EMBA 5207

Quantitative Methods
for Decision Making
Conducted By:

Professor Sk. Mahmudul Hasan

Business Administration Discipline
Khulna University
 Reference Book

Fundamentals of Management
Science

Efraim Turban and Jack R. Meredith

Sixth Edition
 Topics To Be Covered
• Introduction – Chapter 1 and chapter 2
• Decision Analysis – Basics and Extensions – Chapter 09
• Linear Programming – Foundations, Extensions,
Applications, Duality, Post optimality Analysis – Chapter 03,
04 and 05
• PERT, CPM and Other Networks – Basics and
Extensions – Chapter 11
• Forecasting – Basics – Chapter 10
• Waiting Lines – Basics – Chapter 14
 Distribution of Marks on
Continuous Assessment
• Class Tests - 20 marks
• Assignments - 10 marks
Total – 30 Marks
There will three (03) announced class tests throughout
the term and marks obtained on the class tests will
be averaged to get the total marks on class tests.
There will be good number of assignments on problems
given at the end of chapter.
 Rules and Regulations
• Normally dates of class tests will be fixed by the
students – there will be no imposition, but once
a date is given, that date will remain fixed.
• Try to maintain the norm of entering the class
before the course teacher enters.
• Participation and asking questions are highly
encouraged.
 Introduction
• Management and Decision Making -
• Factors affecting decision making –
Factors Trend Results
Technology Increasing More alternatives
to choose from
Information Increasing
Organizational size Increasing Larger cost of
making error
Structural complexity Increasing
Competition Increasing
International impact Increasing More uncertainty
regarding the future
Consumerism Increasing
Government intervention Increasing
 Difference between Quantitative method and
Qualitative method of decision making

• When a decision is made based on the knowledge,

experience, judgment, intuition etc. of the decision
maker, then the method is said to be qualitative.
Here the decision maker does not base the decision
on the information collected directly from the
problem area.
• On the other hand, when the decision maker uses
only the pertinent information regarding the
problem collected directly from the problem area for
decision making, the method is said to be
quantitative.
 Decision Making
• It is a process by which a decision is made.
• Decision is the end result of a process by which
the decision maker chooses between two or
more available courses of action for the purpose
of attaining a specific goal (s).
• It is similar to the important managerial function
of planning.
 Decision Making Process
The process consists of four steps to be followed sequentially

• Defining the problem for which a decision is to

be made as solution to the problem.
• Searching for alternative courses of action.
• Evaluating the alternatives.
• Selecting the best alternative according to the
objective to be pursued.
 Decision Making Process
Contd.
Decision making process can also be divided into
three phases:
• Intelligence: searching for conditions that calls
for a decision.
• Design: inventing, developing and analyzing
possible courses of action.
• Choice: selecting a course of action from those
available.
 Types of Decisions
• Structured Decisions: Decisions are said to be structured
where objectives are clearly stated, input and output
are clearly specified and the steps to be followed are
completely standardized. Such decisions are usually
routine and repetitive.
• Unstructured Decisions: In an unstructured problem,
none of the three phases of decision making are
structured. These are complex in nature for which there
are no standard solution methods. Here human
intuition, experience etc. are usually used in making
decision.
• Semi structured Decisions: Decisions where some, but
not all, of the phases are structured are referred to as
semi structured decisions.
DECISION ANALYSIS
Chapter 9
Decision theory is a quantitative analysis procedure
applied to managerial decision making.

• Decision Table or Payoff Table:

Here the quantitative data given regarding a
particular decision making situation are
arranged in a standardized tabular form
known as Decision Table or Payoff Table.

• The objective of doing so is to enable a

systematic analysis of the problem.
 Decision Table or Payoff Table
• Decision Table or Payoff Table can be defined as the
systematic arrangement of all the pertinent
quantitative information regarding a particular
decision making situation in a standardized tabular
form.
A typical decision table will have the following four components:
Alternative courses of action
States of nature
Probabilities of the states of nature
Payoff or outcome or result
 Alternative Courses of Action

• These are the probable solutions to a problem,

simply the options or strategies to achieve the
predetermined objective.
• The ability to generate alternatives depends on
the creativity, skill, experience etc. of the
decision maker or the manager.
• Decision tables are usually used when the
number of alternatives are finite and usually
small.
 States of Nature
• These are the possible future events or uncertainties
anticipated by the decision maker that affect the
outcome or result of an alternative. The states of
nature are always beyond the control of the decision
maker.

• A state of nature can be state of the economy,

weather condition, political situation etc. which the
decision maker can’t control.

• The states of nature are usually not determined or

influenced by the action of a single individual or
organization. They are basically the result of an “Act
of God” or the result of many forces pushing in
various directions.
 Probabilities of the States of Nature

• This is the likelihood or chance of occurrence

of the states of nature. The probabilities are
given either in percentage or in percentage
fractions.
• Here it is assumed that only one state of
nature will occur in future. That’s why, the
sum of probabilities will always be one.
 Payoff or outcome or result

• It denotes the result or outcome of a

particular alternative if a specific state of
nature occurs.
 Decision Making Situations
There can three types of situations or
environments under which a decision can be
made:
• Decisions under Certainty
• Decisions under Risk
• Decisions under Uncertainty.
 Decisions under Certainty
• When the decision maker is 100% sure about the
outcome/result/pay off of each and every alternative
developed, the decision maker is said to operate in a certain
environment.
• As the outcome is known with 100% certainty, no state of
nature is considered here.
• As there is no state of nature, the question of having
probabilities of occurrence of the state of nature does not
arise at all.
• There will be two components in a certain environment,
alternative courses of action and pay offs
 Decisions under Risk

• Here the decision maker knows the alternative

courses of action, probable states of nature,
the probabilities of occurrence of the states of
nature and the payoffs of all the alternatives
under different states of nature.
• The decision maker will be informed about all
the components of a decision table/decision
tree.
 Decisions under Uncertainty
• Here the decision maker knows the alternative
courses of action, probable states of nature
and the payoffs of all the alternatives under
different states of nature. But the decision
maker does not know or fails to ascertain the
corresponding probabilities of occurrence of
the states of nature.
Mary was in charge of a Trust’s investment department. She has just been authorized to invest a
large sum of money in one of the three alternatives: Corporate bonds, Common stocks or
Certificates of deposits (Time deposits).

The Trust’s objective is to maximize the return on investment over a one year period. The
problem is that economic situation seemed to be uncertain and no one was able to predict the
exact movements of the stock or even bond markets. It was rather obvious to Mary that the
return on investment depends on the state of the economy. Therefore, she consulted the
economic research department. The researchers were not sure what the exact state of the
economy would be after one year. However, they told Mary that they expected the economy to
be in one of three possible conditions or states: there can be solid growth in the economy, the
economy can be stagnant or there can be inflation in the economy. When asked for likelihood of
each condition, the researchers estimated a 50% chance for solid growth, a 30% chance of
stagnation and a 20% chance of inflation.
Mary examined the relationship between the return on possible investments and the states of
the economy and concluded that the past experience indicated the following trends.

1. If there is solid growth, bonds will yield 12%, stocks 15% and time deposits 6.5%.
2. If stagnation prevails, bonds will yield 6%, stocks 3% and time deposits 6.5%
3. If inflation prevails, bonds will yield 3%, value of stock will drop by 2% and time deposit will
yield 6.5%

Now the question is where Mary should invest the amount in order to maximize the return on
investment for one year period?
 Decision Table or Pay off Table

Probability 50% 30% 20%

States of Solid Growth Stagnation Inflation
nature

Alternative
Courses of
Action

Corporate bonds 12% 6% 3%

Common stocks 15% 3% -2%

Time deposits 6.5% 6.5% 6.5%

2 Approaches for taking decision from decision table

1.Expected Monetary Value (EMV) Approach
2.Expected Opportunity Loss (EOL) Approach
• EMV Approach:
We will calculate expected monetary value or expected value for each
alternative by using the following formula:
EV = ∑ (Pay off * Corresponding probability value)

EV for corporate bond = (12*.5) + (6*.3) + (3*.2) = 8.4%

EV for Common stock = (15*.5) + (3*.3) + (-2*.2) = 8.0%

EV for Time deposit= (6.5*.5) + (6.5*.3) + (6.5*.2) = 6.5%

As the expected value is maximum for corporate bond and the objective is to
maximize the return on investment, we have to invest in corporate bond.
EOL Approach:
Opportunity Loss: This is the loss that arises when we accept the next best alternative
instead of accepting the best alternative.
For taking decision by EOL approach, we have to construct an Opportunity loss table from
the basic decision table.
Opportunity Loss Table
Probability 50% 30% 20% Expected
Opportunity Loss
States of Solid growth Stagnation Inflation (EOL)
nature
Alternatives
Corporate bonds 15%-12% = 3% 6.5% - 6% = 6.5% - 3% = 2.35%
0.5% 3.5%
Common stocks 15%-15% = 0 6.5% - 3% = 6.5% - (-2)% = 2.75%
3.5% 8.5%
Time deposits 15%-6.5%% = 6.5% - 6.5% = 0 6.5% - 6.5% = 4.25%
8.5% 0
Expected opportunity Loss = ∑ (Opportunity loss* Corresponding probability value)
As expected opportunity loss is minimum for corporate bond, we have to invest in
Corporate bonds.
Problem 12
Given that, Purchase price of fruit per crate = Tk. 10
Profit per crate if sold on the same day = Tk. 15
Selling price per crate as animal food if sold later= Tk. 2.50
Decision Table
Probability 0.40 0.30 0.25 0.05 Expected
value
States of Demand of Demand of Demand of Demand of (EV)
nature 10 creates 11 creates 12 creates 13 creates
Alternatives

Order 10 crates 150 150 150 150 150

Order 11 crates 150 – 7.5= 165 165 165 156

142.50

Order 12 crates 150 – (7.5*2) 165 – 7.5= 180 180 155.25

=135 157.50

Order 13 crates 150 165 180 -7.5 = 195 148.125

–(7.5*3)= –(7.5*2)=150 172.50
127.5
As expected profit is maximum for ordering 11 crates, Greenwood will order 11 crates
to maximize profit from selling fruits.
 Decision Tree

Symbols used for construction of decision tree:

Decision Point or Decision node: Usually a decision tree will
start from a decision point. Each alternative courses of action will flow
forward from a decision point as individual branch. Each branch from a
decision point may end in pay off, another decision point or in a chance point.

Chance point or chance node: All the states of nature will flow
forward from a chance point as individual branch. Each branch from a chance
point may end in pay off, another chance point or in another decision point.
 Decision making under uncertainty
The Palm Tree Hotel is considering the construction of an additional wing.
Management is evaluating the possibility of adding 30, 40 or 50 rooms in the
additional wing. The success of addition depends on the combination of local
Government legislation and competition in the field. Hence, four states of
nature are being considered. The states of nature are shown together with the
anticipated pay off (yearly return on investment expressed as percentage of
investment) in the following table.

States of Positive Positive No legislation No legislation

Nature legislation & legislation & & low & Strong
low competition strong competition competition
Alternatives competition

Add 30 rooms 10 5 4 -2
Add 40 rooms 17 10 1 -10
Add 50 rooms 24 15 -3 -20
But Management cannot agree on the possibility of occurrence of state of nature.
How many rooms should the Hotel add to maximize the return on investment?
 Decisions under uncertainty

There are 5 approaches or criteria for taking

decision in an uncertain environment:
•The criterion of equal probabilities.
•The criterion of Pessimism
•The criterion of optimism
•The coefficient of optimism criterion
•The criterion of regret
 Probable short questions
1. Differentiate between qualitative approach and quantitative approach of
decision making.
2. What are the steps of decision making?
3. What is decision table and what are the components of a decision table?
4. Define alternative courses of action, states of nature, probabilities of states
of nature and pay offs with examples.
5. What are the decision making environments or situations? Discuss the
characteristics of each decision making situations.
6. What do you mean by opportunity loss?
7. What do you mean by decision point and chance point?
8. What are the process of taking decision from a decision tree?
9. What are the situations when we have to use decision tree instead of a
decision table?
10. What are the approaches of taking decision under uncertain environment?
11. What do you mean by coefficient of optimism? Give example.
12. How can you construct a regret table or opportunity loss table?