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Decision Making Analysis

The document discusses decision making under uncertainty. It provides a payoff table showing the expected payoffs of three investment alternatives: Treasury bills, money placement, and stocks. It then asks the management consultant to build a decision tree and calculate the expected value of investing in stocks using the probabilities and payoffs provided in the table. The document outlines the steps to create a decision tree and calculate expected value to help evaluate the best investment alternative under uncertainty.

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nikko.emping.20
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41 views50 pages

Decision Making Analysis

The document discusses decision making under uncertainty. It provides a payoff table showing the expected payoffs of three investment alternatives: Treasury bills, money placement, and stocks. It then asks the management consultant to build a decision tree and calculate the expected value of investing in stocks using the probabilities and payoffs provided in the table. The document outlines the steps to create a decision tree and calculate expected value to help evaluate the best investment alternative under uncertainty.

Uploaded by

nikko.emping.20
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as PDF, TXT or read online on Scribd
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DECISION MAKING

ANALYSIS
Basis of Decision
Options Suerte Deskarte Meant to
be
Married 20% 50% 100%
Holy Order - - 100%
Single - - 100%
Blessedness
Probability 20% 70% 10%
Variables to consider in making decisions
◦Factors that are relevant to the problem
◦The various alternatives that are available
◦The logical consequences of the possible
alternatives
◦The best alternative in terms of profits and
realization of objectives
To invest Treasury bills, term
5-yr, with an interest rate of
5% per year.

Money placement with 3%


annual interest rate.
To invest bonds or stocks
during pandemic or to invest
money for expansion or
increase in working capital
account
/
Nonprobabilistic

Regrets= Best payoff – Payoff period

Probabilistic
As management consultant, determine which best alternative
to invest considering the uncertainty of the Philippine
economic conditions. The figures below are the expected
payoff of investment per alternatives. Due to pandemic, the
likelihood of economic situations are not known.

Use the following decisions criteria/approach: 1) Maximax;


2) Maximin; 3) Minimax regrets
Decision: Invests in Mutual Funds
Expected Value Analysis and Probability
Assigning probability
It varies from 0 to 1.
- A probability of 0 means the event can not
occur, whereas the probability of 1 means the
event is certain to occur.
- A probability between 0 and 1 indicates the
likelihood of the event’s occurrence.
Types of Probabilities
◦ Objective – calculated from either logic or
actual experiences.
◦ Subjective – are estimates, based on
judgment and past experience, of the
likelihood of future events.
N= 150
BSBA-FM students for
OJT this semester

Training site Private CPA’s Firm

On-site 15 3
Off-site 135 147
Probability 10%,90% 2%,98%

Sample: Probability problem


N= 150
BSBA-FM students for
OJT this semester

Condition Private CPA’s Firm

Vaccination 138 105


Unvaccination 12 45
Probability 92%, 8% 70%, 30%

Sample: Probability problem


Expected Value
◦ It is the mean of all possible outcomes.
◦It is calculated by multiplying each of the
possible outcomes by the likelihood each
outcome will occur and then summing all
of those values.
Expected Value of Perfect Information

◦ The difference between the expected


value with perfect information and the best
expected value under uncertainty.
Let’s say the 8-digit mega lotto is offering grand
prize of P100 million as of today. The cost of the
ticket is P25.

Cost is
PWon P100M
P 25

PSaves 25

Let us assume the probability of winning this lottery is 1 in 175 million (typical for the Powerball)
Expected Value Analysis
Result

PP 25 Win P14.29
P(P10.71)

PSaves 25 PP 25

Let us assume the probability of winning this lottery is 1 in 175 million (typical for the Powerball).
So expected value is: 100M * 25/175M = P14.29
Illustrative Problem
Lebron’s apparel stand sells either boots or shades in a
designated public street, Moalboal, Cebu.
In a rainy day, P100,000 and P60,000 sales are expected if boots
and shades will be sold, respectively.
In a sunny day, P20,000 and P90,000 revenues are expected if
boots and shades will be sold, respectively.
In Moalboal area, the weather is sunny only 40% of the time and
the rest of time, it is rainy.
Required:
1. Compute the expected value under uncertainty of event.
2. Compute the expected value with perfect information
Payoff Table

Options Rainy Sunny


Boots P 100,000 P 20,000
Shades P 60,000 P 90,000
Probability 60% 40%
Expected Value Analysis with Uncertainty

Options Rainy Sunny EXPECTED


VALUE
Boots P 100,000 P 20,000 P 68,000
Shades P 60,000 P 90,000 P 72,000

Boots = (100,000 x 60%) + (20,000 x 40%) = 68,000


Shades = (60,000 x 60%) + (90,000 x 40%) = 72,000
Expected Value Analysis with Perfect
Information
Options Rainy Sunny EXPECTED
VALUE
Hence, the
EMV of
Boots P 100,000 P 20,000 P 68,000 perfect
information
Shades P 60,000 P 90,000 P 72,000 is P 24,000
(P96,000
Best P 100,000 P 90,000 P 96,000 minus
P72,000)

Boots = (100,000 x 60%) = 60,000


Shades = (90,000 x 40%) = 36,000
Linear Programming

Z = 10x + 5y
Graphical or Algebraic
Approach

Statistical data
Payoff Matrix/Table – shows the outcome of
specific decision when certain states on nature
occur.
Decision Tree
The tree is composed of nodes and branches
Steps of Making a Decision Tree
P

Expected
Value

P
As Management Consultant, you were
asked to prepare a decision tree based on
the payoff table below.
Step 2

1 2 Step 3

3
Step 4

EV(Stocks)
0.4(70) + 0.6(-13) = 20.2
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