Scribd
Upload
27 views2 pages

INDR 430 - Sample Final

Uploaded by

esraaltinay067
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PDF, TXT or read online on Scribd
27 views2 pages

INDR 430 - Sample Final

Uploaded by

esraaltinay067
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PDF, TXT or read online on Scribd
You are on page 1/ 2

INDR 430/530: DECISION ANALYSIS

SAMPLE FINAL
QUESTION I. Bryan, a venture capitalist, is considering two start-up companies for
investment, BioTech and SoftWare. He currently has $5M and can invest in at most one of the
companies. If he invests in BioTech, he will earn an additional $2M with probability 10% and
an additional $6M with probability 90%. If he invests in SoftWare, he will earn an additional
$20M with probability 60% and lose $4M of his wealth with probability 40%. In making
investment decisions, Bryan aims at maximizing his expected utility with utility function
𝑢(𝑥) = ln 𝑥 for total wealth 𝑥 > 0.
1. State whether Bryan is risk averse, risk neutral or risk seeking. Justify your answer.
2. How does Bryan’s risk attitude change as his wealth increases? Justify your answer.
3. Draw a decision tree for Bryan’s decision-making problem. Clearly label all nodes and
include all relevant information.
4. Solve the decision tree obtained in Part 3 and identify an optimal strategy.
5. Calculate the risk premium for the optimal strategy found in Part 4.
6. Without any calculations, state how your answers to Parts 4 and 5 would change if Bryan
initially had $20M instead of $5M. Explain the changes by relating to Bryan’s risk attitude.
QUESTION II. An e-commerce company is ready to launch a new service and is considering
various marketing alternatives. The company wishes to minimize cost and to maximize impact.
Let 𝑢𝐶 (𝑥) and 𝑢𝐼 (𝑦) denote the company’s utility function for cost and impact, respectively.
The cost and the impact of each alternative are given in the following table.

Cost Impact
Alternative
(millions of dollars) (millions of people)

A1 1 1

A2 21 9

A3 6 3

1. Is preferential independence a reasonable assumption for cost and impact? Explain why.
2. Using proportional scores, compute the utility values for each attribute and alternative.
3. Suppose that cost and impact satisfy utility independence and the company remains
indifferent in each one of the following two cases.
 Case 1: Option 1 has cost $1M and impact 9M with probability 0.3, and cost $21M and
impact 1M with probability 0.7. Option 2 has cost $1M and impact 1M for sure.
 Case 2: Option 1 has cost $1M and impact 9M with probability 0.6, and cost $21M and
impact 1M with probability 0.4. Option 2 has cost $21M and impact 9M for sure.
Suggest a two-attribute utility function that represents the preferences of the company.

1
4. Are cost and impact substitutes or complements according to the utility function found in
Part 3? Justify and interpret your answer.

QUESTION III.
1. An individual whose utility function is 𝑢(𝑥) = 1 − 𝑒 −𝑥⁄𝑅 with 𝑅 > 0 is offered a gamble
that returns 𝑧 or −𝑧 with equal probability, where 𝑧 > 0. What is the highest amount that
the individual would be willing to pay for obtaining perfect information on the outcome of
this gamble? How does this amount change as a function of 𝑅?
2. Calculate the sure amount 𝑥̅ such that an individual with a multilinear utility function will
be indifferent between getting (𝑥̅ , 𝑦) with probability 1, and playing a lottery that has
outcome (𝑥1 , 𝑦) with probability 𝑝 and (𝑥2 , 𝑦) with probability 1 − 𝑝. How does this amount
depend on 𝑦? Justify your answer.

You might also like