ACC 115| Management Science

Module #3 Teacher’s Guide

Lesson title: Pay off Table and Decision Tree Materials:

Learning Targets: Pen and non-scientific calculator
At the end of this module, you should be able to: Strategic Cost Management by
1. Interpret the concepts of a payoff table. Cabrera
2. Prepare a decision tree.
3. References:
www.wisdomjobs.com
people.richland.edu

A. LESSON PREVIEW/REVIEW
Introduction
In our day to day life, the “probability” or “chance” is a very common used term. The theory of
probability has been developed in 17th century. It got its origin from games, tossing coins, throwing
a dice, drawing a card from a pack. Probability has become one of the basic tools of statistics and
quantitative techniques for decision making.

B. MAIN LESSON

Content and Skill-Building (40 mins)

Lesson Objective 1
Payoff (Decision) Table
A payoff table represents the outcomes (payoff) of specific decisions when certain statutes of nature
(events not within the control of the decision maker) occur.
Definition of terms
Expected Value (Realist)
Compute the expected value under each action and then pick the action with the largest expected
value. This is the only method of the four that incorporates the probabilities of the states of nature. The
expected value criterion is also called the Bayesian principle.

Maximax (Optimist)
The maximax looks at the best that could happen under each action and then chooses the action with
the largest value. They assume that they will get the most possible and then they take the action with
the best case scenario. The maximum of the maximums or the "best of the best". This is the lotto
player; they see large payoffs and ignore the probabilities.

Maximin (Pessimist)
The maximin looks at the worst that could happen under each action and then choose the action with
the largest payoff. They assume that the worst that can happen will, and then they take the action with
the best worst case scenario. The maximum of the minimums or the "best of the worst". This is the
person who puts their money into a savings account because they could lose money at the stock
market.
Minimax (Opportunist)

This document is the property of PHINMA EDUCATION 1

 ACC 115| Management Science
Module #3 Teacher’s Guide

Minimax decision making is based on opportunistic loss. They are the kind that look back after the state
of nature has occurred and say "Now that I know what happened, if I had only picked this other action
instead of the one I actually did, I could have done better". So, to make their decision (before the event
occurs), they create an opportunistic loss (or regret) table. Then they take the minimum of the
maximum. That sounds backwards, but remember, this is a loss table. This similar to the maximin
principle in theory; they want the best of the worst losses.

Illustration
Gentle Rain Corporation is in a condominium project and is deciding whether to construct a small,
medium, or large complex. If the demand is strong, Gentle Rain is estimated to be able to have a profit
of ₱8M with small complex, ₱14M with medium complex, and ₱20M with large complex. If the demand
is weak, the company is estimated to be able to earn a profit of ₱7M with small complex, ₱5M with
medium complex, and a loss of ₱9M for large complex.

The payoff table is as follows:

State of Nature
Decision Alternative
Strong Demand Weak Demand
Small Complex ₱12 0
Medium Complex ₱6 ₱2M
Large Complex 0 ₱16M
Required:
Evaluate whether which project should be chosen applying:
a. Maximax b. Maximin c. Minimax Regret d. Laplace
Solution:
a. Maximax
This is the maximum of the maximums or the best of the best. The best profit that can be earned under
the condominium project is constructing a large complex with ₱20M on strong demand.
Answer: Large Complex

b. Maximin
This is the maximum of the minimums or the best of the worst. The worst that could happen is to have a
weak demand. The best alternative on having weak demand is to construct a small complex with a
profit of ₱7M.
Answer: Small Complex

c. Minimax Regret
First, we have to create a regret table.

Minimax Regret Table / Opportunistic Loss Table

Decision Alternative Strong Demand Weak Demand
Small Complex ₱12M 0
Medium Complex ₱6M ₱2M

This document is the property of PHINMA EDUCATION 2

 ACC 115| Management Science
Module #3 Teacher’s Guide

Large Complex 0 ₱16M

 To construct the regret table, we have to determine the loss each decision for not choosing the
best alternative in each economic condition (strong and weak demand).
 With strong demand, the best alternative is the large complex with a ₱20M profit. Under strong
demand no loss for not choosing the best alternative because it is the best alternative. If
medium complex is chosen, there would be a loss of ₱6M (₱20M - ₱14M) for not choosing the
best alternative and the same explanation applies for small complex (₱20M - ₱8M = ₱12M).
 With weak demand, the best alternative is the small complex with a ₱7M profit. Under weak
demand no loss for not choosing the best alternative because it is the best alternative. If
medium complex is chosen, there would be a loss of ₱2M (₱7M - ₱5M) for not choosing the
best alternative and the same explanation applies for small complex (₱7M – (-₱9M) = ₱16M).

The next step is to choose the highest possible loss for each alternative:
Decision Alternative Strong Demand Weak Demand
Small Complex ₱12 0 ₱12M
Medium Complex ₱6 ₱2M ₱6M
Large Complex 0 ₱16M ₱16M

 In the small complex, the highest possible loss is ₱12M.

 In the medium complex, the highest possible loss is ₱6M.
 In the large complex, the highest possible loss is ₱16M.
The last step is to choose the alternative lowest possible loss among the highest possible losses of
each alternative and that would be medium complex with ₱6M compared to ₱12M of small complex
and ₱16M of large complex.
Answer: Medium Complex

d. Laplace
Laplace is choosing the alternative with the highest average profit considering the 2 economic
conditions.
Decision Alternative Strong Demand Weak Demand Laplace
Small Complex ₱8M ₱7M (8+7)/2 = ₱7.5
Medium Complex ₱14M ₱5M (14+5)/2 = ₱9.5
Large Complex ₱20M ₱ (9M) (20+(-9)/2 = ₱5.5
The medium complex would be the one with the highest average.
Answer: Medium Complex

Decision Tree
A decision tree is an analytical tool used in a problem in which a series of decision has to be
made at various time intervals, with each decision influenced by the information that is available at the
time it is made.
In its simplest form, a decision tree is a diagram that shows the several decisions or acts and
the possible consequences called events of each act. In a more elaborate form, the probabilities and

This document is the property of PHINMA EDUCATION 3

 ACC 115| Management Science
Module #3 Teacher’s Guide

the revenue and costs of each event’s outcome are estimated and these are combined to give an
expected value for the event.

Illustration
A property owner is faced with a choice of:
(a) A large-scale investment. This could produce a substantial pay-off in terms of increased
revenue net of costs but will require an investment of ₱1,400,000. After extensive market
research it is considered that there is a 40% chance that a pay-off of ₱2,500,000 will be
obtained, but there is a 60% chance that it will be only ₱800,000.
(b) A smaller scale project. At ₱500,000 this is less costly but will produce a lower pay-off.
esearch data suggests a 30 chance of a gain of ₱1,000,000 but a 70 chance of it being
only ₱500,000.
(c) Continuing the present operation without change. It will cost nothing, but neither will it produce
any pay-off.
Required: Make a decision tree and determine what option should the owner pursue.

Step 1: Draw the decision tree representing the options open to the property owner.

Step 2: Add the chance/probability nodes, the probabilities and the outcomes.

This document is the property of PHINMA EDUCATION 4

 ACC 115| Management Science
Module #3 Teacher’s Guide

Step 3: Calculate the expected values

Step 4: Calculate the net expected values and compare the options.

The decision would be to pursue the small scale project.

Skill-building Activities
Zed and Adrian and run a small bicycle shop called "Z to A Bicycles". They must order bicycles for the
coming season. Orders for the bicycles must be placed in quantities of twenty (20). The cost per bicycle
is ₱70 if they order 20, ₱67 if they order 40, ₱65 if they order 60, and ₱64 if they order 80. The bicycles
will be sold for ₱100 each. Any bicycles left over at the end of the season can be sold (for certain) at
₱45 each. If Zed and Adrian run out of bicycles during the season, then they will suffer a loss of
"goodwill" among their customers. They estimate this goodwill loss to be ₱5 per customer who was
unable to buy a bicycle. Zed and Adrian estimate that the demand for bicycles this season will be 10,
30, 50, or 70 bicycles with probabilities of 0.2, 0.4, 0.3, and 0.1 respectively.
Actions States of Nature
1. Buy 20 bicycles 1. The demand is 10 bicycles
2. Buy 40 bicycles 2. The demand is 30 bicycles
3. Buy 60 bicycles 3. The demand is 50 bicycles
4. Buy 80 bicycles 4. The demand is 70 bicycles
Required:
1. Make a payoff table
2. Using the payoff table, what action will be chosen applying:
a. expected value b. maximax c. maximin

This document is the property of PHINMA EDUCATION 5

 ACC 115| Management Science
Module #3 Teacher’s Guide

3. Make an opportunistic loss table and determine what action should be taken applying minimax.

Check your answers against the Key to Corrections found at the end of this SAS. Be sure to complete
each activity before looking. Write your score on your paper.

Check for Understanding

You are watching a race of 4 people and you are undecided on whether to bet on Gerby or on Jeb. You
are considering the following information:
Bet on Gerby – It costs ₱1 to place a bet and you are paid ₱2 if he wins.
Bet on Jeb – It costs ₱1 to place a bet and you are paid ₱11 is he wins.
You believe that probability of winning for Gerby and Jeb is 70% and 10%, respectively.

This document is the property of PHINMA EDUCATION 6

 ACC 115| Management Science
Module #3 Teacher’s Guide

Required: Draw a decision tree and identify where to place your bet using it.

C. LESSON WRAP-UP
Thinking about Learning (5 mins)

How do you feel today?

I feel (unsatisfactory/satisfactory/excellent) because_________________________________________
__________________________________________________________________________________

What are your challenges in learning the concepts in this module? If you do not have challenges,
what is your best learning for today?
__________________________________________________________________________________
_______________________________________________________________________________

What are the questions/thoughts you want to share to your teacher today?

This document is the property of PHINMA EDUCATION 7

 ACC 115| Management Science
Module #3 Teacher’s Guide

__________________________________________________________________________________
_______________________________________________________________________________

ANSWER KEY
Skill Building Activity
1. Payoff table
State of Nature
Action Demand 10 Demand 30 Demand 50 Demand 70
(0.20) (0.40) (0.30) (0.10)
Buy 20 50 550 450 350
Buy 40 -330 770 1,270 1,170
Buy 60 -650 450 1,550 2,050
Buy 80 -970 130 1,230 2,330

2. a. Expected value – Buy 40 bicycles

For each action, do the following: Multiply the payoff by the probability of that payoff occurring. Then
add those values together.
Buy 20  0.2(50) + 0.4(550) + 0.3(450) + 0.1(350) = 400
Buy 40  0.2(-330) + 0.4(770) + 0.3(1,270) + 0.1(1,170) = 740
Buy 60  0.2(-650) + 0.4(450) + 0.3(1,550) + 0.1(2,050) = 720
Buy 80  0.2(-970) + 0.4(130) + 0.3(1,230) + 0.1(2,330) = 460
The expected values for buying 20, 40, 60, and 80 bicycles are ₱400, 740, 720, and 460 respectively.
Since the best that you could expect to do is ₱740, you would buy 40 bicycles.

b. Maximax – Buy 80 bicycles

The largest payoff if you buy 20, 40, 60, and 80 bicycles are ₱550, 1270, 2050, and 2330 respectively.
Since the largest of those is ₱2330, you would buy 80 bicycles.

c. Maximin – Buy 20 bicycles

The smallest payoff if you buy 20, 40, 60, and 80 bicycles are ₱50, -330, -650, and -970 respectively.
Since the largest of those is ₱50, you would buy 20 bicycles.

3. Opportunistic loss table

State of Nature
Action Demand 10 Demand 30 Demand 50 Demand 70
(0.20) (0.40) (0.30) (0.10)
Buy 20 0 220 1,100 1,980
Buy 40 380 0 280 1,160
Buy 60 700 320 0 280
Buy 80 1,020 640 320 0

Maximin – Buy 60 bicycles

The largest losses if you buy 20, 40, 60, and 80 bicycles are ₱1980, 1160, 700, and 1020 respectively.
Since the smallest of those is ₱700, you would buy 60 bicycles.

This document is the property of PHINMA EDUCATION 8

 ACC 115| Management Science
Module #3 Teacher’s Guide

Check for Understanding

Win 70% Income Expected Value on bet on Gerby

₱1
note 1 x 70% = 0.70
Bet on Gerby -1x 30% = -0.30
₱0.40
Lose 30%
-₱1
Win 10%
₱10 Expected Value on bet on Jeb
10 x 10% = 1.00
Bet on Jeb -1x 90% = -0.90
Lose 90% ₱0.10
-₱1

The decision tree shows to that you should place your bet on Gerby.

ADDITIONAL NOTES FOR TEACHERS

In this portion, you may include:

● Additional exercises that teachers may give to students during face-to-face classes or
during remote coaching sessions
● Additional reading materials or references that teachers may use
● Instructions for activities during face-to-face classes
● Answer Keys for quizzes and exams

This document is the property of PHINMA EDUCATION 9