 5 percent

Construct the bookstore's payoff table below and determine how many cases should the
bakery should produce each day in order to maximize profit?

A. Make 10
B. Make 11
C. Make 12
D. Make 13
E. Make 14
Answer: C

Deman Demand Demand Demand Demand

Profit   EMV
d 10 11 12 13 14
Probability 0.3 0.35 0.25 0.05 0.05    
Make 10 1500 1500 1500 1500 1500   1500
Make 11 1475 1650 1650 1650 1650   1597.5
Make 12 1450 1625 1800 1800 1800  Maximum 1633.75
Make 13 1425 1600 1775 1950 1950 1626.25
Make 14 1400 1575 1750 1925 2100   1610

24) A problem that involves a sequence of decisions

 A. cannot be analyzed with expected monetary value
B. can be better analyzed with a decision tree than by a decision table
C. must be analyzed in the same order that the decisions are made
D. cannot be analyzed with decision tree software
E. can only be analyzed using decision making under certainty
Answer: B

25) What is the expected value of perfect information of the following decision table
(rounded to the nearest whole number)?

  States of Nature  
Alternative
S1 S2 S3
s
P 0.3 0.25 0.45
Option 1 200 300 140
Option 2 50 350 275
Option 3 300 240 220
Option 4 200 200 200

A. 0
B. 274
C. 52
D. 198
E. None of the above
Answer: C

  States of Nature  
Alternative
S1 S2 S3
s
P 0.3 0.25 0.45
Option 1 200 300 140 198
Option 2 50 350 275 226.25
Option 3 300 240 220 249 Best EMV
Option 4 200 200 200 200
301.25 EVwPI
52.25 EVoPI

26) Sprockets, Corp. is attempting to decide whether or not to open a new factory,
expand operations at their current factory, or maintain their current capacity. To build a
new factory will cost $2.5 million, to expand operations will cost $900,000, and to
maintaining the current capacity will incur no additional cost. If the market is good, a
new factory will yield $5 million in increased revenue, an expanded factory will yield $1.5
million in increased revenue, and doing nothing will yield no additional revenue. If the
market is poor no additional revenue will be generated regardless of the capacity choice
made. There is an 80% chance of there being a good market, and a 20% chance of
there being a poor market. Construct a decision tree and answer the following
questions.

What is the Expected Value of expanding operations at the current factory?

A. $750,000
B. $1,500,000
C. $480,000
D. $300,000
E. None of the Above
Answer: D

EMV Expanded Factory = -$900,000 + (0.8)*($1,500,000) + (0.2)*($0) = $300,000

27) A manager’s staff has calculated the information below regarding a decision to
produce a new product at one of its four facilities (N. American, S. American, Europe,
and SW Asia). Each decision has a separate cost and complex cost function but the
expected payoffs (in 10,000s) are presented in the table below for four different levels of
demand (Very Low, Low, Medium, High).

Product Acceptance
Very Low Low Medium High
N. America -50 -5 29 65
S. America -15 2 32 61
Europe -62 -18 24 50
Asia -16 3 32 72

If maximin were the default decision criterion for the manager which factors would he
choose to produce the new product at?

A. N. America
B. S. America
C. Europe
D. Asia
E. Very Low
Answer: B

Min N. America: -50

Min S. America: -15
Min Europe: -62
Min Asia: -16
Max of mins: S. America, -15

28) The manager was unhappy with the level of information in the above question and
requested further market research so that he could evaluate the decision under risk
rather then uncertainty. His staff has returned the previous table to him with the addition
of an estimated probability of each of the levels of product acceptance occurring.

Product Acceptance
 Very Low Low Medium High
.2 .3 .4 .1
N. America -50 -5 29 65
S. America -15 2 32 61
Europe -62 -18 24 50
Asia -16 3 32 72

Using EMV as a decision criterion which location would he select for manufacturing the
new product?

A. N. America
B. S. America
C. Europe
D. Asia
E. Do not manufacture the new product. No option has a positive EMV.
Answer: D

  Product Acceptance
  Very Low Low Medium High
  0.2 0.3 0.4 0.1 1
N.
-50 -5 29 65
America 6.6
S.
-15 2 32 61
America 16.5
Europe -62 -18 24 50 -3.2
Asia -16 3 32 72 17.7

29) The manager from the previous two questions has once again received a revised
table with updated numbers. This time the payoffs have been updated to reflect current
cost data.

Product Acceptance
Very Low Low Medium High
.2 .3 .4 .1
N. America -45 -5 29 65
S. America -10 2 30 61
Europe -60 -18 24 52
Asia -15 4 28 68

If the manager were able to hire a consultant to provide perfect information what would
be the value of perfect information? (Remember, the table is in 10,000s)

A. 13,000
B. 80,000
C. 165,000
D. 180,000 answer numbers different
E. None of the above
 Answer: A

  Product Acceptance
  Very Low Low Medium High
  0.2 0.3 0.4 0.1 1
N.
-45 -5 29 65
America 7.6
S.
-10 2 30 61
America 16.7
Europe -60 -18 24 52 -2.6
Asia -15 4 28 68 16.2
-10 4 30 68 18
1.3

30) The bakery sells bread that it produces in batches of 120 loafs. Cost per batch,
including delivery to local restaurants, is $100. Revenue per batch is $350. Any batches
unsold will be discounted and sold at $50 the next day for local restaurants needing less
fresh bread for crotons, bread pudding and other uses. The bakery has estimated that
demand will follow the pattern below

Demand level Probability

10 batches 20 percent
11 batches 25 percent
12 batches 30 percent
13 batches 20 percent
14 batches 5 percent

Construct the bookstore's payoff table below and determine how many cases should the
bakery should produce each day in order to maximize profit?

Demand Demand Demand Demand Demand

Profit   EMV
10 11 12 13 14
Probability 0.2 0.25 0.3 0.2 0.05   1
Make 10 2500 2500 2500 2500 2500   2500
Make 11 2450 2750 2750 2750 2750   2690
Make 12 2400 2700 3000 3000 3000   2805
Make 13 2350 2650 2950 3250 3250  Maximum 2830
Make 14 2300 2600 2900 3200 3500   2795

A. Make 10
B. Make 11
C. Make 12
D. Make 13
E. Make 14
 Answer: D

31) A toy manufacturer has three different mechanisms that can be installed in a doll that
it sells. The different mechanisms have three different setup costs (overheads) and
variable costs and, therefore, the profit from the dolls is dependent on the volume of
sales. The anticipated payoffs are as follows. What is the expected value of perfect
information?

Moderate
Light Demand Demand Heavy Demand
Probability 0.25 0.45 0.3
Wind-up action $325,000 $190,000 $170,000
Pneumatic action $300,000 $420,000 $400,000
Electrical action -$400,000 $240,000 $800,000

A. $248,000
B. $384,500
C. $489,750
D. $126,250
E. None of the Above

Answer: EVPI = $510,250 - $384,000 = $126,250.

32) The operations manager at Pillow Pets is deciding between adding a mega-sized
Panda Pillow Pet, a normal-sized Panda Pillow Pet, or nothing to their product line. The
probability for a favorable market is 0.3, while the probability for an unfavorable market is
0.7. It is estimated that the mega-sized Panda Pillow Pet will garner $500,000 in revenue
under a favorable market, and lose $100,000 in an unfavorable market. The normal-
sized Panda Pillow Pet will gain $300,000 in a favorable market, and lost $50,000 in an
unfavorable market. What is the best alternative for the operations manager to choose?

A. Add the mega-sized Panda Pillow Pet

B. Add the normal-sized Panda Pillow Pet
C. Do nothing
Answer: A, pg. 672

Mega: (.3*500,000)+(.7*-100,000) = $80,000

Normal: (.3*300,000)+(.7*-50,000) = $55,000
Do nothing: (.3*0)+(.7*0) = 0

33) A decision-maker using the maximax criterion on the problem below would choose
Alternative __________.

States of Nature
1 2 3
Alternative A 200 50 -50
Alternative B -150 -200 250
Alternative C 75 40 30
Alternative D -100 -10 60

A. A
B. B
C. C
D. D
Answer: B
The max of each alternative: A=200 B=250 C=75 D=60, B provides the highest
max

34) If the user wants to maximize the minimum outcome they are most likely to select
which criterion

A. Maximax
B. Maximin
C. Equally Likely
D. Minimin
E. None of the above
Answer: B, Maximin – definition page 671 textbook

35) What is the expected value of perfect information of the following decision table
(rounded to the nearest whole number)?

States of Nature
Alternative
S1 S2 S3
s
p 0.20 0.30 0.50
Option 1 150 200 100
Option 2 100 100 300
Option 3 -200 300 500

A. 50
B. 70
C. 300
D. 370
E. none of the above
Answer: B

Option 1: 30 + 60 + 50 = 140
Option 2: 20 + 30 + 150 = 200
Option 3: -40 + 90 + 250 = 300 (best EMV)
EVwPI: .2*150 + .3*300 + .5*500 = 370
EVoPI: 370 – 300 = 70
36) Miles is considering buying a new pickup truck for his lawn service firm. The
economy in town seems to be growing, and he is wondering whether he should opt for a
subcompact, compact, or full-size pickup truck. The smaller truck would have better fuel
economy, but would sacrifice capacity and some durability. A friend at the Bureau of
Economic Research told him that there is a 30% chance of lower gas prices in his area
this year, a 20% chance of higher gas prices, and a 50% chance that gas prices will stay
roughly unchanged. Based on this information, Miles has developed a decision table that
indicates the profit amount he would end up with after a year for each combination of
truck and gas prices.

States of Nature
Gas prices
Alternatives Lower gas prices unchanged Higher gas prices
Probability .3 .5 .2
Subcompact $16,000 $21,000 $23,000
Compact $15,000 $20,000 $22,000
Full size $18,000 $19,000 $6,000

Calculate the expected monetary value for each decision alternative. What is the EMV
for the decision a risk neutral decision make would choose?

A. $18,900
B. $19,900
C. $16,100
D. $3,800
E. None of the above
Answer: The expected values are: subcompact $19,900, compact $18,900, and
full size $16,100. The highest EMV is that of the subcompact truck.

37) Daily sales of bread by Salvador Monella's Baking Company follow the historical
pattern shown in the table below. It costs the bakery 50 cents to produce a loaf of bread,
which sells for 95 cents. Any bread unsold at the end of the day is sold to the parish jail
for 25 cents per loaf. Construct the decision table of conditional payoffs. How many
loaves should Sal bake each day in order to maximize contribution?

Demand 400 500 600 700 800

Probability .20 .20 .40 .15 .05

A. 400
B. 500
C. 600
D. 700
E. 800

Answer: C: The Excel OM decision table and solution appear below. The best
expected value is $228, which occurs with the decision to bake 600 loaves.
Profit Sell 400 Sell 500 Sell 600 Sell 700 Sell 800 EMV
Probability 0.2 0.2 0.4 0.15 0.05
Bake 400 180 180 180 180 180 180
Bake 500 155 225 225 225 225 211
Bake 600 130 200 270 270 270 Maximum 228
Bake 700 105 175 245 315 315 217
Bake 800 80 150 220 290 360 195.5

38) A company has to decide whether or not to drill for oil in a particular place. There are
three possible results of drilling: a high yield where net present value (NPV) of revenue
over the time horizon of interest will be $10 million, a moderate yield with a NPV $5
million, or no oil with an NPV of $0. The drilling operation has an upfront cost $5 million.
At geologically similar locations, 50%, 30%, and 20% of previous drillings have given
high, moderate, or no yield respectively. A seismic test is available which would indicate
a favorable, neutral, or discouraging prospect for the drilling.   The test cost an additional
$0.5 million.

There is a 52% chance the test will give favorable results; if it does, the respective
probabilities of High, Moderate, or No yield become .68, .28, and .04.

There is a 22% chance the test will give neutral results; if it does, the respective
probabilities of High, Moderate, or No yield become .45, .28, and .27

There is a 26% chance the test will give unfavorable results; if it does, the respective
probabilities of High, Moderate, or No yield become .2, .3, and .5

What is the optimal sequence of decisions?

 
A. Do Nothing
B. Drill without testing **
C. Test first, and then drill if the results of the test are favorable
D. Test first, and then drill if the results of the test are neutral
E. Test first, and then Do NOT drill if the results of the test are unfavorable 

ANS:  B, Drill without testing. 

EMV = 1.5 vs 0 and 1.362 for testing
39) A company owner has a business, which is facing a down market. Future conditions
will either be favorable, unfavorable or neutral. What alternative would a risk adverse
decision maker select it the following decision table represented his decision alternatives
and their payoff under uncertain conditions?

Profit Favorable Unfavorable Neutral

Sell -500000 1200000 -25000
Expand 600000 -400000 180000
Partner 250000 -260000 17000
Do Nothing 390000 -140000 0

A. Sell the company

B. Expand the company
C. Bring in a partner
D. Do Nothing **
E. None of the above

Ans: D

40) Elsa is debating whether or not to build herself a large ice castle, a small ice castle,
or to remain in Arendelle. If she builds a large ice castle, in an unfavorable market, she
will lose $150,000, but in a favorable market, will gain $200,000. For the small ice castle,
she has the potential to gain $60,000 under favorable conditions, yet also risks losing
$80,000 should conditions be unfavorable. If she remains in Arendelle, she will not lose
make or lose any money. Favorable conditions have a 40% probability. What is the best
choice for Elsa?

A. Build the large ice castle

B. Build the small ice castle
C. Remain in Arendelle **
D. Not enough information

Ans: C

Large- (.6*-150) + (.4*200) = -90+80 = -10

Small- (.6*-80) + (.4*60) = -48+24 = -24

41) A company owner has a business, which is facing a down market. She is uncertain
whether she should sell her business, expand her business, bring in a partner or just try
to wait out the market. Future conditions will either be favorable, unfavorable or neutral
for her product. She has estimated what she feels is the likelihood of each of the future
conditions occurring and listed them in the table below. An economist has offered to
provide her with perfect information about future conditions for a price. What is the
maximum price she should be willing to pay for that infromation?

Profit Favorable Unfavorable Neutral

Probability 0.4 0.3 0.3
Sell -500000 1200000 -25000
Expand 600000 -400000 180000
Partner 250000 -260000 17000
Do
390000 -140000 0
Nothing

A. $284,000
B. $174,000
C. $654,000
D. $480,000 **
E. None of the other answers are correct to within $1000

Ans: D

<-Expected value WITH perfect

654000 information    
174000 <-Best expected value    
<-Expected value OF perfect
480000 information    

42) In the table below we see the payouts associated with an expansion decision for
Bob’s Best Bargains. We also see that there is a 40% chance for a favorable market
and a 60% chance of an unfavorable market. A new research firm tells bob that they
can predict the future and for a price can provide him with perfect information. What is
the expect value with perfect information (EVC)?

Alternatives Favorable Market Unfavorable Market

Construct Large Plant $4,000,000 -$2,000,000
Construct Small Plant $2,000,000 $500,000
Do Nothing $0 $0
Probabilities .40 .60

A. $500,000
B. $800,000
C. $1,100,000
D. $1,900,000 **
E. $2,000,000
Ans: D

43) – removed. It was in the wrong chapter.

44) – Was a duplicate with Number 38. Solution is located at #38

45) A company owner has a business, which is facing a down market. Future conditions
will either be favorable, unfavorable or neutral. What alternative would a risk adverse
decision maker select it the following decision table represented his decision alternatives
and their payoff under uncertain conditions?

States of Nature
Alternatives Favorable Unfavorable Neutral
Sell the company -$500,000 $1,300,000 -$15,000
Expand the company $600,000 -$400,000 $200,000
Bring in a partner $250,000 -$150,000 $18,000
Do nothing $390,000 -$220,000 $0

A. Sell the company

B. Expand the company
C. Bring in a partner
D. Do Nothing
E. None of the above

ANS: C

46) Elsa is debating whether or not to build herself a large ice castle, a small ice castle,
or to remain in Arendelle. If she builds a large ice castle, in an unfavorable market, she
will lose $150,000, but in a favorable market, will gain $200,000. For the small ice castle,
she has the potential to gain $60,000 under favorable conditions, yet also risks losing
$80,000 should conditions be unfavorable. If she remains in Arendelle, she will not lose
any money but will be secluded from society. Favorable conditions have a 40%
probability. What is the best choice for Elsa?

A. Build the large ice castle

B. Build the small ice castle
C. Remain in Arendelle
D. Not enough information

ANS: C,
Large- (.6*-150) + (.4*200) = -90+80 = -10
 Small- (.6*-80) + (.4*60) = -48+24 = -24

47) In the table below we see the payouts associated with an expansion decision for
Bob’s Best Bargains. We also see that there is a 40% chance for a favorable market
and a 60% chance of an unfavorable market. A new research firm tells bob that they
can predict the future and for a price can provide him with perfect information. What is
the expect value of perfect information?

Alternatives Favorable Market Unfavorable Market

Construct Large Plant $4,000,000 -$2,000,000
Construct Small Plant $2,000,000 $500,000
Do Nothing $0 $0
Probabilities .40 .60

A. $500,000
B. $800,000
C. $1,100,000
D. $1,900,000
E. $2,000,000

ANS: B

48) A company must decide whether to build a small, medium, or large grocery store.
Marketing research findings indicate a 0.35 probability that demand will be low and a
0.65 probability that demand will be high. If the company builds a small grocery store
and demand is low, the net present value will be $150,000. If demand is high the
company can buy its additional grocery needs from a wholesaler and realize a net present
value of $100,000 or expand and realize a net present value of $120,000. If the company
builds a medium grocery store and demand is low, the net present value will be $175,000;
if demand turns to be high the company could do nothing and realize a net present value
of $100,000, or expand and realize a net present value of $135,000. If the firm builds a
large grocery store and demand is low, the net present value will be $50,000; if demand
turns out to be high the net present value will be $250,000. Analyze the decision and
determine the EMV of the best course of action.

A) $250,000
B) *$180,000
C) $149,000
D) $130,500
E) None of the above are correct to within $1000 of the best answer
ANS: B : Build "Large" with an EMV of $180,000

49) A decision maker using the maximin criterion on the problem below would choose
Alternative ________ because the maximum of the row minimums is ________.

States of Nature
1 2 3
Alternative A 50 55 60
Alternative B 30 50 80
Alternative C 70 80 70
Alternative D -100 -10 140

A) A; 55
B) B; 30
C) C; 70
D) D; 140
E) D; 10
Answer: C