BM2102

PROBLEM-SOLVING FOR DECISION ANALYSIS

NAME: SECTION: DATE: SCORE:

Quiz
T. Bone Puckett, a corporate raider, has acquired a textile company and is contemplating the future
of one of its major plants, located in South Carolina. Three alternative decisions are being
considered:
(1) Expand the plant and produce lightweight, durable materials for possible sales to the military, a
market with little foreign competition; (2) maintain the status quo at the plant, continuing production
of textile goods that are subject to heavy foreign competition; or (3) sell the plant now. If one of the
first two (2) alternatives is chosen, the plant will still be sold at the end of a year. The amount of
profit that could be earned by selling the plant in a year depends on foreign market conditions,
including the status of a trade embargo bill in Congress. The following payoff table describes this
decision situation:

State of Nature
Good Foreign Poor Foreign Competitive
Decision
Competitive Conditions
Conditions
Expand 800,000 500,000
Maintain status quo 1,300,000 -150,000
Sell now 320,000 320,000

A. Determine the best decision by using the following decision criteria:

a. Maximax

Maximum Payoffs:
Expand 800,000
Maintain status quo 1,300,000 Maximum
Sell now 320,000

Decision:
The decision would be to maintain the status quo at the
plant, continuing production of textile goods that are
subject to heavy foreign competition.

b. Maximin

Minimum Payoffs:
Expand 500,000 Maximum
Maintain status quo -150,000
Sell now 320,000

Decision:
The decision would be to expand the plant and produce
lightweight, durable materials for possible sales to the
military, a market with little foreign competition.

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 c. Minimax regret

Decisions Good Foreign Competitive Poor Foreign Competitive

Conditions Conditions
Expand 1,300,000 - 800,000 = 500,000 500,000 - 500,000 = 0 Minimum
Maintain status quo 1,300,000 - 1,300,000 = 0 500,000 – (-150,000) = 650,000
Sell now 1,300,000 - 320,000 = 980,000 500,000 - 320,000 = 180,000

State of Nature
Good Foreign Competitive Poor Foreign Competitive
Decisio
n Conditions Conditions
Expand 500,000 0
Maintain status quo 0 650,000
Sell now 980,000 180,000

Decision:
The decision would be to expand the plant and produce lightweight, durable materials for possible
sales to the military, a market with little foreign competition.

d. Hurwicz (� = 0.3)

Coefficient of Optimism = � = 0.3

Coefficient of Pessimism = 1 – � = 1 – 0.3 = 0.7

Decisions Values
Expand 800,000 (0.3) + 500,000 (0.7) = 590,000 Maximum weighted value
Maintain status quo 1,300,000 (0.3) – 150,000 (0.7) = 285,000
Sell now 320,000 (0.3) + 320,000 (0.7) = 320,000

Decision:
The decision would be to expand the plant and produce lightweight, durable materials for possible
sales to the military, a market with little foreign competition.

e. Equal likelihood

Decisions Values
Expand 800,000 (0.5) + 500,000 (0.5) = 650,000 Maximum weighted value
Maintain status quo 1,300,000 (0.5) – 150,000 (0.5) = 575,000
Sell now 320,000 (0.5) + 320,000 (0.5) = 320,000

Decision:
The decision would be to expand the plant and produce lightweight, durable materials for possible
sales to the military, a market with little foreign competition.

B. Assume that it is now possible to estimate a probability of 0.70 that good foreign competitive
conditions will exist and a probability of 0.30 that poor conditions will exist. Determine the
best decision by using expected value and expected opportunity loss.
State of Nature
Good Foreign Competitive Poor Foreign Competitive
Decisio
n Conditions Conditions
0.70
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Expand 800,000 500,000
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 Maintain status quo 1,300,000 -150,000
Sell now 320,000 320,000

Expected Value:
EV (Expand) 800,000 (0.7) + 500,000 (0.3) = 710,000
EV (Maintain status Greatest expected value
1,300,000 (0.7) – 150,000 (0.3) = 865,000
quo)
EV (Sell now) 320,000 (0.7) + 320,000 (0.3) = 320,000

Decision:
The decision would be to maintain the status quo at the plant, continuing production of textile goods
that are subject to heavy foreign competition.

State of Nature
Good Foreign Competitive Poor Foreign Competitive
Decision
Conditions Conditions
0.70 0.30
Expand 500,000 0
Maintain status quo 0 650,000
Sell now 980,000 180,000

Expected Opportunity Loss:

EOL (Expand) 500,000 (0.7) + 0 (0.3) = 350,000
EOL (Maintain status quo) 0 (0.7) + 650,000 (0.3) = 195,000 Minimum expected regret
EOL (Sell now) 980,000 (0.7) + 180,000 (0.3) = 740,000

Decision:
The decision would be to maintain the status quo at the plant, continuing production of textile goods
that are subject to heavy foreign competition.

C. Compute the expected value of perfect information.

Expected Value Given Perfect Information = 1,300,000 (0.7) + 500,000 (0.3) = 1,060,000
Expected Value without Perfect Information = 1,300,000 (0.7) -150,000 (0.3) = 865,000
Expected Value of Perfect Information (EVPI) = 1,060,000 - 865,000 = 195,000

D. Develop a decision tree with expected values at the probability nodes.

Figurefrom
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 EV (node 2) = 0.70 (800,000) + 0.30 (500,000) = 710,000
EV (node 3) = 0.70 (1,300,000) + 0.30 (-150,000) = 865,000
EV (node 4) = 0.70 (320,000) + 0.30 (320,000) = 320,000

Rubric for grading computation:

CRITERIA POINTS
Complete solution with the correct answer 5
At least two major steps of the solution are incorrect 4
Half of the solution is correct 3
The first two major steps of the solution are correct 2
The first major step of the solution is correct 1
REFERENCES
Taylor III, B. W. (2016). Introduction to Management Science (12th ed.). New York: Pearson Education Limited.

08 Problem Solving 1 *Property of STI

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