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Decision Theory Problem Set

Really Big Ideas, Inc. is considering two product development options: a smoke and fire detector with a high potential return but low success probability, and a motion detector with lower costs and higher success probability. New information about certification requirements for the smoke detector complicates the decision, necessitating a revised analysis. Additionally, Hemmingway, Inc. is evaluating an R&D project with uncertain outcomes and potential costs, requiring a decision tree to determine the best course of action.

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25 views2 pages

Decision Theory Problem Set

Really Big Ideas, Inc. is considering two product development options: a smoke and fire detector with a high potential return but low success probability, and a motion detector with lower costs and higher success probability. New information about certification requirements for the smoke detector complicates the decision, necessitating a revised analysis. Additionally, Hemmingway, Inc. is evaluating an R&D project with uncertain outcomes and potential costs, requiring a decision tree to determine the best course of action.

Uploaded by

ejayramos75
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 DOCX, PDF, TXT or read online on Scribd
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Decision Analysis Problem Set

1. Consider the following scenario, Really Big Ideas, Inc. A small company that develops
inventions for the consumer market, has recruited you as a consultant to make
recommendation on critical business decision. AT 10 AM, you meet Adam Smith, The VP in
charge in product development. Smith expresses his wish for an outside opinion on the
decision of the company must make soon. Your job is to supply an informed opinion.
At 10:05, you and Smith enter the meeting room. Smith explains that the Really Big
Ideas, Inc has 3-month window of opportunity to develop a new product using new pattern
recognition software the company recently created. Surprisingly, the software adapts easily
to different applications. Really Big Ideas, Inc only has resources and time to develop two
projects or to develop none. Project Manager Aisha Ali and Ben Bertrand arrived. After a
brief introduction, Aisha Ali launches her pitch. She says that a smoke and fire detector is
the best product to develop. It can detect smoke and flames beyond an ordinary detector
can. It will cost $100,000 to develop and if succeeds it can generate an income of
$1,000,000. The probability of success was estimated to be 50%. Not to be outdone, Ben
Bertrand announces that a motion detector is a better device to develop. It uses
conventional lighting will only cost $10,000 to develop and expects to generate $400,000
revenue and probability of 80% success.
With the results of the meeting, Smith asks you what is the better option? Make a decision
tree to support your advice.

2. Consider the following information, which continues the Really Big Ideas decision scenario.
VP Smith calls you the following day and reports that the company has learned a new
information that may affect the decision. Smith wants to know if you can prepare a new
analysis using the new information. Smith tells you that the proposed smoke and fire
detector must pass an Underwriters Laboratory (UL) safety certification before in can be
sold. This certification is not necessary for the motion detector. The new information is
given below:
1. A commercial grade certification will result in $1,000,000 sales (originally expected).
However, the likelihood of obtaining the commercial grade certification is only 30% due to
the stringent standard.
2. A less stringent residential grade certification is 60% likely but would only generate
$800,000 sales.
3. There is a 10% chance that the smoke and detector will not pass any certification test. In
this case a complete failure. The company will lose the initial $100,000 investment cost.
4. The UL charges $5000 non-refundable fee for certification applications.
You task is to construct and evaluate a new decision tree based on the new
information.
3. Given this payoff table determine the appropriate decision on which alternative to use on the
given criterion

OUTCOME
Alternative 1 2 3 4 5
A 100 70 115 95 60
B 95 120 120 90 150
C 180 130 60 160 120
D 80 75 50 100 95
E 60 140 100 170 160

a. Criterion of realism using alpha= 0.6

b. Laplace

c. Minimax Regret

4. Hemmingway, Inc., is considering a $5 million research and development (R&D)


project for the next two years. Profit projections appear promising, but
Hemmingway’s president is concerned because the probability that the R&D
project will be successful is only 0.50. Secondly, the president knows that even if
the project is successful, it will require that the company build a new production
facility at a cost of $20 million in order to manufacture the product. If the facility is
built, uncertainty remains about the demand and thus uncertainty about the
profit that will be realized. Another option is that if the R&D project is successful,
the company could sell the rights to the product for an estimated $25 million.
Under this option, the company would not build the $20 million production facility.
The table below shows the expected income for each market outcome.
High demand 59 M p=0.3
Moderate Demand 45 M p=0.45
Low Demand 34 M p=0.25
Develop a decision tree and determine the best alternative for the company.
Determine if the company should push through the project? If so, what is the best
alternative after that?

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